Monthly Archives: March 2017

S&P 500 Technical Analysis Review 11-14-19

A technical review of the S&P 500 using daily, weekly and monthly charts to determine overbought, oversold, and risk/reward scenarios for carrying equity exposure.

Daily

  • The S&P 500 has broken out to new highs which is bullish.
  • However, as noted earlier this week, we have added a short-term S&P 500 short position to portfolios due to the more extreme overbought condition of the market.
  • As noted in the top panel, the overbought indicator is at extremes. The center panel shows the market 2-standard deviations above the 50-dma, and the lower panel shows momentum back to the top of its historical range.
  • None of this is bearish, in the short-term, but does suggest a pullback is necessary before the market can advance higher.
  • Reading: Bullish

Daily Overbought/Sold

  • The chart above shows a variety of measures from the Volatility Index ($VIX) to momentum and deviation from intermediate term moving averages.
  • We noted back in September and early October that a rally into year-end was likely. At that time all of the indicators had pushed down into their respective “BUY” ranges.
  • Now that situation has reversed, with all indicators back into their respective “SELL” ranges.
  • Again, as stated above, this is not “bearish” or suggestive of a “crash” coming, but rather just suggesting that currently the risk/reward for adding additional equity risk is not optimal.
  • Be patient for a correction back to support that allows for a better entry point for trading positions.
  • Reading: Bullish

Weekly

  • On a weekly basis, the market backdrop remains bullish with a weekly buy signal being triggered at the beginning of the month along with expectation of a “seasonally strong period” beginning.
  • However, even with that signal in place, the market is back to extreme “overbought” conditions on a weekly basis as well.
  • With the market trading above 2-standard deviations of the intermediate term moving average, some caution is suggested in adding additional exposure. A correction is likely over the next month or so that will provide a better opportunity. Remain patient for now.
  • Reading: Bullish

Monthly

  • On a montly basis we can see a pattern emerging as well as extremes.
  • First, from an investment standpoint, look at the previous two bull market advances compared to the current Central Bank fueled explosion. When the next mean reverting event occurs, make no mistake, it will be brutal for investors.
  • Secondly, the market is trading 2-standard deviations above the long-term mean and is still flirting with reversing the “buy signal” to a sell.
  • As noted in the red lines, the market continues to trade in a bullish trend from the 2009 lows, but with the market pushing back up into more extreme overbought conditions long-term, there is not likely a lot left to the current bull market.
  • Importantly, MONTHLY data is ONLY valid at the end of the month. Therefore, these indicators are VERY SLOW to turn. Use the Daily and Weekly charts to manage your risk. The monthly and quarterly chart (below) is to give you some idea about overall risk management.
  • However, the important takeaway is that the bull market is still largely intact but there is some deterioration around the edges. This suggests that investors should remain invested for now, but maintain risk controls accordingly.
  • All good things do eventually come to an end.
  • Reading: Neutral/Caution

Quarterly

  • As noted above, this chart is not about short-term trading but long-term management of risks in portfolios. This is a quarterly chart of the market going back to 1920.
  • Note the market has, only on a few rare occasions, been as overbought as it is currently. In every single case the reversion was not kind to investors.
  • Secondly, in the bottom panel, the market has never been this overbought and extended in history,
  • As an investor it is important to keep some perspective about where we are in the current cycle, there is every bit of evidence that a major mean reverting event will occur. Timing is always the issue which is why use daily and weekly measures to manage risk.
  • Don’t get lost in the mainstream media. This is a very important chart.
  • Reading: Cautious

S&P 500 vs Yield Curve (10yr-2yr)

  • The chart above compares the S&P 500 to the 10-2 year yeild curve.
  • Yield curve inversions, and subsequent un-inversions, as we are experiencing now, have preceded previous market reversions. (Refer to Quarterly chart above)
  • Sure, this time could be different, and it may seem that way for the time being with Central Banks once again throwing in the towel and providing liquidity. However, in every previous case it was always believed this time was different for one reason or another…it wasn’t. I suspect eventually this time will be the same so it is worth paying attention to the message the yield curve is sending.
  • As with the Monthly and Quarterly charts above, this is a “big warning” sign to pay attention and manage risk accordingly. It does NOT mean sell everything and go to cash. Currently the Daily and Weekly charts suggest the bullish trend is intact, so we remain invested, but hedged.
  • Reading: Bearish

Consumers Are Keeping The US Out Of Recession? Don’t Count On It.

Just recently, Jeffry Bartash published an interesting article for MarketWatch.

“Like a stiff tent pole, consumers are keeping the U.S. economy propped up. And it looks like they’ll have to do so for at least the next year.

Strong consumer spending has given the economy a backbone to withstand spine-tingling political fights at home and abroad. Households boosted spending by 4.6% in the spring, and nearly 3% in the summer, to offset back-to-back drops in business investment and whispered talk of recession.”

That statement is correct, and considering the consumer makes up roughly 70% of economic growth, this is why you “never count the consumer out.” 

The most valuable thing about the consumer is they are “financially stupid.” But what would expect from a generation whose personal motto is “YOLO – You Only Live Once.” 

This is why companies spend billions on social media, personal influencers, television, radio, and internet advertising. If there is an outlet where someone will watch, listen, or read, you will find ads on it. Why? Because consumers have been psychologically bred to “shop till they drop.” 

As long as individuals have a paycheck, they will spend it. Give them a tax refund, they will spend it. Issue them a credit card, they will max it out. Don’t believe me, then why is consumer debt at record levels?

This record level of household debt is also why the Fed’s measure of “Saving Rates” is entirely wrong:

“The ‘gap’ between the ‘standard of living’ and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the ‘gap.’ However, following the ‘financial crisis,’ even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $2654 annual deficit that cannot be filled.”

Delayed gratification is a thing of the past.

If consumers were even partially responsible, financial guru’s like Dave Ramsey wouldn’t have a job counseling people on how to get out of the “debt trap” they got themselves into.

However, as Steve Liesman once stated on CNBC:

“Debt is always pointed out as a negative thing, when in fact debt is the great bridge between working hard and playing hard in this country.This country has been built on consumer debt.”

While the statement is clearly wrongheaded, it does show the importance of consumer spending as it relates to keeping the economy GOING.  Note, that I said “going,” and not “growing,” Take a look at the chart below:

In the 1980’s and 90’s consumption, as a percentage of the economy, grew from roughly 61% to 68% currently.  The increase in consumption was largely built upon a falling interest rate environment, lower borrowing costs, and relaxation of lending standards.

In 1980, household credit market debt stood at $1.3 Trillion. To move consumption, as a percent of the economy, from 61% to 67% by the year 2000 it required an increase of $5.6 Trillion in debt. Since 2000, consumption as a percent of the economy has risen by 1% over the last 19 years. To support that increase in consumption, it required an increase in personal debt of more than $7 Trillion.

The importance of that statement should not be dismissed. It has required more debt to increase consumption by 1% of the economy since 2000 than it did to increase it by 6% from 1980-2000. The problem is quite clear. With interest rates already at historic lows, consumers already heavily leveraged and economic growth running at sub-par rates – there is not likely a capability to increase consumption as a percent of the economy to levels that would replicate the economic growth rates of the past.

Debt is a negative thing for the borrower. It has been known to be such a thing even in biblical times as quoted in Proverbs 22:7:

“The borrower is the slave to the lender.”

Debt acts as a “cancer” on an individual’s wealth as it siphons potential savings from income to service the debt. Rising levels of debt means rising levels of debt service which reduces actual disposable personal incomes that could be saved or reinvested back into the economy.

The mirage of consumer wealth has been a function of surging debt levels. “Wealth” is not borrowed but “saved” and as shown in the chart above this is a lesson that too few individuals have learned.

Consumption Is Function Of A Paycheck

Currently, it is believed the “consumer is just fine” because they are continuing to spend at a fairly healthy clip.

However, this spending is based on “confidence” and currently, that level of confidence is at historically high levels, as shown below. (The chart below shows our composite confidence index, which combines both the University of Michigan and Conference Board measures.)

If we overlay that confidence composite with personal consumption expenditures, it is not surprising there is a reasonably high correlation.

Not surprisingly, since retail sales make up 40% of personal consumption expenditures, it also has a high correlation with consumer confidence.

Do you know what else has a high correlation with consumer confidence?

Employment.

This should be a relatively obvious connection.

No job = No paycheck = No spending. 

This is a point Jeffry misses in his article when he states:

“Most Americans feel secure about their jobs and income prospects, with layoffs and unemployment at a 50-year low. They’re earning more money, saving more than they used to and are not as burdened by debt. That’s why surveys show consumer confidence remain near post 2008 recession highs.”

That is true. Confidence is high because employment is high, and consumers operate in a microcosm of their own environment. As we noted just recently:

“[Who is a better measure of economic strength?] Is it the consumer cranking out work hours, raising a family, and trying to make ends meet? Or the CEO of a company who is watching sales, prices, managing inventory, dealing with collections, paying bills, and managing changes to the economic landscape on a daily basis? A quick look at history shows this level of disparity (between consumer and CEO confidence) is not unusual. It happens every time prior to the onset of a recession.

“Notice that CEO confidence leads consumer confidence by a wide margin. This lures bullish investors, and the media, into believing that CEO’s really don’t know what they are doing. Unfortunately, consumer confidence tends to crash as it catches up with what CEO’s were already telling them.

What were CEO’s telling consumers that crushed their confidence?

“I’m sorry, we think you are really great, but I have to let you go.” 

It is hard for consumers to remain “confident,” and continue spending, when they have lost their source of income. This is why consumer confidence doesn’t “go gently into the night,” but rather “screaming into the abyss.”

Given that GDP is roughly 70% consumption, deterioration in economic confidence is a hugely important factor. The most significant factors weighing on that consumption, as noted above, are job losses which crush spending decisions by consumers.

This starts a virtual spiral in the economy as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices, until the cycle is complete. Note, bear markets end when the negative deviation reverses back to positive.

Conclusion

Are consumers currently keeping the economy out of recession? You bet.

Will it stay that way? Probably not.

Records are records for a reason. It is where things end, not begin, and all economics cycle.

What CEO confidence is telling us is that we are likely nearing the end of this current cycle. Since employers are slow to hire, and slow to fire, the current slowdown in hiring is an early indication the end of the cycle is approaching.

When job losses begin to accelerate, confidence will fall very quickly, as does consumer spending, and then the markets. While the financial media is salivating over new “records” being set for this “bull market,” here is something to think about.

  • Bull markets END when everything is as “good as it can get.”
  • Bear markets END when things simply can’t “get any worse.”

Currently, everything is just about “as good as it can get.”

Just remember, that for every “bull market” there MUST be a “bear market.” It is part of the “full-market cycle.” 

How does every bear market begin?

Slowly at first, then all of a sudden. 

Selected Portfolio Position Review: 11-13-19

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

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

This week we are reviewing positions which may require some additional attention soon, either trimming, adding, or removing, plus recent additions.

SDS – Proshares Ultra-Short S&P 500

  • In Tuesday’s “technically speaking” post, we discussed all the various measures of “overbought and extended” conditions which currently exist in the market.
  • While we have taken profits and rebalanced risks in portfolios over the course of the last several months, we have a lot of equity exposure vulnerable to a short-term correction.
  • This is why we added 5% of a 2x leveraged S&P 500 index which gives us an effective 10% equity hedge in portfolios against a short-term decline.
  • We don’t expect a big correction, just 2-5% to work off some of the current overbought and extended condition. Currently the S&P is trading more than 2-std deviations above the 50-dma.
  • Stop is set at $26ish

AGNC – AGNC Investment Corp.

  • We previously discussed adding TWO positions to the portfolio to hedge our BOND holdings against a period of rising rates and a steeper yield curve.
  • AGNC and NLY are those two positions which benefit from a steeper curve because of their mortgage related holdings and duration gap used to fund the mortgages.
  • With a 10% plus yield, we have been happy to patiently wait for the curve to steepen and just collect the dividend. However, with the curve now steepening we are seeing the positive net benefit.
  • Once the curve reaches what we believe will be its apex, we will take profits and reduce our holdings somewhat.

AEP – American Electric Power

  • Utilities were very strong performers early in the year, and we have repeatedly stated they were do for some profit taking (which we did) due to the extreme overbought condition.
  • That correction is in process and there is likely more downside to go while we rate for interest rates to hit our target of 2.2 to 2.3%.
  • In the meantime we will collect the 3% yield and look to add back to our portfolios when we get the next buy signal.
  • Stop loss is set at $85

ABT – Abbott Laboratories

  • ABT continues to hold its uptrend and healthcare stocks continue to perform despite the “risk on” rotation that has been occurring in the market.
  • This was a bet we made earlier this year when we overweighted healthcare stocks in the portfolio.
  • Despite the current “sell signal” – ABT continues to hold its long-running bullish trend.
  • While we have taken profits, we are still mindful of market risk.
  • Stop loss is set at $80.

CHCT – Community Healthcare Trust

  • Since REITs are interest rate sensitive, it isn’t surprising to see a fairly sharp pullback in the sector.
  • This sell-off is not unexpected and something we have discussed previously when we took profits in the position.
  • CHCT is holding its bullish trendline currently, but is close to a sell signal.
  • We are watching the position closely for an opportunity to add back to our holdings at a cheaper price. We like the 3.5% yield for portfolios so we can afford to be a little patient, but not negligent.
  • Stop has been moved up to $42

CMCSA – Comcast Corp.

  • Comcast has been a very good performer since adding it to the portfolio in January.
  • Have have taken profits in the position previously, but are watching the current uptrend and support levels to see if further action will need to be taken.
  • With a sell signal registered we could see further pressure on the position.
  • Stop is currently set at $42

DUK – Duke Energy Corp.

  • As noted above, Utilities have been under pressure with the rise in rates.
  • We have taken profits in DUK which gives us some room to be patient for a point to add back to the share while we collect a 4% dividend. (Notice that many of our positions have healthy yields which is a key factor to our purchase decisions.)
  • DUK has broken support, which is concerning so we will see if it can find support and hold in the short-term. Otherwise we will reconsider our holdings.
  • Again, we still like the position longer-term and will look to add back to holdings at lower levels.
  • Stop loss has been adjusted to $82.50

JNJ – Johnson & Johnson

  • Along with our healthcare holdings we have been building a position in JNJ for some time now following their legal troubles.
  • The fundamentals are solid, and carries a near 3% yield.
  • JNJ continues to trudge along its bullish trend support line, and is very close to registering a buy signal. We will consider adding further to our holdings when the stock begins to perform as expected.
  • Stop loss remains at $125

NLY – Annaly Capital Management

  • As noted above NLY is the pair-trade to AGNC for our yield curve “steepener position.”
  • We are only carrying 1/2 weight in NLY and will look to bring it to full weight very soon but need a pullback in interest rates first.
  • Again, with a 10%+ yield we will be patient on this holding.
  • The sell signal reversed to a buy which is more encouraging.
  • Stop-loss remains at $8.0

UNH – United Healthcare

  • UNH has had a tough run since the beginning of the year, but we like the positioning within the Healthcare segment and the fundamentals.
  • That patience may finally be paying off as UNH is now testing the top of its bearish trend and has just registered a buy signal.
  • Look for a break above resistance to see the position test old highs.
  • Stop loss remains at $210

Impact Investing- Is It Right For You?

Over the last 30 years, the popularity of impact investing and a desire to ‘do good’ with investment portfolios has blossomed. In April 2019, The Global Impact Investing Network estimated the global impact investing market was $502 billion. While impressive, it represents less than 1% of the investing universe.

Impact investors, looking to have a positive social and environmental influence, tend to analyze factors not typically on the radar of traditional investors. In particular, ESG, an acronym for environmental, social, and corporate governance, is a framework for investors to assess investments within three broad factors.  

We all want to make the world a better place, but are investment portfolios the right tool to do that?

To answer the question it is important to step back from impact investing and explore investment goals and how wealth grows fastest to help answer the question.

As a wealth fiduciary, our mission is managing our client’s portfolios in a risk-appropriate manner to meet their financial goals. Whether a client is ultra-conservative or uber-aggressive, the principle of compounding underlies every strategy we employ.  Compounding, dubbed the “eighth wonder of the world” by Albert Einstein, is an incredibly important factor in wealth management.

Wealth compounding is achieved through consistency. Targeting steady growth while avoiding large drawdowns is the key.  To do this, we develop an aggregation of diversified investment ideas.

Investment diversification is well-touted but not well understood. Commonly it is believed that portfolio diversification is about adding exposure to many different investments within many different asset classes. True portfolio diversification is best created by owning a variety of assets with unique, uncorrelated cash flows that each individually, offer a promising risk and return trade-off.

To demonstrate the importance of drawdown avoidance, we compare two portfolios. Both average 5% annual growth. Portfolio A grows by a very dependable 5% every year. Portfolio B is a more typical portfolio with larger growth rates but occasional drawdowns. Portfolio B grows 10% a year for four years but experiences a 15% drawdown every fifth year. Despite earning 5% a year less in four of five years, portfolio A avoids losses and grows at an increasing rate to portfolio B as highlighted below.

Consistent, steady returns and no drawdowns build wealth in the most efficient manner. The more investment options we have, the better we can diversify and minimize portfolio drawdowns. When options are limited, our ability to manage risk is limited.

Is doing ‘good,’ good for you?

The cost of impact investing is two-fold. First, by limiting the purchase of certain companies and industries, you forego the potential to buy assets offering a better risk-return tradeoff than other assets in the market.  Second, due to the smaller size of your investable pool, your ability to diversify is hampered. The combination of these costs show up as more volatile returns which results in a lessened ability to compound.  

While impossible to quantify, this cost is hopefully more than offset by the feeling of having a positive impact on the world.

Inclusion or Exclusion

To invest with purpose, there are some things you may or may not have considered. Foremost on the list is the question, “Where are your investment dollars truly going?”  Most investments in stocks and bonds are in securities that were issued in the past. The company behind those stocks or bonds already raised capital and is using it to achieve their mission. We may avoid buying stocks in coal miners or tobacco companies, but the funds from a market transaction go to another investor, not the company. This holds equally true if we buy stocks or bonds of a company we deem has a positive social or environmental impact.

That does not mean our investment decisions are fruitless. Our participation affects the perceived health of a company via the liquidity we’ve provided or taken from the company’s securities. When equity prices decline and/or bond yields rise, a company will find it harder and more costly to raise new capital.

Bill Gates has some interesting views to help us understand our potential role in social impact investing. 

In a recent Financial Times article, Fossil fuel divestment has ‘zero’ climate impact, says Bill Gates, the billionaire philanthropist argues environmental change is achieved via investing in disruptive and innovative companies that tackle environmental problems, not divesting from those that do not.

Divestment, to date, probably has reduced about zero tonnes of emissions. It’s not like you’ve capital-starved [the] people making steel and gasoline,” he said. “I don’t know the mechanism of action where divestment [keeps] emissions [from] going up every year. I’m just too damn numeric.”

If you are interested in impact investing, we ask you to consider Bill Gates advice of inclusion not exclusion. Use the entire menu of investment opportunities and rigorous analysis to determine which assets are worthy. If the “disrupters” qualify under your investment protocol, include them in your portfolio and perhaps favor them. However, be cognizant of the cost of shunning companies that are doing things you don’t like.

A well-diversified portfolio with a positive risk/return structure will provide more stability and limit drawdowns. By growing your wealth as efficiently as possible, you will be able to invest more into companies that are having a positive social impact and have more wealth which you can donate in more direct, impactful ways.  

Sector Buy/Sell Review: 11-12-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

NOTE – Not much changed in the charts from last week. So recommendations remain primarily the same. With markets and sectors EXTREMELY overbought, it is likely best to wait for some corrective action before adding exposure. Hence the “short position” we added into portfolios yesterday to hedge risk. See portfolio commentary on home page.

Basic Materials

  • We are continuing to look to increase weighting slightly to Materials particularly since the current “sell signal” has been reversed.
  • XLB is extremely overbought short-term so look for a bit of consolidation or pullback, which does not reverse the “buy signal” to add to positions.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • XLC held important support and has now rallied back to previous resistance at the highs but has been unable to establish new highs as of yet.
  • A reversal of the “sell signal” has finally occurred and should help lift the sector higher, but in the short-term XLC is extremely overbought.
  • XLC is currently a full-weight in portfolios but should perform better if a year-end advance ensues.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $47.50
  • Long-Term Positioning: Bearish

Energy

  • We have noted previously, that XLE needs to move higher which it has done as of late.
  • The “sell signal” has been reversed. With relative performance improving, we may see more gains. However, a break of the current downtrend is a must before adding exposure.
  • While there is “value” in the sector, there is no need to rush into a position just yet. The right opportunity and timing will come, it just isn’t right now.
  • Short-Term Positioning: Bearish
    • Last week: No Position – looking to add
    • This week: No Position – looking to add
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF finally broke out to new highs which makes it much more interesting to add to the portfolio.
  • The sector is extremely overbought, but on a buy signal, so a pull back or consolidation is required to add holdings into the portfolio.
  • We previously closed out of positioning as inverted yield curves and Fed rate cuts are not good for bank profitability. That is still the case, however, the sector is performing technically which we can not ignore.
  • We will see if a break above resistance can hold before adding exposure back into portfolios for a “trading basis” only.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • Like XLF, XLI broke out to new highs. After a long-consolidation, this is an important development.
  • As with Materials above, a rotation into cyclical exposures is likely heading into year end, so we are looking for a bit of consolidation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • We have adjusted our stop-loss for the remaining position. We are looking to add back to our holdings on a reversal to a buy signal.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $75
  • Long-Term Positioning: Neutral

Technology

  • XLK is back to a more extreme overbought condition, but has now broken out of the consolidation. Given technology makes up about 1/5th of the S&P 500 weighting, this sector is dragging the whole market higher.
  • We are currently target weight on Technology, but may increase to overweight on a confirmed breakout. (A retest of the breakout that holds) The upper rising trendline is also providing resistance so look to add on a pullback that holds the lower trendline support.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $77.50
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform a little “less well” as of late as money is rotating from some defensive areas.
  • XLP continues to hold its very strong uptrend but is threatening to break that support. If it does, it could lead to a rather abrupt sell off.
  • The “buy” signal (lower panel) is still in place but is threatening to turn into a sell if performance doesn’t pick up soon.
  • We previously took profits in XLP and reduced our weighting from overweight. We will likely look to reduce further when opportunity presents itself.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $58
    • Long-Term Positioning: Bullish

Real Estate

  • As noted last week, XLRE was consolidating its advance within a very tight pattern.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. XLRE reversed the breakout this past week, and is now testing support again.
  • XLRE Registered a “sell signal” in the last week which is the first such signal since 2018. With interest rates getting VERY oversold we may be getting a very good setup for adding to our holdings.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLRE and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup. We may be getting an opportunity here soon if support can hold as the overbought condition is reversed. Watch the $63 level.
  • Long-term trend line remains intact but XLU is grossly deviated from longer-term means. A correction back to the uptrend is underway and needs to hold without breaking lower.
  • Interest rates will be key here.
  • We took profits recently but will likely do more if performance continues to struggle.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and has broken out to new highs. With the “buy signal” now triggered, healthcare is much more interesting.
  • As noted previously, healthcare will likely begin to perform better soon if money begins to look for “value” in the market. We are looking for entry points to add to current holdings and we added a new holding in the Equity portfolio.
  • We continue to maintain a fairly tight stop for now, but look for a reduction of the overbought condition to add weight to the sector.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY has not participated as much as other sectors like Financials, Industrials and Materials, and has failed to break above resistance.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is struggling to reverse back to a buy signal, and overhead resistance is going to problematic short-term.
  • Hold current positions for now, as the Christmas Shopping Season is approaching, which should help push the sector higher. However, the dismal performance relative to other sectors of the markets suggests not adding new/additional exposure currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has broken out of consolidation but will quickly run into previous highs. The chase into previously “out of favor” sectors is likely going to end as quickly as it began.
  • With a “buy” signal in place, combined with the fact XTN is not overbought, a better setup is forming to add holdings. Take profits if long, and wait for a pullback to add to holdings.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: A Correction Is Coming, Just Don’t Tell The Bulls…Yet.

In this past weekend’s newsletter, I discussed the rather severe extensions of the market above both the longer-term bullish trend and the 200-dma. To wit:

“Currently, it will likely pay to remain patient as we head into the end of the year. With a big chunk of earnings season now behind us, and economic data looking weak heading into Q4, the market has gotten a bit ahead of itself over the last few weeks.

On a short-term basis, the market is now more than 6% above its 200-dma. These more extreme price extensions tend to denote short-term tops to the market, and waiting for a pull-back to add exposures has been prudent..”

But it isn’t just the more extreme advance of the market over the past 5-weeks which has us a bit concerned in the short-term, but a series of other indications which typically suggest short- to intermediate-terms corrections in the market. 

Not surprisingly, whenever I discuss the potential of a market correction, it is almost always perceived as being “bearish.” Therefore, by extension, such must mean I am either all in cash or shorting the market. In either case, it is assumed I “missed out” on the previous advance.

If you have been reading our work for long, you already know we have remained primarily invested in the markets, but hedge our risk with fixed income and cash, despite our “bearish” views. I am reminded of something famed Morgan Stanley strategist Gerard Minack said once:

The funny thing is there is a disconnect between what investors are saying and what they are doing. No one thinks all the problems the global financial crisis revealed have been healed. But when you have an equity rally like you’ve seen for the past four or five years, then everybody has had to participate to some extent.

What you’ve had are fully invested bears.”

While the mainstream media continues to misalign individual’s expectations by chastising them for “not beating the market,” which is actually impossible to do, the job of a portfolio manager is to participate in the markets with a preference toward capital preservation. This is an important point:

“It is the destruction of capital during market declines that have the greatest impact on long-term portfolio performance.”

It is from that view, as a portfolio manager, the idea of “fully invested bears” defines the reality of the markets that we live with today. Despite this understanding, the markets are overly bullish, extended, and overvalued and portfolio managers must stay invested or suffer potential “career risk” for underperformance. What the Federal Reserve’s ongoing interventions have done is push portfolio managers to chase performance despite concerns of potential capital loss.

Managing portfolios for both risk adjusted returns while protecting capital is a delicate balance. Each week in the Real Investment Report (click here for free weekly e-delivery) we discuss the risks and challenges of the current market environment and report on how we are adjusting our exposures to the market over time.

In this past weekend’s missive, we discussed how to “play” the latest round of the Fed’s QE program, along with what sectors and markets tend to perform the best.

However, I wanted to share a few charts which suggests that being patient currently, will likely yield a much better entry point for investors in the not-so-distant future.

Overbought And Extended

By the majority of measures that we track from momentum, to price, and deviation, the market’s sharp advance has pushed the totality of those indicators back to overbought.

Historically, when all of the indicators are suggesting the market has likely encompassed the majority of its price advance, a correction to reverse those conditions is often not far away. Regardless of the timing of that correction, it is unlikely there is much upside remaining in the current advance, and taking on additional equity exposure at these levels will likely yield a poor result.

Overly Complacent

The post-Fed rate cut and QE driven advance in the market has also pushed investors back to levels of extreme complacency.

Such extremely low levels of volatility, combined with investors piling into record “short positions” on the VIX, provides all the “fuel” necessary for a fairly sharp 3-5% correction given the proper catalyst.

Given that investors are “all in,” as discussed last week, there is plenty of room for investors to get forced out of holdings and push markets lower over the next few weeks. However, it isn’t just individual investors that are “all in,” but professionals as well.

Eurodollar Sends A Warning

Eurodollar positioning is also sending a major warning. (“Eurodollar” refers to U.S. dollar-denominated deposits at foreign banks, or at the overseas branches of American banks.)

When the ECB launched QE following the 2016 selloff, foreign banks liquidated Eurodollar deposits as it was deemed less risky to hold foreign denominated deposits. Currently, that view has reversed sharply as the global economy slows, and foreign banks are “hedging” their risk by flooding money into U.S. dollar denominated deposits. Historically, when you have an extremely sharp reversal in Eurodollars, it has preceded more troubling market events.

With Eurodollar deposits at record levels, do foreign banks know something we don’t?

Earnings Vs. Profits

The deviation between corporate GAAP earnings and corporate profits is currently at record levels. It is also entirely unsustainable. Either corporate profits will catch up with earnings, or vice-versa. Historically, profits have never caught up with earnings, it is always the other way around.

Expectations for corporate earnings going forward are still way to elevated, and with corporate share buybacks slowing, this leaves lots of room for disappointment.

Deviation

I have written many times in the past that the financial markets are not immune to the laws of physics.

There is a simple rule for markets:

“What goes up, must, and will, eventually comes down.”

The example I use most often is the resemblance to “stretching a rubber-band.” Stock prices are tied to their long-term trend which acts as a gravitational pull. When prices deviate too far from the long-term trend they will eventually, and inevitably, “revert to the mean.”

See Bob Farrell’s Rule #1

Currently, the market is not only more than 6% above its 200-dma, as shown in the opening of this missive, but is currently more than 15% above its 3-year moving average.

More importantly, the market is currently extremely deviated above it long-term bullish trend. During this entire decade-long bull market advance, the trendline is retested with some regularity from such extreme extensions.

Sentiment

Lastly, is sentiment. When sentiment is heavily skewed toward those willing to “buy,” prices can rise rapidly and seemingly “climb a wall of worry.” However, the problem comes when that sentiment begins to change and those willing to “buy” disappear.

This “vacuum” of buyers leads to rapid reductions in prices as sellers are forced to lower their price to complete a transaction. The problem is magnified when prices decline rapidly. When sellers panic, and are willing to sell “at any price,” the buyers that remain gain almost absolute control over the price they will pay. This “lack of liquidity” for sellers leads to rapid and sharp declines in price, which further exacerbates the problem and escalates until “sellers” are exhausted.

Currently, there is a scarcity of “bears.”

See Bob Farrell’s Rule #6

As we discussed just recently, consumer and investor confidence are both closely tied and are extremely elevated. However, CEO confidence is pushing record lows. A quick look at history shows this level of disparity is not unusual around market peaks and recessionary onsets.

Another way to analyze confidence data is to look at the consumer expectations index minus the current situation index in the consumer confidence report.

This measure also is signaling a correction/recession is coming. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than prior to the “dot.com” crash. Recessions start after this indicator bottoms, which has already started happening.

Currently, the bottoming process, and potential turn higher, which signals a recession and bear market, appears to be in process.

None of this should be surprising as we head into 2020. With near-record low levels of unemployment and jobless claims, combined with record high levels of sentiment, job openings, and record asset prices, it seems to be just about as “good as it can get.”

Does this mean the current bull market is over?

No.

However, it does suggest the “risk” to investors is currently to the downside, and some caution with respect to equity-based exposure should be considered.

What Are We Doing About It?

Given the fact that the short, intermediate, and long-term indicators have all aligned, the risk of running portfolios without a hedge is no longer optimal. As such, we added an “inverse” S&P 500 position to all of our portfolios late yesterday afternoon. 

While none of the charts above necessarily mean the next “great bear market” is coming, they do suggest a modest correction is likely. The reason we hedge against declines is that one day, and we never know when, a modest correction will turn into a more significant decline.

Remaining fully invested in the financial markets without a thorough understanding of your “risk exposure” will likely not have the desirable end result you have been promised. All of the charts above have linkages to each other, and when one breaks, they all break.

So pay attention to the details.

As I stated above, my job, like every portfolio manager, is to participate when markets are rising. However, it is also my job to keep a measured approach to capital preservation.

SO, why shouldn’t you show these charts to the bulls?

Because you need someone to “sell to” first.

Major Market Buy/Sell Review: 11-11-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

This update focuses on the impact the “trade deal” announced on Friday will have on each market going forward.

S&P 500 Index

  • With a “buy signal” triggered, there is a positive bias and with the breakout there is the only resistance to the upside is the more extreme deviation from the 200-dma.
  • Given that deviation from the mean, and the more extreme overbought condition, it is advisable to wait for some consolidation/correction before increasing equity allocations.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position with a bias to add to holdings.
    • Stop-loss remains at $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • DIA broke out to new highs this week with a reversal of the “buy” signal to the positive.
  • Hold current positions, but as with SPY, with the very overbought short-term condition, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $260.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Like SPY, the technology heavy Nasdaq also broke out to new highs.
  • With the “sell signal” now reversed, positions can be added.
  • However, as with SPY, QQQ is EXTREMELY overbought short-term, so remain a cautious adding exposure. A slight correction that alleviates some of the extension will provide a much better entry point.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $185
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • One of the markets which historically performed the best under QE is small caps.
  • However, while small-caps have popped on a lot of short-covering, it has barely broken out above previous resistance. More importantly, the index is now back to more extreme overbought conditions.
  • Be patient on adding exposure, it may seem like you are missing out, but these historical deviations tend not to last long.
  • We are looking to potentially add a trading position but need a slight correction/consolidation to do so.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss previously violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY is the same as SLY.
  • MDY has now registered a short-term “buy” signal, but needs a slight correction/consolidation to reduce the extreme overbought and extended condition.
  • Look to add exposure to the market on a pullback that doesn’t violate support.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. However, as noted last week, QE4 has pushed EEM sharply higher over the last week.
  • The current spurt higher did break above resistance, but EEM is back to extreme overbought. So be patient on adding a position until we confirm the breakout is sustainable.
  • We are looking to add a trading position on a pullback that holds support.
  • However, PAY ATTENTION to the Dollar (Last chart). If the dollar is beginning a new leg higher, EEM and EFA will fail.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA also spurted higher.
  • Like EEM, a buy signal has been triggered and is back to EXTREMELY overbought.
  • Be patient for now and wait for a confirmed breakout before adding exposure, and again, watch the U.S. Dollar for important clues.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position.
    • Stop-loss was violated at $64
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • The week saw an uptick in oil prices as “speculation” returned to the markets from QE4. A nice bottom has been forming for oil prices between $51-52 so look for a move to the upper downtrend line at $59/
  • Commodities tend to perform well under liquidity programs due to their inherent leverage. So we are looking to add exposure to energy holdings.
  • Don’t get too excited, there is not much going on with oil currently, but there is likely a tradeable opportunity approaching given the deeply oversold conditions.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position
    • Stop-loss for any existing positions is $54.
  • Long-Term Positioning: Bearish

Gold

  • Gold got back to oversold and broke support at the 200-dma this past week.
  • We are sitting on our stop-loss for the position currently, and had previously sold half our position.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. So, if we get stopped out of our holdings, we will look to buy them back at lower levels.
  • Short-Term Positioning: Neutral
    • Last week: Hold remaining position.
    • This week: Hold remaining position.
    • Stop-loss for whole position moved up to $137.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices also broke support and triggered a sell-signal.
  • Watch your exposure and either take profits or shorten your duration in your portfolio.
  • With the oversold condition in place, we will likely get a bounce to rebalance holdings a bit into. So remain patient for now.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Despite much of the rhetoric to the contrary, the dollar remains in a strongly rising uptrend. Given a “strong dollar” erodes corporate profits on exports (which makes up 40% of corporate profits overall) a strong dollar combined with tariffs isn’t great for corporate bottom lines. Watch earnings carefully during this quarter.
  • Furthermore, the dollar bounced off support of the 200-dma and the bottom of the uptrend. If the dollar rallies back to the top of its trend, which is likely, this will take the wind out of the emerging market, international, and oil plays.
  • The “sell” signal is also turning up. If it triggers a “buy” the dollar will likely accelerate pretty quickly.

The One Chart Every Millennial Should Ignore

The media is full of articles about the financial situation of Millennials in today’s economy. According to numerous surveys, they are saddled with too much debt, can’t secure higher wage-paying jobs, and are financially distressed on many fronts. Moreover, this is occurring during the longest financial and economic boom in the history of the United States.

Of course, the media is always there to help by chastising boot-strapped Millennials to dump their savings into the financial markets to chase overvalued, extended, and financially questionable stocks.

To wit:

“Only about half of American families are participating in some way in the stock market, according to research from the St. Louis Fed. When it comes to millennials (ages 23 to 38), about 60% have no direct or indirect exposure to the stock market.

Of course, you don’t definitely don’t have to invest, Erin Lowry, author of ‘Broke Millennial Takes on Investing,’ tells CNBC Make It. It’s not a life requirement. But you should understand what you’re losing out on if you avoid the markets. It’s a shocking amount, Lowry says. ‘You’re going to have to save so much more money to achieve the same goals because the market is helping do some of the work.’”

Great, you have a person with NO financial experience advising Millennials to put their “savings” into the single most difficult game on the planet.

Of course, this is all dependent on the same “myth” we just addressed last week:

“That’s because when you use a high-yield savings account or an investment account with higher returns, you put the magic of compound interest to work for you. When your money earns returns, those returns also generate their own earnings. It’s that simple.”

Here’s the math they use to prove their point.

“Let’s say you have $1,000 and add $100 a month to your savings over the course of 35 years. At the end, you’d have $43,000. Not bad. But if you had invested that money and earned a 10% rate of return, which is in line with average historic levels, you’d have over $370,000.”

Of course, you have to have a cool chart to go along with it.

Here’s a little secret.

It’s a complete fallacy.

From CNBC:

“Of course, investing is not risk-free. Typically, investors see some years where they earn double-digit returns and other years where they experience a loss. Losses happens, on average, about one out of every four years, and can be bad. During a bear market — which is when stocks fall by at least 20% — research shows that the market drops by an average of 30%. That condition typically lasts for about 13 months.

That means if you invested $1,000 and the market lost 30%, your investment would be worth $700. And it may take you more than 13 months to recover the $300 you lost.”

The importance of that statement is that “losses” destroy the “power of compounding.”

Let’s assume an investor wants to compound their investments by 10% a year over a 5-year period.

The ‘power of compounding’ ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required. In reality, chasing returns is much less important to your long-term investment success than most believe.”

When imputing volatility into returns, the differential between what investors were promised (and this is a huge flaw in financial planning) and what actually happened to their money is substantial over long-term time frames.

Here is another way to look at it.

If you could simply just stick money in the market and it grew by 6% every year, then how is it possible to have 10 and 20-year periods of near ZERO to negative returns?

Morgan Stanley just recently published research on this exact issue:

On our estimates, the expected return of a US 60/40 portfolio of stocks and government bonds will return just 4.1% per year over the next decade, close to the lowest expected return over the last 20 years, and one that has only been worse in 4% of observations since 1950.”

4.1% isn’t 6, 8 or 10%.

There went your savings plan.

The level of valuations when you start your investing journey is all you need to know about where you are going to wind up. Based on current valuations, if you are betting on the last decade of returns to continue 30-years into the future, you are likely going to be very disappointed.

Don’t Forget The Impact Of Inflation

Here’s the second problem.

A recent article from MarketWatch pointed out how much it would cost to retire in each state. Using data from the BLS, Howmuch.net created the following visual.

“The average yearly expenses across the country for someone over the age of 65 is $51,624, but that figure comes in at $44,758 in the low-cost-of-living Mississippi and a whopping $99,170 on the other end of the spectrum in the Aloha State. ‘

This is misleading as the amounts shown above are based on TODAY’s data and what is required if your want to RETIRE TODAY.

What happens if you are a Millennial wanting to retire in 30-years? While $1 million sounds like a lot of money today, and might net you a comfortable retirement in Colorado ($1 million at a 3% annual withdrawal rate nets you $30,000 plus social security), will it be enough in 30-years?

Probably not. Let’s run it backwards.

In 1980, $1 million would generate between $100,000 and $120,000 per year while the cost of living for a family of four in the U.S. was approximately $20,000/year. Today, there is about a $40,000 shortfall between the income $1 million will generate and the cost of living.

This is just a rough calculation based on historical averages. However, the amount of money you need in retirement is based on what you think your income needs will be in the future, not today, and how long you have to reach that goal.

For most, there is a desire to live a similar, or better, lifestyle in retirement. However, over time, our standard of living will increase to reflect our life-cycle stages. Children, bigger houses to accommodate those children, education, travel, etc. all require higher incomes. (Which is the reason the U.S. has the largest retirement savings gap in the world.)

If you are like me with four kids, “a million dollars ain’t gonna cut it.”

The problem with Erin Lowry’s advice to her “millennial cohorts,” is not just the lack of accounting for variable rates of returns, but impact of inflation on future living standards.

Let’s run an easy example.

  • John is 23 years old and earns $40,000 a year.
  • He saves $14 a day 
  • At 67 he will have $1 million saved up (assuming he gets the promised 10% annual rate of return)
  • He then withdraws 4% of the balance to live on matching his $40,000 annual income.

That’s pretty straightforward math.

The problem is that it’s entirely wrong.

The living requirement in 44 years is based on today’s income level, not the future income level required to maintain the SAME living standard. 

Look at the chart below and select your current level of income. The number on the left is your income level today and the number on the right is the amount of income you will need in 30-years to live the same lifestyle you are living today.

This is based on the average inflation rate over the last two decades of 2.1%. However, if inflation runs hotter in the future, these numbers become materially larger.

The chart above exposes two problems with the entire premise:

  1. The required income is not adjusted for inflation over the savings time-frame, and;
  2. The shortfall between the levels of current income and what is actually required at 4% to generate the income level needed.

The chart below takes the inflation-adjusted level of income for each brackets and calculates the asset level necessary to generate that income assuming a 4% withdrawal rate. (For comparison purposes, the red bar is the “F.I.R.E. Movement” recommendation of 25x your income.)

If you need to fund a lifestyle of $100,000, or more, in today’s dollars, as Sheriff Brody quipped in “Jaws,”

“You are going to need a bigger boat.”

Not accounting for the future cost of living is going to leave a lot of people short, even including social security. 

While authors like Ms. Lowry are creating a nice income for themselves by selling books to “broke Millennials,” the content is only as good as the current market cycle you are in. Ms. Lowry, and her cohorts, have never been through a bear market.

Mean reverting events expose the fallacies of “buy-and-hold” investment strategies. The “stock market” is NOT the same as a “high yield savings account,” and losses devastate retirement plans. (Ask any “boomer” who went through the dot.com crash or the financial crisis.”)

Unfortunately, for individuals, the results between what is promised and what occurs continues to be two entirely different things, and generally not for the better. 

RIA PRO: The QE Rally Is On – How To Play It & What Happens Next


  • The “QE, Not QE” Rally Is ON
  • How To Play It
  • What Happens Next
  • Sector & Market Analysis
  • 401k Plan Manager

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



The “QE, Not QE” Rally Is On

Just recently, we released a study for our RIAPro Subscribers (30-Day Free Trial) on historical QE programs and what sectors,  markets, and commodities perform best. (If you subscribe for a 30-day Free Trail you can read the entire report “An Investor’s Guide To QE-4.”)

“On October 9, 2019, the Federal Reserve announced a resumption of quantitative easing (QE). Fed Chairman Jerome Powell went to great lengths to make sure he characterized the new operation as something different than QE. Like QE 1, 2, and 3, this new action involves a series of large asset purchases of Treasury securities conducted by the Fed. The action is designed to pump liquidity and reserves into the banking system.

Regardless of the nomenclature, what matters to investors is whether this new action will have an effect on asset prices similar to prior rounds of QE. For the remainder of this article, we refer to the latest action as QE 4.

To quantify what a similar effect may mean, we start by examining the performance of various equity indexes, equity sectors, commodities, and yields during the three prior QE operations. We then normalize the data for the duration and amount of QE to project what QE 4 might hold in store for the assets.”

The following is one of the tables from article.

As you will notice, all major markets increased in value during QE-1, 2, and 3.

Since the market increased each time the Fed engaged in monetary programs, it should not be surprising investors now have a “Pavlovian” response to the Fed “ringing the bell.” 

Over the last month, we have been discussing the end of the year rally which would be supported by both the Fed, and a “trade deal.” 

This past week, as expected, headlines were floated which suggested that tariffs would be reduced in exchange for essentially nothing, This is precisely the case we laid out in September:

Trump can set aside the last 20%, drop tariffs, and keep market access open, in exchange for China signing off on the 80% of the deal they already agreed to. 

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

Kind of like that ‘Denuclearization deal’ with North Korea.”

We followed that in early October by laying out the case for the “trade deal” to push the markets to 3300:

“Assuming we are correct, and Trump does indeed ‘cave’ into China in mid-October to get a ‘small deal’ done, what does this mean for the market. 

The most obvious impact, assuming all ‘tariffs’ are removed, would be a psychological ‘pop’ to the markets which, given that markets are already hovering near all-time highs, would suggest a rally into the end of the year.”

Then, just two week’s ago, as the Fed went into action:

“Clearly, the Fed is concerned about something other than the impact of ‘Trump’s Trade War’ on the economy. In the meantime, the injection of liquidity continues to support asset prices as the litany of ‘algo’s’ which drive -80% of the trading on Wall Street, respond to more liquidity.”

That is where we are today.

The questions now are:

  1. How do you play it; and,
  2. What happens next?

How To Play It

As we have been noting over the last month, with the Fed’s more accommodative positioning, we continue to maintain a long-equity bias in our portfolios currently. We have reduced our hedges, along with some of our more defensive positioning. We are also adding opportunistically, to our equity allocations, even as we carry a slightly higher than normal level of cash along with our fixed income positioning.

Currently, it will likely pay to remain patient as we head into the end of the year. With a big chunk of earnings season now behind us, and economic data looking weak heading into Q4, the market has gotten a bit ahead of itself over the last two weeks.

On a short-term basis, the market is now more than 6% above its 200-dma. These more extreme price extensions tend to denote short-term tops to the market, and waiting for a pull-back to add exposures has been prudent.

Also, the majority of our indicators are back to more extreme overbought readings, which have typically denoted short-term tops at a minimum.

As I noted last week:

“Given the markets tend to pullback just before Thanksgiving, and during the second week of December, we will have a better opportunity increase allocations if we are patient.

Once we see that pullback, or even a slight consolidation of the recent advance, we can increase allocations in portfolios towards more equity related exposure.

This begs the question of “what to buy,” which brings us back to our recent RIAPRO.NET article:

“If we assume that assets will perform similarly under QE 4, we can easily forecast returns using the normalized data from above. The following three tables show these forecasts. Below the tables are rankings by asset class as well as in aggregate. For purposes of this exercise, we assume, based on the Fed’s guidance, that they will purchase $60 billion a month for six months ($360 billion) of U.S. Treasury Bills.

The expected top five performers during QE4 on a normalized basis from highest to lowest are: Silver, S&P 400, Discretionary stocks, S&P 600, and Crude Oil. 

I would highly suggest reading the whole article.

What Happens Next?

Michael Lebowitz, CFA recently penned:

“A Honus Wagner baseball card from 1909 was recently auctioned for over $3 million. While that may seem like a lot of money, it is not necessarily expensive. A baseball card is nothing more than paper and ink with no real value. Its street value, or price, is based on the whims of collectors. “Whim” is impossible to value.

Stocks are not baseball cards. Stocks represent ownership in a corporation, and therefore, their share prices are based on a future series of expected earnings and cash flows. Further, there are many other types of investments that serve not only as alternatives, but provide a means to assess relative value.

Today, investors are trading stocks on a “whim,” with scant attention to their value. Unlike a baseball card, when a stock’s street value rises much more than its real value, an inevitable correction will occur. The only question is not if but when will investors realize what they are truly buying.”

There is an important distinction to be made here between “investing” vs. “speculating.” 

Benjamin Graham, in his seminal work Security Analysis (1934) defined investing as:

“An operation in which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” 

The problem is that today, the term “investor” is now being applied ubiquitously to anyone who participates in the stock market. As Graham noted later in “The Intelligent Investor:”

“The newspaper employed the word ‘investor’ in these instances because, in the easy language of Wall Street, everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin.” 

To understand “what happens next,” one must understand the difference between “investment” and “speculation.” 

While QE-4 may be driving stocks higher today based on a “whim,” there are two very important difference between QE-4 and QE-1 or 2; 1) stocks are no longer undervalued or 2) under-owned. 

“With cash levels at the lowest level since 1997, and equity allocations near the highest levels since 1999 and 2007, it suggests investors are now functionally ‘all in.’” 

With investors paying exceptionally high prices for equity ownership, expected forward returns becomes much more problematic. As we addressed on Thursday:

“The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to ‘remain irrational longer than logic would predict,’ but it never lasts indefinitely.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.’” – Jeremy Grantham

Another way to look at the issue of profits as it relates to the market is shown below. When we measure the cumulative change in the S&P 500 index as compared to the level of profits, we find again that when investors pay more than $1 for a $1 worth of profits there is an eventual mean reversion.

With investors paying more today than at any point in history for each $1 of profit, the next mean reversion will be a humbling event.

That is just math.

However, in the meantime, individuals are “speculating” within the markets based solely on the premise that a “greater fool” will be there when the time comes to sell.

Unfortunately, that is rarely the case.

There are virtually no measures of valuation which suggest making investments today, and holding them for the next 20-30 years, will work to any great degree.

This is the difference between “investing” and “speculation.”

When you think about QE-4, as it relates to your portfolio, you have to consider the premise of valuations, margin of safety, and risk. Yes, the markets are indeed bullish by all measures, and holding risk will likely pay off in the short-term. (speculation) However, over the long-term, the “house will always win.” (investing)

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet    


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels

Sector-by-Sector

Improving – Energy (XLE), Healthcare (XLV)

The relative performance improvement of Healthcare relative to the S&P 500 lagged a bit this past week after breaking out to new highs. Energy also improved as the rotation to “value” continues but faltered at resistance on Friday at the 200-dma. Energy needs to break above the downtrend to become an attractive candidate for portfolios.

Current Positions: Target weight XLV

Outperforming – Industrials (XLI), Financials (XLF)

Financials have been running hard on Fed rate cuts and more QE, but rate cuts are, longer-term, not great for net-interest income margins on banks. Combined with the high level of corporate debt on their books, we remain cautious on the sector. But, with the breakout to new highs, we will are looking for some consolidation to add exposure to the sector which is extremely overbought currently.

Industrials, which perform better when the Fed is active with QE, also broke out to new highs, and like Financials are extremely overbought. We are looking to add back to our position but need a bit of a correction or consolidation first.

Current Positions:  1/2 weight XLI

Weakening – Real Estate (XLRE), Staples (XLP), Technology (XLK), Utilities (XLU)

After having taken profits in our defensive sectors, the rotation from defense to offense has picked up some steam. Utilities, Real Estates and Staples have all broken their 50-dmas and are FINALLY working off the extreme overbought condition that existed. This is good news and will allow us to buy additional exposure to the sectors at cheaper prices.

Technology broke out to all-time highs, which is bullish for now, but, as with most running sectors of the market,  is back to extremely overbought. Hold positions for now but be patient on adding new positions as we will likely get a better opportunity soon.

Current Position: Target weight XLK, XLRE, XLU, XLP

Lagging – Basic Materials (XLB), Discretionary (XLY), Communications (XLC)

Basic Materials broke out to new highs as well, following Industrials, and we expect to see better performance as money rotates into the sector. Be patient as, just like the other offensive sectors, the market is VERY overbought. Communications has lagged, but also finally broke out to new highs. We are looking to add to our holdings of Materials and Communications, but these sectors are also currently extremely overbought so be patient for now.

Current Position: 1/2 weight XLB, Target weight XLC

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps have finally broken out of the previous ranges which suggests higher highs to come. This aligns with our commentary above about the sectors which perform the best under QE programs. However, both markets are EXTREMELY overbought currently. Be patient for the right entry point.

Current Position: No position

Emerging, International (EEM) & Total International Markets (EFA)

The same advice goes for Emerging and International Markets, which we have been out of portfolios for several weeks due to lack of performance. These markets rallied recently on news of “more QE,” and finally broke above important resistance. However, these markets are sensitive to the US Dollar which is showing some strength. With both markets EXTREMELY overbought currently, be patient for the right entry point.

Current Position: No Position

Dividends (VYM), Market (IVV), and Equal Weight (RSP) – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with economic growth and inflation. Currently, the short-term bullish trend is positive, and our core positions are providing the “base” around which we overweight/underweight our allocations based on our outlook.

Be aware that all of our core positions are VERY overbought. A short-term correction or consolidation is likely before a further advance can be made.

Current Position: RSP, VYM, IVV

Gold (GLD) – With QE-4 in play, the most defensive of sectors got hit last week. Gold is one of those sectors, and after taking profits, Gold broke support at the $140 level. Next support is $135 and stops should be placed on all positions at $130. Gold is very oversold so a tradeable opportunity is approaching.

Current Position: GDX (Gold Miners), IAU (Gold)

Bonds (TLT) – 

Bonds are now back to extremely oversold. This rise in yields was expected, which is why we added a “steepner trade” to our portfolios. Given that we improved our credit quality and shortened duration previously, we are holding our positions for now. We have tightened up our stops.

Stay long current positions for now, and look for an opportunity to add to holdings.

Current Positions: DBLTX, SHY, IEF

Sector / Market Recommendations

The table below shows thoughts on specific actions related to the current market environment. 

(These are not recommendations or solicitations to take any action. This is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)

Portfolio/Client Update:

Over the last couple of weeks we have been discussing the need to cautiously, and opportunistically add exposure to portfolios. The reason for the increase is simply a function of current market momentum and the fact the Fed is back into the “QE game.” We have been constantly reviewing portfolios and markets looking for right opportunities.

Currently, the market is extremely overbought which limits our ability to add “broad market” exposures. We are waiting for a brief market pullback or consolidation to add exposure to ETF Models in small and mid-capitalization markets, basic materials, industrials, financials and energy.

These additions will increase our overall allocation towards equity risk as we head into the end of the year. These are NOT permanent additions, but rather opportunistic positions to potentially add some “alpha generation” to portfolios over the next couple of months. We will be carrying tight stops and re-evaluating the holdings regularly for adjustments.

In the Equity model, as noted below we were able to pick off some very beaten up stocks we have been watching for a while, and we trimmed off some issues which were under pressure from the markets rotation to offense from defense.

We are actively looking to slowly increase our equity exposure modestly to “rent whatever rally” we may get from the “QE-4.” 

  • New clients: Please contact your adviser with any questions. 
  • Equity Model: Sold YUM, MDLZ. Bought KHC, ABBV, XOM, MU, IEF
  • ETF Model: Bought IEF

Note for new clients:

It is important to understand that when we add to our equity allocations, ALL purchases are initially “trades” that can, and will, be closed out quickly if they fail to work as anticipated. This is why we “step” into positions initially. Once a “trade” begins to work as anticipated, it is then brought to the appropriate portfolio weight and becomes a long-term investment. We will unwind these actions either by reducing, selling, or hedging if the market environment changes for the worse.


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.

401k-PlanManager-AllocationShift

Watch Your Step Getting On The Bull

Last week we noted:

“Given the ‘bulls’ upper-hand heading into the end of the year, we looking to increase our equity exposure slowly. Given the markets tend to pullback just before Thanksgiving, and during the second week of December, we will have a better opportunity to increase allocations if we are patient.

We need to see a bit of a pullback to reduce the rather excessive extension of the market above the 200-dma, but a pullback that doesn’t break back below the previous highs. Such action will confirm the breakout and suggest our target of 3300 is attainable.”

Please review the chart above. While we are indeed looking to increase equity allocations, thre are reasons to remain cautious.

With the market once again pushing above it’s cyclical bullish trend line, and testing the cycle trend highs from 2007, the risk of a short-term correction action is elevated. Such a correction will provide a much better entry point to add risk to portfolios accordingly.

This week, continue making adjustments to prepare to opportunistically increase equity exposure on a pullback which doesn’t fail at support levels.

  • If you are overweight equities – Hold current positions.
  • If you are underweight equities – rebalance portfolios to target weights
  • If at target weight equities, hold positioning and look for a pullback to increase exposure.

Understand this increase could well be short-lived. The markets have been in a very long consolidation process and the breakout to the upside is indeed bullish. However, we must counter-balance that view with the simple reality we are VERY long in the current economic and market cycle which is where “unexpected” events have destroyed capital in the past.

If you need help after reading the alert; do not hesitate to contact me.

401k Plan Manager Beta Is Live

Become a RIA PRO subscriber and be part of our “Break It Early Testing Associate” group by using CODE: 401 (You get your first 30-days free)

The code will give you access to the entire site during the 401k-BETA testing process, so not only will you get to help us work out the bugs on the 401k plan manager, you can submit your comments about the rest of the site as well.

We are building models specific to company plans. So, if you would like to see your company plan included specifically, send me the following:

  • Name of the company
  • Plan Sponsor
  • A print out of your plan choices. (Fund Symbol and Fund Name)

I have gotten quite a few plans, so keep sending them and I will include as many as we can.

If you would like to offer our service to your employees at a deeply discounted corporate rate, please contact me.

Current 401-k Allocation Model

The 401k plan allocation plan below follows the K.I.S.S. principle. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)


Model performance is based on a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. This is strictly for informational and educational purposes only and should not be relied upon for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril. 

Corporate Profits Are Worse Than You Think – Addendum

We recently published Corporate Profits Are Worse Than You Think to expose stock prices that have surged well beyond levels that are justified by corporate profits. 

A topic not raised in the article, but a frequent theme of ours, is the role that share buybacks have played in this bull market. Corporations have not only been the largest buyer of stocks over the last few years, but share buybacks result in misleading earnings per share data, which warp valuations and makes stocks look cheaper. Over the last five years, corporations have been heavily leaning on the issuance of corporate debt to facilitate share buybacks. In doing so, earnings per share appear to sustain a healthy upward trajectory, but only because the denominator of the ratio (number of shares) is being reduced as debt on the balance sheet rises. This corporate shell game is one of the most obvious and egregious manifestations of imprudent Federal Reserve policies of the past decade.

Given the importance of debt to share buybacks, we provide two graphs below which question the sustainability of this practice.

The first graph below compares the growth of corporate debt and corporate profits since the early 1950s. The growing divergence, especially as of late, is a clear warning that debt is not being used for productive purposes. If it were, profits would be rising in a manner commensurate or even greater than the debt curve. The unproductive nature of corporate debt is also seen in the rising ratio of corporate debt to GDP, which now stands at all-time highs. Too much debt is being used for buybacks that curtail capital investment, innovation, productivity, and ultimately profits.  

Data Courtesy St. Louis Federal Reserve

The next graph uses the same data but presents the growth rates of profits and debt since 2015. Keep in mind the bump up in corporate profits in 2018 was largely due to tax legislation.

Data Courtesy St. Louis Federal Reserve

Lastly, we present a favorite chart of ours showing how the universe of corporate debt has migrated towards the lower end of the investment-grade bucket. Many investment-grade companies (AAA – BBB-) are issuing debt until they reach the risk of a credit downgrade to junk status (BB+ or lower). We believe many companies are now limited in their use of debt for fear of downgrades, which will naturally restrict their further ability to conduct buybacks. For more on this graph, please read The Corporate Maginot Line.

3 Quality Blue Chip Stocks For Rising Dividends

This is a guest contribution by Bob Ciura with Sure Dividend.  Sure Dividend helps individual investors build and maintain their high quality dividend growth portfolios rising passive income over the long run.

There is no exact definition of what constitutes a “blue-chip” stock, but at Sure Dividend we generally define a blue chip as a stock that belongs to one of three lists. In our view, a blue chip is a dividend stock that is either a Dividend Achiever (10+ consecutive years of dividend increases); Dividend Aristocrat (25+ years); or Dividend King (50+ years).

We have compiled a list of companies that currently qualify as blue chip stocks, as well as our top-ranked blue chip stocks. The following 3 stocks are among our favorite blue chip stocks for dividend growth investors interested in rising dividend income over the long term. These 3 stocks combine strong business models with future growth potential, as well as high current yields.

Blue Chip Stock #3: Exxon Mobil (XOM)

Exxon Mobil is an integrated oil and gas super-major. It is the largest U.S. energy company, with a market capitalization above $300 billion. It has also increased its dividend for over 30 years in a row, making it a member of the Dividend Aristocrats. The stock has a current yield of 4.9%, which is significantly above the ~2% dividend yield of the broader S&P 500 Index.

Exxon Mobil continues to struggle with weak oil prices, but thanks to its diversified business model, the company still generates impressive cash flows. In the most recent quarter, Exxon Mobil grew its upstream liquids production by 5% over last year’s quarter mostly thanks to impressive growth in the Permian Basin, where output grew 4% for the quarter. Exxon Mobil generated over $9 billion in operating cash flow last quarter, as the company is highly profitable across its large upstream, downstream, and refining businesses.

Despite the difficult short-term conditions, investors should remain confident of Exxon Mobil’s long-term prospects. Production growth will fuel higher profits going forward, as Exxon Mobil expects production to increase 25% by 2025, to 5.0 million barrels per day. The Permian Basin will be a major growth driver, which Exxon Mobil expects to account for more than 1.0 million barrels per day of its production by 2024.

Exxon Mobil continues to generate strong cash flow, which it uses to reward shareholders with annual dividend increases, including the 6% increase in April 2019. It also has the best balance sheet of all the integrated oil and gas majors, which further boosts its dividend sustainability. With a nearly 5% dividend yield, Exxon Mobil is among the safest dividend stocks in the energy sector.

Blue Chip Stock #2: Walgreens Boots Alliance (WBA)

Next up is pharmacy retail giant Walgreens Boots Alliance, which like Exxon Mobil is on the list of Dividend Aristocrats. Walgreens has a global presence with over 18,000 stores in 11 countries, and a market capitalization of approximately $50 billion. Walgreens has increased its dividend for 44 consecutive years, which makes it a member of the Dividend Aristocrats.

Walgreens faces heightened competition, both from established retailers as well as the looming threat of Amazon (AMZN) which purchased online pharmacy PillPack for nearly $1 billion. But Walgreens continues to generate sales growth, including 2.6% comparable revenue growth in the most recent quarter. Pharmacy sales increased 5.4% on a comparable basis, primarily due to higher brand inflation, and prescription volume growth. Pharmacy sales should continue to provide growth for Walgreens, particularly because of the aging U.S. population. Walgreens is also a highly recession-resistant company, as consumers are unlikely to cut spending on prescriptions and other healthcare products even during a recession. Walgreens is one of the most recognized brands in retail, and its huge store count serves as a competitive advantage.

Walgreens is also working aggressively to cut costs to improve its profitability. The company recently raised its cost-cutting target from $1.5 billion, to over $1.8 billion by fiscal 2022. Walgreens returns a significant portion of its profits to shareholders in the form of dividends. The company has a current dividend yield of 3%, and has increased its dividend each year for more than 40 consecutive years.

Blue Chip Stock #1: Altria Group (MO)

Altria Group is a consumer staples giant. Its main product is the Marlboro cigarette brand, but Altria has a diversified product portfolio that also includes smokeless tobacco, wine, and a 10% equity stake in global beer giant Anheuser Busch Inbev (BUD).

Altria stock has performed poorly this year, with a year-to-date decline of 7% versus a 23% gain for the S&P 500 Index. The company is struggling with the persistent trend of declining smoking rates in the United States. Altria expects cigarette volumes will decline at a 4% to 6% annual rate through 2023.

In response, Altria has invested heavily in expanding its product portfolio beyond traditional cigarettes. Its most recent investments include a $1.8 billion investment for 45% of Canadian marijuana producer Cronos Group (CRON). Separately, Altria invested $12.8 billion in e-vapor manufacturer JUUL Labs for a 35% equity stake in the company. In June, Altria announced that it took control of Burger Söhne, a Swiss company that makes oral nicotine pouches. The 80% stake was purchased for $372 million.  

These investments have allowed Altria to continue generating growth in its core metrics this year. In late October, Altria reported strong third-quarter earnings. Revenue (net of excise taxes) increased 2.3% year-over-year to $5.4 billion. Adjusted earnings-per-share came of $1.19 increased 10% over the year-ago period. Revenue and earnings-per-share both beat analyst expectations. Altria said it was on track to achieve $575 million in annual cost savings this year as it combats lower smoking rates in its markets.

Altria took a non-cash impairment charge of $4.5 billion related to its investment in Juul. But its investments in Juul, Cronos Group, and Burger Söhne represent major growth opportunities and the company’s best chance to diversify away from cigarettes. These investments will fuel Altria’s long-term growth. Altria expects 5% to 7% growth in adjusted earnings-per-share in 2019, as well as 5% to 8% adjusted EPS growth from 2020-2022. This growth will allow Altria to continue increasing its dividend to shareholders, as it has done for 50 consecutive years, making Altria a member of the Dividend Kings list.

Final Thoughts

Dividend growth investors are generally interested in a strong current yield that is well above the market average, and a sustainable dividend with room for growth over the long term. Blue chip stocks are a great place to look for stocks that combine both qualities. The three stocks in this article have dividend yields that significantly exceed the S&P 500 Index average. And, thanks to their steady profitability, durable competitive advantages, and future growth potential, they are likely to continue increasing their dividends each year for the foreseeable future.

What We Bought & Sold In Our Equity Portfolio

Each week on RIAPRO (Try For Free For 30-Days) we produce a series of chart books which cover buy/sell/hold recommendations for:

  • Monday – Major Markets
  • Tuesday – Major Sectors
  • Wednesday – Our Portfolio Holdings
  • Thursday Rotation – Commodities, Sub-Sectors, Breadth/Participation, or our Watch List.

We also produce daily market commentaries, portfolio action alerts, and a variety of special reports for our subscribers.

RIAPRO is a robust “Do-it-yourself” research platform which uses our technical and fundamental parameters to screen, research, and develop ideas for your own portfolios and investment strategies. From macro analysis to individual stock analysis, there is a wide range of tools available to help you manage your investment portfolio better.

The following are the latest actions we have taken in our 60/40 Equity Portfolio. Unlike most sites that use hypothetical models, we run live, actual portfolios. The accounts are managed exactly the same as the portfolios we run for our clients at RIA Advisors. (If you’re an adviser looking for a great firm – click here.)

The following is the latest review of some of the positions in our Equity Portfolio which are either a concern, an opportunity, or are worth watching more closely.

XOM – Exxon Mobil

  • As of two weeks ago, XOM was deeply oversold, and the energy sector was deeply out of favor. That is a setup for a rotation very often. With a 5% dividend yield we can afford to wait for a turn.
  • We added to our existing position last week. Total return so far since the addition is 5.18% as of the close yesterday.
  • We are still carrying a stop-loss on the position if our thesis doesn’t work out, but if there is a rally into the end of the year, we should see Energy pick up performance.
  • The position can still be bought on pullbacks during market corrections.
  • Stop is set at $66

MU – Micron Technologies

  • Previously, we noted that MU had improved in performance, and a removal of tariffs will likely clear the way for a move higher in semi-conductors.
  • With a P/E of 9, we like the valuation, and MU has now established a positive trend and held support.
  • There is some tough resistance at $50, and we are watching that carefully.
  • We added a full position to the portfolio last week on expectations of a push higher. Return is 9.86% since the addition and we will increase size above $50. The position can still be added on pullbacks.
  • Stop is moved up to $42.50.

AMZN – Amazon.com

  • We added a position in AMZN for the end of year shopping season. We got a little worried following the earnings announcement, but revenue growth remained solid.
  • AMZN tends to perform better during the shopping season, and with the very oversold condition, the risk/reward is descent for now.
  • Performance so far has been lackluster with the position only up 1.5% since our addition.
  • The long-term trend remains positive and a move above $1850 should clear the way to old highs. A position can still be added.
  • Stop loss is set at $1700

ABBV – Abbvie Corp.

  • ABBV had a massive correction and was deeply oversold.
  • With a buy signal recently triggered and breaking above resistance and the downtrend line from the old highs, we have added 1/2 position.
  • We will scale into ABBV on opportunity and in the meantime we like the 5% yield on the position to pay us while we wait. Return so far has been modest at 4.63% but we like the position longer-term.
  • Use pullbacks to add holdings.
  • Stop loss is set at $65

KHC – Kraft Heinz

  • Two weeks ago we talked about our speculative turnaround story in KHC. We still think that is the case and we added a “trading position” to the portfolio on October 30th.
  • Earnings came in a bit better than expected which popped the position above important overhead resistance. Return so far since our add is 16.90%.
  • With a 6% yield, and the stock turning higher, we are liking the position, BUT it is now extremely overbought short-term.
  • Wait for a correction that doesn’t break support to add holdings.
  • This remains a very speculative trade.
  • Stop has been moved up to $30.

MDLZ – Mondelez (Sold)

  • We noted last week that Mondelez had broken support but is holding its longer-term moving average.
  • We had taken profits in the position previously, but we decided to go ahead and cut the position from the portfolio last week.
  • That move paid off well, as the position has continued to erode.
  • Position has been sold.

WELL – Welltower, Inc. (Sold 1/2)

  • We have recently talked about the rotation from “defense” back to “offense” as QE gained traction in the market. That is occurring so we have reduce WELL from 1.5% of the portfolio to 0.75%.
  • We still like the position longer-term and will look to add back to holdings at lower levels.
  • As such we are looking at continuing to modify our positioning accordingly.
  • Stop loss has been adjusted to $82.50

YUM – Yum Brands (Sold)

  • Like MDLZ, YUM has come under pressure and earnings are weakening.
  • We made the decision to SELL the entire position last week.

EEM – Emerging Markets (Watch List)

  • As noted in yesterday’s major market commentary, EEM continues to underperform but is improving..
  • However, as noted last week, QE4 is bleeding into EEM if a performance chase begins for year-end positioning.
  • The current spurt higher is trying to break above resistance, but EEM is back to extremely overbought. So be patient on adding a position until we confirm the breakout is sustainable.
  • The sell signal reversed to a buy last week, so with the breakout, there is potential for EEM.
  • We are looking to add some exposure on any weakness and scale into our holding opportunistically.

MDYV – Mid-Cap Value (Watch List)

  • As noted in our report on QE programs previously, small and mid-cap value are benefactors of increased liquidity.
  • With the breakout of consolidation we are getting the entry opportunity we are looking for. The index is extremely overbought so a bit of a rest that holds the breakout will confirm a better entry point.
  • We will load 1/2 of the position initially and add the second 1/2 on a breakout above previous highs.
  • Stop loss will be set at $50

If you like what you see here, and need a better way to manage your own portfolio, then try out RIAPRO.NET today. Your first 30-days are on us, and there are never any contracts. We also value your privacy and never share any information from the site.

Have a great weekend.

#WhatYouMissed On RIA: Week Of 11-04-19

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

The Week In Blogs


The Best Of “The Lance Roberts Show”

Video Of The Week

John Dorfman On Value Investing

Sometimes it’s good to get back to the basics: The essence of value trading, and what makes a value stock so; commentary on the rise of ETF’s, and the myth of passive investing; the price distortion in share buy backs; how to factor in the Fed.

Our Best Tweets Of The Week

Our Latest Newsletter


What You Missed At RIA Pro

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

See you next week!

Mauldin: Modern Central Banking Is More Vulnerable Than We Think

Banks are a place where you store your cash, right? Not exactly.

When you deposit money in a checking or savings account, you aren’t just letting the bank hold it on your behalf. You are lending the bank that money and the bank is borrowing it.

That’s why deposits show as a liability on the bank’s balance sheet.

We think of banks as lenders, and they are, but they’re also borrowers. They make money by lending at higher rates than they pay as borrowers, and by leveraging their deposits via fractional reserves.

Modern Central Banking

This is obvious if you think about it.

How can your bank simultaneously a) promise you can withdraw your cash on demand and b) lend that same cash to someone else?

That’s possible only because they know only a few people will want their cash back on any given day. And if cash requirements are more than expected, they can borrow from other banks or the Federal Reserve, as needed.

Modern central banking and regulatory practices have practically eliminated the old-fashioned bank run. It still happens occasionally, but the system can absorb it.

That’s because, while depositors can withdraw cash from a given bank, it is hard to withdraw from the banking system. Even if you buy gold, the gold dealer will probably deposit your cash in their bank, leaving the system exactly where it was before.

The System Is Vulnerable

Now, the system can be shaken up if too many people decide to hold physical paper money, or they transfer deposit money into other instruments banks can’t leverage as easily.

Central bank reserve requirements also play a role. The banking system is far more elaborate than the most complicated Swiss watch but it just keeps on ticking… until it stops.

Something weird happened in September, for reasons that remain a little murky. The repurchase agreement or “repo” market seized up.

I’ll spare you a plumbing lesson; all you need to know is that repos are really, really important for overnight funding.

Without them, it’s very hard for banks, brokers, funds, and other market participants to square their books. Modern banking simply wouldn’t function and the system would shut down.

Now, this wasn’t a catastrophe. The Fed injected some liquidity and everything seems okay for now. The important part is that it shouldn’t have happened and worse, apparently no one saw it coming.

Shades of 2007–2008

We had a string of similar hiccups in 2007–2008. All were manageable but eventually they added up to something much worse. So, this wasn’t a good sign for market stability.

That’s the problem with unconventional monetary policy. It may solve your immediate problem but create bigger ones later, as French economist Frédéric Bastiat said. We now know the Fed’s 2017–2018 rate hikes, concurrent with the balance sheet reductions or “QT” (quantitative tightening), were probably too aggressive, as even the Fed now tacitly admits. I said at the time they were running a two-factor experiment with unpredictable results. Could we now be seeing them? And if so, are they over?

No one knows, but the Fed looks rattled. And a rattled Fed isn’t what we need.


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

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

10-Reasons Why Productivity Is Declining

Economists debate whether the decline in productivity is real. It is real. let’s investigate 10 reasons why.

Productivity Measurement

Brookings questions the Productivity Slump. It cites measurement issues.

Much of the recent debate, and related research, on productivity measurement issues has focused on this decline in productivity in the U.S. Predating the financial crisis and the ensuing Great Recession, and now continuing for more than a decade, the productivity slowdown in the U.S. does not appear to be just cyclical in nature, but rather seems to reflect also deeper, structural phenomena. There are different views on what factors explain the slowdown. But one view challenges the very reality of the slowdown, arguing that the slowdown wholly or largely reflects the failure of the productivity statistics to capture recent productivity gains, particularly those from new and higher-quality ICT goods and services

There are two potentially important sources of underestimation of productivity related to ICT goods and services. First, if prices do not fully capture quality improvements in the new ICT products, price deflators are overestimated and real output (adjusted for improvements in quality, including product variety) is underestimated. Second, many ICT services, in particular internet-based services such as Google searches and Facebook, are largely not reflected in GDP measurement even though they generate substantial utility for consumers, the reason being that their use does not involve monetary cost as they are available free of charge to the users.


Facebook a Productivity Killer

Google searches are indeed a time-saver. But what the hell is “produced” by them. And where do the searches and Facebook playing take place?

At work perhaps. After discussing the above Brookings did come to this conclusion: “In large part, the productivity slowdown—and the associated productivity paradox—are real.”

It never explained why. Rather Brookings remains puzzled: “While recent research suggests that mismeasurement, although sizable, does not explain most of the observed decline in productivity, it must be noted that there remain unknowns and gaps in data.”

Real or Imagined

The National Bureau of Economic Research (NBER) asks Is the U.S. Productivity Slowdown a Mirage?

Labor productivity in the United States—defined as total output divided by total hours of labor—has been increasing for over a century and continues to increase today. However, its growth rate has fallen. One explanation for this phenomenon focuses on measurement difficulties, in particular the possibility that current tools for measuring economic growth do not fully capture recent advances in the goods and services associated with digital communications technology.

One reason some analysts believe that labor productivity is understated is that price inflation may be overstated for digital goods and services.

As with Brookings, the NBER concludes there is some mismeasurement but fails to figure out why.

As an aside, the NBER group is the official arbiter of recession dates in the US.

Federal Reserve Bank of San Francisco Study

The FRBSF asked the same question: Does Growing Mismeasurement Explain Disappointing Growth?

The FRBSF came to the same conclusion that mismeasurement is a problem but like the others fails to offer credible rationale.

No Hidden Productivity

The problem with the above analysis is the Fed, Brookings, and the NBER all focused on the measurement issue in apparent belief there is some sort of hidden productivity waiting to be discovered.

Mismeasurement Irony

I propose productivity is likely to be overstated, not understated because of mismeasurement.

How so?

  • How many overtime hours do supervisory workers at Walmart, Target, etc., actually work while getting paid for 40?
  • How many hours do employees work at home and on vacation while not getting paid for them?

Before diving into a 6-point practical explanation as to why productivity losses are real, please ponder a few charts that I put together.

Nonfarm Productivity 1990-Present

In the above and all the following charts, I let Excel plot the trendline. The chart shows declining productivity, but it’s horribly misleading. Let’s investigate other timeframes to understand why.

Nonfarm Productivity 1990-2000

Those are the heydays of the internet revolution. Computers replaced people. Spreadsheets replaced accountants. Robots replaced manufacturing workers at an increased pace.

Nonfarm Productivity 2001-2007

Productivity soared coming out of the dotcom and 911-related recession.

By 2004, economic activity was all about housing and finance.

Nonfarm Productivity 2009-2019

Productivity soared coming out the the Great Recession as is the case coming out of any recession. Since then corporate productivity has been anemic.

Manufacturing Real Output vs Employees

From 1990 until 2008 manufacturing output per employee skyrocketed. Both plunged in the Great Recession and the trends are now positive but output per employee has slowed to a crawl as the number of manufacturing employees has been on the rise.

This indicates decreasing marginal utility of robots, lower worker skill sets, or both.

Obesity Trends

Chart from the National Institute of Health.

Obese workers have more health-related issues and thus need more time off. They also move slower and do not function as well as healthy workers.

Rise of the Zombies

Zombie firms are companies that are unable to cover debt servicing costs from current profits over an extended period. Cheap financing is the primary cause. The result is low productivity.

Please review Rise of the Zombie Corporations: Percentage Keeps Increasing

Collective Bargaining with Militant Unions

On October 31, I asked Chicago ISM Crashes: How Much is GM to Blame?

I do not pretend to have the answer, but GM agreed to a lot of worker protections, guaranteed hours, plant improvements, etc, that will not make any sense if there is an economic slowdown.

Chicago also just settled its teacher strike to which I commented Chicago Headed for Insolvency, Get the Hell Out Now

Chicago Teacher Contract Details

  1. 16% raise over five years (not including raises based on longevity)
  2. Three-year freeze on health insurance premiums
  3. Lower insurance copays
  4. Caps on class sizes
  5. More than 450 new social workers and nurses.
  6. New job protections for substitute teachers who going forward may only be removed after conferring with the union about “performance deficiencies.”
  7. Chicago Public Schools will become a “sanctuary district,” meaning school officials won’t be allowed to cooperate with the Immigration and Customs Enforcement without a court order.
  8. Employees will be allowed 10 unpaid days for personal immigration matters.
  9. Under the new contract, a joint union-school board committee will be convened to “mitigate or eliminate any disproportionate impacts of observations or student growth measures” on teacher evaluations.
  10. Instead of student performance, teachers will probably be rated on more subjective measures, perhaps congeniality in the lunchroom.
  11. The new union contract caps the number of charter-school seats, so no new schools will be able to open without others closing.

Points four through 11 are all productivity killers.

Soaring Fiscal Deficits

Government does not spend money wisely to say the least. It collects money via taxes then wastes in on counterproductive military operations and other nonsense.

When it spends on infrastructure, it overpays because of prevailing wage laws and collective bargaining.

For further discussion of the debt vs deficits, please see Budget Deficit Lies: What’s the Real Deficit?

It’s the Debt Stupid

It takes $103 in public debt for a $100 increase in GDP.

Build up public debt, expect lower productivity.

Interest on the National Debt

According to Treasury Direct, Interest on the National Debt is $574 billion.

There is nothing remotely productive about paying interest to banks.

Corporate Buybacks

Trump’s tax cuts did not spur investment as claimed. Corporations took the cuts and another repatriation holiday for dividend and buybacks.

In addition to using profits to buy back shares, some companies went further into debt to buy back shares.

If you skimp on investment, don’t expect productivity miracles.

Real Productivity Decline, 10 Simple Explanations

  1. The internet boom and the rising productivity associated with it were very real. The rate of change in internet-related improvements has fallen since 2000.
  2. Decreasing marginal utility of robots.
  3. The Fed’s easy money policies sponsored numerous corporate zombies. Those zombies survive only because of ultra-easy financing. Zombie companies are unproductive, by definition. Things are even worse in the EU because of negative rates.
  4. The Fed’s easy money policies also sponsored a “store on every corner”. There are far more retail stores, restaurants, fast food establishments, and outlet malls than needed.
  5. Marginal stores have to be manned by somebody and they are, by increasingly marginal employees as the unemployment rate declines.
  6. Demographics. As skilled workers retire, those workers are replaced by workers with lower skills.
  7. Health issues in general. Obesity and drug-related issues are on the rise as are time off for those reasons.
  8. Militant unions demand and receiving unwarranted pay, time off, and control over workplace conditions.
  9. Corporate buybacks mainly benefit CEOs and executives who cash out their shares and options. It takes careful investment, not reckless expansion, not buybacks to have productivity gains.
  10. It’s the debt, stupid. Fiscal deficits are totally out of control. Interest on the national debt by itself is $574 billion. What are we getting for it?

Looking in the Wrong Place

The San Francisco Fed, Brookings, and the National Bureau of Economic Research all struggle to explain falling productivity.

They can’t come up with the answer because they all have a spotlight on mismeasurement (and in the wrong direction at that, failing to count supervisory overtime and hours worked at home).

But there’s the answer, in ten easy to understand points, supported by data, logical analysis, and graphs.

By the way, this enormous buildup of debt at every level is hugely deflationary. Bubbles do burst eventually.

Sub-Sector Buy/Sell Review: 11-07-19

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

We are now adding a NEW REPORT looking at some of the SUB-SECTORS of the major S&P 500 sectors. This new report is from reader requests asking about specific sectors like Biotech, Oil Services, etc.

Each week will highly 8 of these sub-sectors which have caught our attention either for an investment, trade or sell.

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

ITB – iShares – US Home Construction

  • Home builders are extremely far ahead of the underlying fundamentals. However, the price rise over the last year has been breathtaking nonetheless.
  • If ITB is going to continue its advance it needs to break out to all-time highs.
  • While it is currently on a buy signal, it is “crazy” overbought on many levels.
  • I would NOT try to initiate a position until either there is a confirmed breakout or a pullback.
  • My hunch is this will likely be a better “short” opportunity in the not so distant future.
  • Short-Term Positioning: Neutral
  • Stop-loss on open holdings at $43
  • Long-Term Positioning: Bearish

IAK – iShares US Insurance

  • IAK has been consolidation over the last several months near highs.
  • Currently on a “sell signal,” look for a reversal for a potential entry opportunity.
  • Ideally some more consolidation that works off the short-term overbought condition would be best.
  • Short-Term Positioning: Neutral
    • Stop set at $68
  • Long-Term Positioning: Neutral

SOXX – iShares Semiconductor Index

  • SOXX has had very good performance this year despite ongoing trade wars and concerns about inventory problems.
  • The “buy signal” is intact with SOXX breaking out of its consolidation a few days ago. This sets the sector up for higher highs as the Government extends licenses to sell products to Huawei.
  • There is “value” in the sector, why we recently added MU to our portfolios, but there is no need to rush into a position just yet. Look for a bit of a pullback or consolidation to take on a position.
  • Short-Term Positioning: Bullish
    • Stop set at $210
  • Long-Term Positioning: Bullish

IBB – iShares Biotechnology

  • IBB has finally broken above the downtrend AND has triggered a “buy signal.”
  • The sector is not extremely overbought, which gives some decent upside to the sector.
  • Look for a break above resistance at $110 to add a position.
  • Short-Term Positioning: Bullish
    • Stop-loss after purchases $104.00
  • Long-Term Positioning: Neutral

PBJ – iShares Food & Beverage

  • PBJ had a terrific advance earlier this year but the rotation from “defense” to “offense” has taken hold. (This is why we sold MDLZ and YUM in our portfolios.)
  • Currently on a “sell signal” the sector is in full correction mode and is NOT grossly oversold yet.
  • We recommend reducing or eliminating holdings if long for now and look for a better entry point later.
  • Short-Term Positioning: Bearish
    • Stop-loss set at $33.50
  • Long-Term Positioning: Neutral

IYK – iShares Consumer Goods

  • Consumer goods have continued to perform well so far, but are in a very tight trading range.
  • A break to the downside will likely be very sharp so we suggest taking profits if you are long the sector.
  • The sector is grossly overbought on multiple levels so be patient adding exposure to portfolios.
  • Short-Term Positioning: Neutral
    • Stop-loss set at $125
    • Long-Term Positioning: Neutral

IAT – iShares Regional Banks

  • With the Fed back in QE mode, it isn’t surprising to see regional banks pick up a bit.
  • The breakout of consolidation is encouraging but with the sector very overbought look for a bit of a pullback to add exposure.
  • A buy signal is in place which supports the idea of a further advance given the right entry point.
  • Short-Term Positioning: Bullish
    • Stop-loss set at $46
    • Long-Term Positioning: Bullish

IEZ – iShares Oil & Equipment Services

  • We recently added to our holdings of XOM in the Equity Portfolio because the sector is very beaten up.
  • IEZ has been deeply routed and is extremely oversold. With the “sell signal” set to trigger, a break above $18 should provide a tradeable opportunity short-term.
  • The risk reward for a trade is not bad with an entry at $18 and a stop at $16
  • Wait for a confirmed buy signal and break above the trendline before buying.
  • Short-Term Positioning: Bearish / Trading Opportunity
    • Stop-loss after entry set at $16
  • Long-Term Positioning: Bearish

Corporate Profits Are Worse Than You Think

Corporate profits are worse than you think.

In a recent post, I discussed the deviation of the stock market from corporate profitability. To wit:

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

It isn’t just the deviation of asset prices from corporate profitability which is skewed, but also reported earnings per share. As I have discussed previously, the operating and reported earnings per share are heavily manipulated by accounting gimmicks, share buybacks, and cost suppression. To wit:

“It should come as no surprise that companies manipulate bottom line earnings to win the quarterly ‘beat the estimate’ game. By utilizing ‘cookie-jar’ reserves, heavy use of accruals, and other accounting instruments they can mold earnings to expectations.

‘The tricks are well-known: A difficult quarter can be made easier by releasing reserves set aside for a rainy day or recognizing revenues before sales are made, while a good quarter is often the time to hide a big ‘restructuring charge’ that would otherwise stand out like a sore thumb.

What is more surprising though is CFOs’ belief that these practices leave a significant mark on companies’ reported profits and losses. When asked about the magnitude of the earnings misrepresentation, the study’s respondents said it was around 10% of earnings per share.’

This is also why EBITDA has become an ineffective measure of financial strength. As I noted in “What To Watch For This Earnings Season:”

cooking-the-books-2

“As shown in the table, it is not surprising to see that 93% of the respondents pointed to ‘influence on stock price’ and ‘outside pressure’ as the reason for manipulating earnings figures. For fundamental investors this manipulation of earnings skews valuation analysis particularly with respect to P/E’s, EV/EBITDA, PEG, etc.”

Ramy Elitzur, via The Account Art Of War, expounded on the problems of using EBITDA.

“Being a CPA and having an MBA, in my arrogance I thought that I am well beyond such materials. I stood corrected, whatever I thought I knew about accounting was turned on its head. One of the things that I thought that I knew well was the importance of income-based metrics such as EBITDA and that cash flow information is not as important. It turned out that common garden variety metrics, such as EBITDA, could be hazardous to your health.”

The article is worth reading, and chocked full of good information; however, here are four-crucial points:

  1. EBITDA is not a good surrogate for cash flow analysis because it assumes that all revenues are collected immediately and all expenses are paid immediately, leading, as I illustrated above, to a false sense of liquidity.
  2. Superficial common garden-variety accounting ratios will fail to detect signs of liquidity problems.
  3. Direct cash flow statements provide a much deeper insight than the indirect cash flow statements as to what happened in operating cash flows. Note that the vast majority (well over 90%) of public companies use the indirect format.
  4. EBITDA just like net income is very sensitive to accounting manipulations.

The last point is the most critical. As discussed above, the tricks to manipulate earnings are well-known which inflates the results to a significant degree making an investment appear “cheaper” than it actually is.

As Charlie Munger once said:

“I think that every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

What About Those Corporate Profits?

Currently, the deviation between reported earnings and corporate profits is one of the largest on record. This is an anomaly that should, in reality, not exist.

However, it is worse than it appears.

There is an interesting company included in the calculation of corporate profits which is not widely recognized in most analysis. If you are astute follower of our blog, you may recognize this particular company by the size of their balance sheet as shown below.

Yes, you guessed it (and it’s in the title). It’s the Federal Reserve.

When the Treasury Department pays interest one the debt, an expense to the U.S. Government, the Federal Reserve takes that in as “profits” which is reported on their balance sheet. Then, at the end of the year, the Fed remits a portion of the “revenue” back to the Government.

These profits,” which are generated by the Federal Reserve’s balance sheet, are included in the corporate profits discussed here. As shown below, actual corporate profitability is weaker if you extract the Fed’s profits from the analysis.

To put this into perspective, the Federal Reserve generates more profit in the last quarter than Apple, Microsoft, JP Morgan, Facebook, Google, and Intel COMBINED.

It’s quite amazing.

Nonetheless, since the Fed’s balance sheet is part of the corporate profit calculation, we must include them in our analysis. While the media is focused on record operating profits, reported corporate profits are roughly at the same level as their were in 2011. Yet, the market has been making consistent new highs during that same period.

The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to “remain irrational longer than logic would predict,” but it never lasts indefinitely.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

As shown, when we look at inflation-adjusted profit margins as a percentage of inflation-adjusted GDP we see a clear process of mean-reverting activity over time. Of course, those mean reverting events are always coupled with recessions, crisis, or bear markets.

More importantly, corporate profit margins have physical constraints. Out of each dollar of revenue created there are costs such as infrastructure, R&D, wages, etc. Currently, one of the biggest beneficiaries to expanding profit margins has been the suppression of employment, wage growth, and artificially suppressed interest rates which have significantly lowered borrowing costs. Should either of the issues change in the future, the impact to profit margins will likely be significant.

The chart below shows the ratio overlaid against the S&P 500 index.

I have highlighted peaks in the profits-to-GDP ratio with the green vertical bars. As you can see, peaks, and subsequent reversions, in the ratio have been a leading indicator of more severe corrections in the stock market over time. This should not be surprising as asset prices should eventually reflect the underlying reality of corporate profitability.

It is often suggested that, as mentioned above, low interest rates, accounting rule changes, and debt-funded buybacks have changed the game. While that statement is true, it is worth noting that each of those supports are artificial and finite in nature.

Another way to look at the issue of profits as it relates to the market is shown below. When we measure the cumulative change in the S&P 500 index as compared to the level of profits, we find again that when investors pay more than $1 for a $1 worth of profits there is an eventual mean reversion.

The correlation is clearer when looking at the market versus the ratio of corporate profits to GDP. (Again, since corporate profits are ultimately a function of economic growth, the correlation is not unexpected.) 

It seems to be a simple formula for investors that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy doesn’t matter. 

It is hard to argue that point. However, with investors paying more today than at any point in history for each $1 of profit, the next mean reversion will be a humbling event.

But, that is just history repeating itself.

Bonds Are Stocks Without A Circuit Breaker

We are thrilled to introduce Samantha LaDuc, the Founder of LaDucTrading.com and the CIO at LaDuc Capital LLC. 

Samantha LaDuc is known for timing major inflection points in equities, commodities, bonds/rates, currencies and volatility. As a Macro-to-Micro strategic technical analyst, educator and trader, she makes her insights available to active traders and investors who want to minimize risk while seizing year-making opportunities.  


Don’t Overthink The Market. It’s Not That Smart.

That is what those with Consensus Opinions have done if they have stayed bullish. After all, there is evidence to support their claims:

  • Earnings on the S&P 500 almost tripled between 2009 and 2018 ($56.86 to $143.34) and the dividend grew by 144% ($21.97 to $53.61). The actual index price has more than quadrupled (4.6X) from $666 to $3060!
  • The S&P 500 index (excluding dividends) has compounded at over a 16% annual rate in that time, although the return from 2000 has only compounded 4.5% (and that is including dividends).

But there are those who feel strongly that ignorance is not bliss. We think and overthink the markets against the weight of evidence that is somewhere between Risk-Aware and Risk-Averse. It’s not a fair comparison, but I will use it anyway: Even Bernie Madoff had fabulous returns until he didn’t. In the same way, investors who are full of fear that the next correction will be “The Big One’ feel in large part this way because, like Madoff, there is no real price discovery. There is no way in fact to price risk!

As such, volumes have been historically low which means it is quite easy to move markets in either direction, especially if you are an Algo. The direction, just happens to be up. Nice for bulls that the designers of these algorithms programmed it this way! And that beats the alternative. Bears are not wishing for the markets’ demise. They are just having a hard time to trust these markets as corporate profits are declining, economic data is declining (labor market data are trailing indicators.), debt and deficits are exploding and inversion of yield curve shows big concerns from big investors.

Be Careful What You Ask For Bulls

A higher stock market could actually be its undoing. Money has flown out of equities and into bonds ever since the global financial crisis of 2008/2009, but especially since 2018 when Trump started the Trade War with China. This year has seen this trend continue:

Year-to Date (through October) Capital Flows per Bloomberg, EPFR Global

  • Cash: +$475B
  • Corporate Debt: +$320B
  • Government Bonds: +$60B
  • Global Equities: -$225B

But just as bonds have been bubbly, equities have risen in large part due to stock buybacks, fueled by cheap money made available from Fed monetary policy:

Ned Davis Research: S&P 500 would be 19% lower between 2011 and the first quarter of 2019 without buybacks. The broad market is up more than 125% in that time while net buybacks have totaled about $3.5 trillion.

So equities have risen strongly from a “generational low” in 2009 when Fed introduced QE. Combine higher earnings with consolidation of buying in Large Cap and Tech from passive investing (and a few central banks like Switzerland) and part of the advance can be explained. Include the availability of ‘cheap money’ made available from QE liquidity and Large Cap/Tech heavily weighted in the indices and we have the other part of the equation explaining the 10-year bull run. Now add in stock buybacks, which reduce the number of shares outstanding which inflates a company’s EPS contributing to its P/E expansion, which in turn triggers analysts to recommend these stocks to funds. And yet, actual fund flows favor bonds and cash over equities!

CEO Confidence is at historic lows and why wouldn’t it be? Why would they seek to expand production, risk not getting the return from that investment, when the Fed is communicating danger and Trump’s Trade War represents danger and global trade and earnings are both contracting without a trusted resolution in sight? Same thing goes for chasing all-time-highs in the stock market. So why wouldn’t both fall together in a deleveraging liquidity event?

There are plenty of wealth managers who understand this underlying dynamic and as a result have little to no trust in a market based on a closed-loop system of Fed money, Passive Investment, Algos and Stock Buybacks. Until now, there was also very little reason to jump in front of this train.

Bonds Are The New Stocks

At some point this momentum-driven bond bubble will be unwound. Granted, it is like a fully-loaded locomotive that needs miles and miles of track to even come to a stop so as not to derail, but wouldn’t it be logical, and somewhat ironic, if it is in fact higher equities that triggers the selling of bonds that causes the next market correction?

It’s going to plan perfectly when bonds roll over, structurally forcing rates to pop, then oil spikes with the Reflation trades (think inflation spike), while Momentum stocks are sold off because they’re overvalued relative to Value…and cause indices to correct. This move could be quicker than folks think as liquidity is ‘challenged’ in bonds sell off and Volatility in the bond market spills over into equities.  Samantha LaDuc 

Now let me add some more non-consensus opinion for a Bond Sell-Off: Impeachment prospects pick up and with it Elizabeth Warren’s chance of becoming President.

At risk: the practice of buying back shares as perceived by Presidential candidates to artificially raise prices for the benefit of management. Should this practice be limited or banned by an incoming President opposed to this practice – like Warren or Sanders, as both filed bills to do so and have announced as part of their economic platform in their election campaign – then the market should start to price this in. It hasn’t yet. But unlike stocks, there are no circuit breakers for bonds. And fixed income folks move together in large part so sudden moves can upend markets. Consider even below-investment grade bonds. They don’t trade anywhere near the volume the ETFs they populate. In a fast-moving bond market, those ETFs can sink hard and fast as the underlying collateral moves. But unlike their ETF equivalent that trades on the stock market with a ‘limit-down’ circuit breaker, the bonds will be under more pressure and settle with huge mark downs. Credit spreads will be widened and funding markets can freeze.


Ignorance Is Not Bliss

For over a decade, money has been coming out of equities and going into the bond market as investors continue to anticipate imminent market collapse. Investors were full of fear at the March 2009 lows and they are full of fear at the 2019 highs. Investors are so fearful that today they are willing to accept a 1.8% return on a 10-year U.S. treasury note rather than a near 2% return on the S&P 500. So in essence, ‘risk free money’ has been parked at the same time ‘risk free money’ from Fed policies of monetary easing has flooded markets with liquidity, which in turn has fueled stock buybacks and speculation.

But now there is a sense the Fed may be losing control. Now, Fed liquidity is going into Repo markets to backstop bank liquidity requirements (and concerns) to the tune of $1T to start over the next year, driving up the cost of collateral in their overnight financing activities. Fed liquidity is also needing to be printed to fund ever-growing fiscal deficits which are exploding and showing no signs of slowing. If it wasn’t for the Fed, and corporate stock buybacks, and a mountain in cash which private equity has leveraged, our markets wouldn’t be pushing through all time highs. They would be cut by a third. That is the growing body of fundamental evidence that the bears can point to when growling at the status quo of bulls’ complacency.

The great rotation out of bonds will probably be tested before proven. When bonds roll over, structurally forcing interest rates to pop, look for commodities to spike and the reflation trade to move higher in place of momentum trades. Be aware that as bonds sell off, unlike equities, they don’t experience controlled pockets of selling or slow distribution over weeks and months, and there is no backstop for ‘limit down’ selling which triggers halts. There is but one very teeny, tiny exit door. And their hedging strategies of shorting VIX will not help them. The unwind of the short VIX trade (currently at all time highs) would be unwound violently causing a sudden equity sell-off.

Forced Liquidation will beget forced liquidation in both bonds and equities. Favorites like AAPL and MSFT will need to be sold to meet margin calls. Shorting will not be a six-month ride down the waterfall like in 2008. A liquidity freeze is one thing, but a panic for USD, aka CASH, where there isn’t enough of it, globally, can morph into a liquidity flash crash event and convulse for both stock and bond sell-offs within weeks not months. Risk premiums will be so quickly elevated in this race for liquidity and in this time of quant funds and algos that even those who try to short, let alone protect, in the thick of this downdraft will be played by market makers.

And that’s why Bears are not ready to capitulate, as the risk is too great that a true liquidity crisis – for CASH – creates panic and in panic everything sells off – Even gold and bitcoin are not safe. Only those who are sitting on the sidelines will be in a position to pick up shares on the cheap.


LaDuc Trading/LaDuc Capital LLC Is Not a Financial Advisor, RIA or Broker/Dealer.  Trading Stocks, Options, Futures and Forex includes significant financial risk. We teach and inform. You enter trades at your own risk. Learn more.

Powell’s Revelation And A TIP For Defense

I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.” – Jerome Powell 10/30/2019

The recent quote above from Federal Reserve Chairman Jerome Powell is powerful, to say the least. We cannot remember a time in the last 30 years when a Fed Chairman has so clearly articulated such a strong desire for more inflation.

In particular, let’s dissect the bolded words in the quote for further clarification. 

  • “Really Significant”– Powell is not only saying that the Fed will allow a substantial boost to inflation but does one better by adding the word “really.”
  • “Persistent”– Unlike the prior few Fed Chairman who claimed to be vigilant towards inflation, Powell is clearly telling us that he will not react to inflation that is not only a “really significant” leap from current levels, but a rate that lasts for a while.
  • “Even Consider”– The language he uses here conveys the seriousness of the Fed’s commitment. The rise in inflation must not only be “really significant” but also “persistent.” Powell is saying both conditions must be met before they will even discuss rate hikes. A significant rise in inflation but one they do not deem to be persistent will not suffice. Nor would a persistent move in inflation but one they do not measure as significant. Both conditions must be present together based on his language.

We are stunned by the choice of words Powell used to describe the Fed’s view on inflation. We are even more shocked that the markets and the media are ignoring it. Maybe, they are failing to focus on the three bolded sections.

In fact, what they probably think they heard was:

I think we would need to see a move up in inflation before we consider raising rates to address inflation concerns.

Such a statement is more in line with traditional Fed-speak. The other alternative is that Powell has altered his language in so many different ways over the past year that nobody seems to be paying attention to his words anymore. If so, he has lost credibility.

This article presents Treasury Inflation-Protected Securities (TIPS) as a hedge against Jerome Powell and the Fed getting what they want.

Inflation and Stable Prices – Apples and Oranges

Before a discussion on using TIPS as a way to protect your investments from the deleterious effects of inflation, we need to examine how the Fed gauges inflation and debunk the narrative that terms inflation and price stability as one and the same. Price data going back about 250 years, as shown below, shows the stark difference between inflation and price stability.  

Data Courtesy: Lawrence H. Officer and Samuel H. Williamson, ‘The Annual Consumer Price Index for the United States, 1774-Present

The orange line plots annual price changes before the Fed was established in 1913. As shown, prices were volatile year to year, but cumulative inflation over the entire 138 year period was negligible at 23% or .15% annualized. Dare we say prices were stable?

Compare that to the era after the Fed’s creation (represented by the blue line above). Annual inflation rates were less volatile but largely positive. The cumulative growth of prices has been an astonishing 2491% in the post-Fed area, which equates to 3.1% annually. There is nothing stable about such massive price inflation. 

Here is another graph to shed more light on price stability.

Stable prices should be defined as prices that are constant. In other words, a dollar today can purchase the same basket of goods that it did yesterday. Inflation must be near zero over longer periods for this to occur.

The Fed’s definition of stable denotes a consistent rate of annual inflation. Based on their actions and words, they have little regard for the destruction of a dollar’s purchasing power caused by a steady inflation rate. The Fed benefits from this linguistic imprecision because it allows for economic expansion via the accumulation of debt while their Congressional mandates are achieved. This is why the Fed wants to produce inflation. It reduces the amount of debt on an inflation-adjusted basis. The Fed wants inflation but disguises it under the banner of price stability.

With Federal deficits now topping $1 trillion and corporate debt and consumer debt and financial liabilities at all-time highs as a percentage of GDP, we must think about hedging our equity and fixed income portfolios in case the Fed gets more inflation than the 2% goal they consider stable.

Despite what the Fed leads us to believe, they have little control over the rate of inflation and they do not know how to accurately measure it. As occurred 50 years ago, they can easily lose control of prices.

We urge you to focus on the forgotten leg of wealth, purchasing power. The opportunity costs of owning TIPS are minimal and the potential hedge value of TIPS tremendous. Change can happen in a hurry, and the only way to protect yourself or profit from it is to anticipate it.

The rest of this article is for RIA Pro subscribers only. If you are not a subscriber and want to learn about the mechanics of TIPS and how they can protect you in an inflationary or deflationary environment, please SIGN UP HERE for a 30-day free trial.

Selected Portfolio Position Review: 11-06-19

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

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

This week we are reviewing our recent portfolio changes, in case you missed last week’s alerts, and other potential changes on our list.

XOM – Exxon Mobil

  • As of two weeks ago, XOM was deeply oversold, and the energy sector was deeply out of favor. That is a setup for a rotation very often. With a 5% dividend yield we can afford to wait for a turn.
  • We added to our existing position last week. Total return so far since the addition is 5.18% as of the close yesterday.
  • We are still carrying a stop-loss on the position if our thesis doesn’t work out, but if there is a rally into the end of the year, we should see Energy pick up performance.
  • The position can still be bought on pullbacks during market corrections.
  • Stop is set at $66

MU – Micron Technologies

  • Previously, we noted that MU had improved in performance, and a removal of tariffs will likely clear the way for a move higher in semi-conductors.
  • With a P/E of 9, we like the valuation, and MU has now established a positive trend and held support.
  • There is some tough resistance at $50, and we are watching that carefully.
  • We added a full position to the portfolio last week on expectations of a push higher. Return is 9.86% since the addition and we will increase size above $50. The position can still be added on pullbacks.
  • Stop is moved up to $42.50.

AMZN – Amazon.com

  • We added a position in AMZN for the end of year shopping season. We got a little worried following the earnings announcement, but revenue growth remained solid.
  • AMZN tends to perform better during the shopping season, and with the very oversold condition, the risk/reward is descent for now.
  • Performance so far has been lackluster with the position only up 1.5% since our addition.
  • The long-term trend remains positive and a move above $1850 should clear the way to old highs. A position can still be added.
  • Stop loss is set at $1700

ABBV – Abbvie Corp.

  • ABBV had a massive correction and was deeply oversold.
  • With a buy signal recently triggered and breaking above resistance and the downtrend line from the old highs, we have added 1/2 position.
  • We will scale into ABBV on opportunity and in the meantime we like the 5% yield on the position to pay us while we wait. Return so far has been modest at 4.63% but we like the position longer-term.
  • Use pullbacks to add holdings.
  • Stop loss is set at $65

KHC – Kraft Heinz

  • Two weeks ago we talked about our speculative turnaround story in KHC. We still think that is the case and we added a “trading position” to the portfolio on October 30th.
  • Earnings came in a bit better than expected which popped the position above important overhead resistance. Return so far since our add is 16.90%.
  • With a 6% yield, and the stock turning higher, we are liking the position, BUT it is now extremely overbought short-term.
  • Wait for a correction that doesn’t break support to add holdings.
  • This remains a very speculative trade.
  • Stop has been moved up to $30.

MDLZ – Mondelez (Sold)

  • We noted last week that Mondelez had broken support but is holding its longer-term moving average.
  • We had taken profits in the position previously, but we decided to go ahead and cut the position from the portfolio last week.
  • That move paid off well, as the position has continued to erode.
  • Position has been sold.

WELL – Welltower, Inc. (Sold 1/2)

  • We have recently talked about the rotation from “defense” back to “offense” as QE gained traction in the market. That is occurring so we have reduce WELL from 1.5% of the portfolio to 0.75%.
  • We still like the position longer-term and will look to add back to holdings at lower levels.
  • As such we are looking at continuing to modify our positioning accordingly.
  • Stop loss has been adjusted to $82.50

YUM – Yum Brands (Sold)

  • Like MDLZ, YUM has come under pressure and earnings are weakening.
  • We made the decision to SELL the entire position last week.

EEM – Emerging Markets (Watch List)

  • As noted in yesterday’s major market commentary, EEM continues to underperform but is improving..
  • However, as noted last week, QE4 is bleeding into EEM if a performance chase begins for year-end positioning.
  • The current spurt higher is trying to break above resistance, but EEM is back to extremely overbought. So be patient on adding a position until we confirm the breakout is sustainable.
  • The sell signal reversed to a buy last week, so with the breakout, there is potential for EEM.
  • We are looking to add some exposure on any weakness and scale into our holding opportunistically.

MDYV – Mid-Cap Value (Watch List)

  • As noted in our report on QE programs previously, small and mid-cap value are benefactors of increased liquidity.
  • With the breakout of consolidation we are getting the entry opportunity we are looking for. The index is extremely overbought so a bit of a rest that holds the breakout will confirm a better entry point.
  • We will load 1/2 of the position initially and add the second 1/2 on a breakout above previous highs.
  • Stop loss will be set at $50

10 Financial Planning Rules You Shouldn’t Ignore.

Financial planning is misunderstood.

Ask consumers or brokers what financial planning means to them and the conversation steers toward the portfolio or a pitch for investment and insurance products.

“I asked for a financial plan –  he gave me a brochure about long-term care insurance.” Anonymous.

So, you’re considering holistic financial planning? I commend you. 

Here Are The 10-Rules

Rule #1 – Take a holistic approach to every financial decision.

Money doesn’t exist in a vacuum; money is fungible.

  • Consider money concerns as a circle, or a wave. There’s a ripple effect to every decision you make on every facet of your financial picture.
  • Proper planning integrates every asset, liability and source of income along with your ability to save, invest, manage risk and debts.

How did you make your decision about when to take Social Security? I spoke to my – neighbor, relative, friend, the guy at Kroger’s.

Rule #2 – Be smart when it comes to household Social Security planning.

Take the emotion and politics out of your decision-making process.

  • Most recipients will take Social Security early thus cutting at least 20% of lifetime benefits from them and their spouses. A majority work with financial advisors who are not trained in social security strategies.
  • The goal is to maximize benefits for you and your spouse, or surviving children.
  • Since Social Security may be taxable, work with you financial professional to create a coordinated portfolio withdrawal strategy.

Rule #3 – Take an objective view of your health; include healthcare costs and proper rates of inflation in your process.

According to the Kaiser Foundation, Medicare Beneficiaries spent an average of $5,460 out-of-pocket for healthcare in 2016 with some groups spending substantially more.

  • Health care cost inflation can be twice the stated rate of inflation. Ignoring in your planning can be a mistake.
  • Pre-Retirees can contact their insurance company to keep track of health care expenses for planning purposes.
  • Retirees also must do the same and re-examine their coverage during Medicare open enrollments (which ends December 7th.)
  • Average health care expenses in retirement are $220-320,000 based on annual studies.

Rule #4 – Ground your mindset in financial awareness.

If I ask you to explain your greatest financial weakness, I bet you know it off the top of your head.

  • Those who maintain a money awareness and gain a “sixth sense” about spending, debt and investing are the ones with the best “plan” outcomes.
  • Overspending, “Keeping Up With The Jones,’” and not saving assures poor plan outcomes.
  • Outline your money philosophy in two sentences.
  • Work backwards to understand how it was formed. Most likely parents and grandparents forged your money frame of reference.
  • Meet with a Certified Financial Planner to  help you reprogram a negative mindset and identify financial strengths.

Rule #5 – Prioritize needs, wants and wishes BEFORE beginning a comprehensive planning process.

A holistic plan needs to be based on the financial life benchmarks you seek to achieve.

  • Begin with needs. They are the priorities. How much do you require for rent, mortgage, insurance, for example?
  • Then, wants: The fun stuff and other expenses are secondary benchmarks to strive for. Day trips? A second home?
  • Last are your wishes: GO for the gusto! List the big bucket list items. Can your plan handle them?
  • The responsibility of you and your planner is to come up with a workable,  personal plan that works. It’s a give and take. You must remain flexible to be successful.
  • Perhaps it’ll take saving 10% more a year, downsizing, working two more years. Regardless, an action plan needs to be created, worked and monitored.

Rule #6 – Conversations, conversations, conversations!

A successful, workable financial plan must be aligned with open dialogue with people who are important to the implementation of facets of your plan.

  • Utilize your financial planner to facilitate family discussions if you’re reluctant.
  • Intentions must be clear when it comes to gifting and estate plans.
  • Don’t allow misunderstandings to generate family tensions after you’re gone.
  • Lifetime gifting strategies, especially of family heirlooms, should be based on open communication with proposed recipients to make sure the right gifts are destined for the ‘right’ people.

Rule #7 – Don’t be fooled by market averages.

A plan must include realistic rates of return for asset classes based on risk-asset valuations.

  • Financial markets don’t consistently return 8% a year.
  • Understand the cycle you’re retiring into.
  • A realistic plan includes variability of returns, including losses, over time.
  • Retirement income withdrawal plans should be ‘stress-tested’ through real-world market cycles to manage sequence of return risk.
  • Income withdrawal plans should be reviewed every three years.

Rule #8 – Accountability matters.

A financial plan is the beginning, not an end. A plan is an ongoing process that requires monitoring and ‘check ins’ to make sure life benchmarks are being reached.

  • A plan is NOT a loss leader. Financial services firms use ‘free plans’ to get to the good part. The part where you’re placed in expensive managed money products.
  • A plan is the structure where your portfolio and investment philosophy lives and thrives.
  • Long-term financial goals should be broken down to monthly objectives.
  • You and your financial partner together, are responsible for meeting those objectives.

Rule #9 – Understand your Medicare options.

Studies show that most retirees will overpay for  supplemental coverage or fail to understand when to begin Medicare Part A and especially Part B.

  • A Kaiser Foundation study found that relatively few people have used the annual enrollment period to switch Part D prescription drug plans.
  • The relatively small share of PDP enrollees who switched plans at some point between 2006 and 2010 were more likely than those who did not switch to end up in a plan that lowered their premiums. 
  • Nearly half (46%) of enrollees who switched plans saw their premiums fall by at least 5% the following year, compared to 8% of those who did not switch plans. 
  • Plans should be assessed annually during Medicare open enrollment to determine whether the current insurance fits your needs at the lowest possible premium costs.
  • Tracking healthcare costs can help retirees determine how fast their costs are rising. From there, financial plans can be customized for personal healthcare inflation.

Rule #10 – A plan is never perfect. 

A plan represents a human life and life rarely goes the way we expect.

  • If you seek perfection, you’ll never retire or hit the benchmarks sought.
  • If you embrace realistic expectations, a plan is always successful. It can be worked and fine-tuned over years.
  • A financial plan is a snapshot along the road of a long and winding financial path.
  • Over time, those photos no longer represent the final destination for the goals outlined.
  • Twists and turns must be expected and plans revised.

If done properly, comprehensive planning can provide invaluable insight to your financial health; applaud strengths and expose weaknesses which require attention. 

I hope you find these rules helpful.

For objective hourly-based planning, RIA’s deep bench of tenured Certified Financial Planners are here to partner with you.

Sector Buy/Sell Review: 11-05-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • We are continuing to look to increase weighting slightly to Materials particularly since the current “sell signal” has been reversed.
  • XLB is extremely overbought short-term so look for a bit of consolidation or pullback, which does not reverse the “buy signal” to add to positions.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • XLC held important support and has now rallied back to previous resistance at the highs but has been unable to establish new highs as of yet.
  • A reversal of the “sell signal” should help lift the sector higher, but in the short-term XLC is extremely overbought.
  • XLC is currently a full-weight in portfolios but should perform better if a year-end advance ensues.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $47.50
  • Long-Term Positioning: Bearish

Energy

  • We have noted previously, that XLE needs to move higher which it has done as of late.
  • The “sell signal” is once again in the process of being reversed With relative performance improving, we may see more gains. However, a break of the current downtrend is a must before adding exposure.
  • While there is “value” in the sector, there is no need to rush into a position just yet. The right opportunity and timing will come, it just isn’t right now.
  • We were stopped out of our position previously but are looking to add a small piece back to the portfolio for now as we should catch some cyclical rotation into the end of the year.
  • Short-Term Positioning: Bearish
    • Last week: Stopped out.
    • This week: Stopped out.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF finally broke out to new highs which makes it much more interesting to add to the portfolio.
  • The sector is extremely overbought, but on a buy signal, so a pull back or consolidation is required to add holdings into the portfolio.
  • We previously closed out of positioning as inverted yield curves and Fed rate cuts are not good for bank profitability. That is still the case, however, the sector is performing technically which we can not ignore.
  • We will see if a break above resistance can hold before adding exposure back into portfolios for a “trading basis” only.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • Like XLF, XLI broke out to new highs. After a long-consolidation, this is an important development.
  • As with Materials above, a rotation into cyclical exposures is likely heading into year end, so we are looking for a bit of consoldation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • We have adjusted our stop-loss for the remaining position. We are looking to add back to our holdings on a reversal to a buy signal.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $75
  • Long-Term Positioning: Neutral

Technology

  • XLK is back to a more extreme overbought condition, but has now broken out of the consolidation. Given technology makes up about 1/5th of the S&P 500 weighting, this sector is dragging the whole market higher.
  • We are currently target weight on Technology, but may increase to overweight on a confirmed breakout. (A retest of the breakout that holds) The upper rising trendline is also providing resistance so look to add on a pullback that holds the lower trendline support.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $77.50
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform a little “less well” as of late as money is rotating from some defensive areas.
  • XLP continues to hold its very strong uptrend but is threatening to break that support. If it does, it could lead to a rather abrupt sell off.
  • The “buy” signal (lower panel) is still in place but is threatening to turn into a sell if performance doesn’t pick up soon.
  • We previously took profits in XLP and reduced our weighting from overweight. We will likely look to reduce further when opportunity presents itself.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $58
    • Long-Term Positioning: Bullish

Real Estate

  • As noted last week, XLRE was consolidating its advance within a very tight pattern.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. XLRE reversed the breakout this past week, and is now testing support again.
  • Buy signal has been reduced which is bullish for now.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLP and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup. We may be getting an opportunity here soon if support can hold as the overbought condition is reversed. Watch the $63 level.
  • Long-term trend line remains intact but XLU is grossly deviated from longer-term means. A correction back to the uptrend is underway and needs to hold without breaking lower.
  • Interest rates will be key here.
  • We took profits recently but will likely do more if performance continues to struggle.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and is trying to breakout to new highs. With the “buy signal” now triggered, healthcare is much more interesting.
  • As noted previously, healthcare will likely begin to perform better soon if money begins to look for “value” in the market. We are looking for entry points to add to current holdings and we added a new holding in the Equity portfolio.
  • We continue to maintain a fairly tight stop for now, but look for a reduction of the overbought condition to add weight to the sector.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY has taken the sector back to previous highs where resistance sits currently.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is struggling to reverse back to a buy signal, and overhead resistance is going to problematic short-term.
  • Hold current positions for now, as the Christmas Shopping Season is approaching, which should help push the sector higher. However, the dismal performance relative to other sectors of the markets suggests not adding new/additional exposure currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN is making another attempt at recent highs and will be interesting to see if this breakout can hold.
  • With a “buy” signal in place, combined with the fact XTN is not overbought, a better setup is forming to add holdings.
  • If this breakout holds we will look to add, but there is not a rush to do anything.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: Everyone Is Swimming In The “Deep End.”

With the market breaking out to all-time highs, the media has started to once again reach for their party hats as headlines suggest clear sailing for investors ahead.

After all, why not?  

  • The Federal Reserve cut rates for the 3rd time this year.
  • The Fed is also back in the “QE” game of buying bonds.
  • President Trump has “surrendered” to China in order to end the “trade war.” 
  • Corporate stock buybacks are on track for the second largest year on record.
  • Earnings, due to buybacks, are beating lowered estimates, 
  • Consumer sentiment remains near record highs; and,
  • Economic data is weak, but not terrible.

With those supports in place, markets are pushing new highs as we discussed would likely be the case last month:

“Assuming we are correct, and Trump does indeed ‘cave’ into China in mid-October to get a ‘small deal’ done, what does this mean for the market. 

The most obvious impact, assuming all ‘tariffs’ are removed, would be a psychological ‘pop’ to the markets which, given that markets are already hovering near all-time highs, would suggest a rally into the end of the year. “

This is not the first time we presented analysis for a “bull run” to 3300. To wit:

“The Bull Case For 3300

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

All the boxes have been checked.

Even more important than these supports, is the overall psychology of the markets. As Doug Kass recently noted, investors “want to believe.” 

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

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

The “need to believe” is a powerful force which has lured investors back into the “warm waters of complacency.”  The sentiment is certainly understandable given the market’s advance which has triggered investor’s “Pavlovian” response to the ringing of “the bell.” This was shown recently by a series of charts from Sentiment Trader.

Everyone Back In The Pool

As asset prices have escalated, so have individual’s appetite to chase risk. The herding into equities suggests that investors have thrown caution to the wind.

With cash levels at the lowest level since 1997, and equity allocations near the highest levels since 1999 and 2007, it suggests investors are now functionally “all in.” 

With net exposure to equity risk by individuals at historically high levels, it suggests two things:

  1. There is little buying left from individuals to push markets marginally higher, and;
  2. The stock/cash ratio, shown below, is at levels normally coincident with more important market peaks.

But it isn’t just individual investors that are “all in,” but professionals as well.

Importantly, while investors are holding very little “cash,” they have taken on a tremendous amount of “risk” to chase the market. It is worth noting the current levels versus previous market peaks.

Importantly, what these charts clearly show is there is nothing wrong with aggressively chasing the markets, until there is.

As Doug Kass often states: “Risk happens fast.”

Which brings me to something Michael Sincere’s once penned:

“At market tops, it is common to see what I call the ‘high-five effect’ — that is, investors giving high-fives to each other because they are making so much paper money. It is happening now. I am also suspicious when amateurs come out of the woodwork to insult other investors.”

Michael’s point is very pertinent, particularly today. As shown in the two charts below, investors are clearly “high-fiving” each other as risk aversion hits near record lows.

While the fundamental backdrop of the market has materially weakened, the confidence of individuals has surged. Of course, as the markets continue their relentless rise, investors feel “bullet proof” as investment success breeds overconfidence. 

As Sentiment Trader shows, retail investors (dumb money) are currently pushing levels which have typically denoted short-term market peaks, This should not be surprising as individuals, with regularity, “buy tops and sell bottoms.”

Strongly rising asset prices, particularly when driven by emotional exuberance, “hides” investment mistakes in the short term. Poor, or deteriorating, fundamentals, excessive valuations and/or rising credit risk is often ignored as prices increase. Unfortunately, it is after the damage is done that the realization of those “risks” occurs.

Regardless of what you believe, a “bear market” will eventually come. We don’t/won’t know what will trigger it, but some unforeseen exogenous event will start a “flight to safety” by investors. The chart below is the “bear market” probability model from Sentiment Trader. Importantly, note the index peaks a couple of years before the onset of a “bear market.” (The last peak was in 2015)

Here is the point, despite ongoing commentary about mountains of cash on the sidelines, this is far from the case. This leaves the current advance in the markets almost solely in the realm of Central Bank activity.

Again…there is nothing wrong with that, until there is.

Which brings us to the ONE question everyone should be asking.

“If the markets are rising because of expectations of improving economic conditions and earnings, then why are Central Banks pumping liquidity like crazy?”

Despite the best of intentions, Central Bank interventions, while boosting asset prices may seem like a good idea in the short-term, in the long-term it harms economic growth. As such, it leads to the repetitive cycle of monetary policy.

  1. Using monetary policy to drag forward future consumption leaves a larger void in the future that must be continually refilled.
  2. Monetary policy does not create self-sustaining economic growth and therefore requires ever-larger amounts of monetary policy to maintain the same level of activity.
  3. The filling of the “gap” between fundamentals and reality leads to consumer contraction and ultimately, a recession as economic activity recedes.
  4. Job losses rise, wealth effect diminishes, and real wealth is destroyed. 
  5. The middle-class shrinks further.
  6. Central banks act to provide more liquidity to offset recessionary drag and restart economic growth by dragging forward future consumption. 
  7. Wash, Rinse, Repeat.

If you don’t believe me, here is the evidence.

The stock market has returned more than 100% since the 2007 peak, which is more than 2.5x the growth in corporate sales and almost 5x more than GDP. The all-time highs in the stock market have been driven by the $4 trillion increase in the Fed’s balance sheet, hundreds of billions in stock buybacks, PE expansion, and ZIRP.

What could possibly go wrong?

However, whenever there is a discussion of valuations, it is invariably stated that “low rates justify higher valuations.” 

Maybe.

But the argument suggests rates are low BECAUSE the economy is healthy and operating near full capacity.

The reality is quite different.

The main contributors to the illusion of permanent prosperity have been a combination of artificial and cyclical factors. Low interest rates, when growth is low, suggests that no valuation premium is “justified.“’

Currently, investors are taking on excessive risk, and thereby virtually guaranteeing future losses, by paying the highest S&P 500 price/revenue ratio in history and the highest median price/revenue ratio in history across S&P 500 component stocks. This valuation problem was discussed last week by our friends at Crescat Capital. To wit:

There are virtually no measures of valuation which suggest making investments today, and holding them for the next 20-30 years, will work to any great degree.

That is just the math.

The markets are indeed bullish by all measures. From a trading perspective, holding risk will likely pay off in the short-term. However, over the long-term, the “house will win.”

Just remember, at market peaks – “everyone’s in the pool.”

Cartography Corner – November 2019

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

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

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

GTA Users Guide


A Review of October

Random Length Lumber Futures

We begin with a review of Random Length Lumber Futures (LBX9, LBF0) during October 2019. In our October 2019 edition of The Cartography Corner, we wrote the following:

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

  • o M4         447.90
  • o M1         407.70
  • o PMH       393.50
  • o Close      367.10
  • MTrend   364.03
  • M3           363.20
  • M2         357.10             
  • PML        348.10                         
  • M5           316.90

Active traders can use 363.20 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

In our October edition, we anticipated a breakout from consolidation and recognized our ignorance as to which direction by highlighting, “The lumber market has been building energy for the next substantial move for four quarters and four months, respectively.  Relative to our technical methodology, it is a 50-50 proposition as to which direction.”

Figure 1 below displays the daily price action for October 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first eight trading sessions were spent with Lumber oscillating around our isolated pivot level of 363.20.  Longs and shorts were battling to establish a sustained directional move away from equilibrium at MTrend: 364.03. 

Astute readers will notice that the low price of the month was realized at the price of 357.50.  That price was four ticks above October’s M2 level of 357.10.  M2 was the first monthly support level under our isolated pivot.

The following seven trading sessions were spent with Lumber making an assault upon, and settling above, September’s high at PMH: 393.50.  The final eight trading sessions saw Lumber achieve and exceed our isolated resistance level at M1: 407.70.

Conservatively, active traders following our analysis had the opportunity to capture most of the trade up which equated to an approximate 10.5% profit. 

Figure 1:

E-Mini S&P 500 Futures

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

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

  • M4                 3275.75
  • M1                 3037.25
  • M3                 3032.25
  • PMH              3025.75
  • M2               3002.25      
  • Close             2978.50
  • MTrend         2952.81     
  • PML               2889.00     
  • M5                2763.75

Active traders can use 3037.25 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 2952.81 as the downside pivot, whereby they maintain a flat or short position below that level.

Figure 2 below displays the daily price action for October 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  We commented in October, “… the slope of the Weekly Trend could be in the initial stage of forming a rounded top.”  The first two- and one-half trading sessions of October saw the market price descend 123.50 points from September’s settlement price.  The decline accelerated once it settled below our isolated pivot level at MTrend: 2952.81.

The low price for the month was realized (early in the session) on Thursday, October 3rd at the price of 2855.00.  Please pay attention to the commentary that follows next, as it highlights the importance of our multi-time-period analysis.  The Weekly Downside Exhaustion level for the week of September 30th was at W5: 2868.00.  Once our Weekly Downside Exhaustion level was reached, we were immediately anticipating a two-week high to occur over the following four to six weeks.  This was reason one to cover any shorts.  Quarterly Trend for the fourth quarter of 2019 resides at 2840.92.  As we have communicated before, this is the most important level in our analysis and, at a minimum, we expect Quarterly Trend to be defended vigorously on the first approach.  This was reason two to cover any shorts.  By the time of the market’s close on October 3rd, the price had rotated back above September’s low price at PML: 2889.00.  The following five trading sessions were spent with the market price oscillating between MTrend: 2952.81, now acting as resistance, and support at PML: 2889.00.

On October 11th, the market price ascended above and settled above MTrend: 2952.81.  This afforded the market the opportunity to make an assault on our next isolated resistance level at M2: 3002.25.  Two trading sessions later, on October 15th, the market price achieved a high price of 3003.25.  This is notable because it achieved the two-week high that we were anticipating from October 3rd.   The following five trading sessions were spent with the market price oscillating around our isolated resistance level at M2: 3002.25.

On October 23rd, the market price settled above M2 and began its final ascent into the October 30th FOMC meeting.  It is worth noting that the market did not settle above our isolated upside pivot level at 3037.25 prior to October 30thWith one trading session remaining in October, common sense suggested waiting for November’s analysis to be produced in lieu of committing capital on the day of the FOMC meeting.

Humbly offered, our analysis captured the trade down early in the month, the rally into the pre-FOMC high, and the significant pivots in between.

Figure 2:

November 2019 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESZ9).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Daily Trend             3038.39       
  • Current Settle         3035.75
  • Weekly Trend         2980.58       
  • Monthly Trend        2950.42       
  • Quarterly Trend      2840.92

In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures have been “Trend Up” for three quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures have been “Trend Up” for five months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures have been “Trend Up” for three weeks.  The relative positioning of the Trend Levels is bullishly aligned.  The market price is above all of them (with exception of Daily Trend) which is bullish as well.

In the monthly time-period, the “signal” was given in August 2019 to anticipate a two-month high within the following four to six months.  That two-month high was realized in October 2019, with the trade above 3025.75.

 

Support/Resistance:

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

  • M4                 3221.00
  • M3                 3093.00
  • M1                 3084.25
  • PMH              3055.00
  • Close             3035.75     
  • MTrend         2950.42
  • PML               2855.00     
  • M2                 2821.00    
  • M5                2684.25

Active traders can use 3055.00 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 2950.42 as the downside pivot, whereby they maintain a flat or short position below that level.

New Zealand Dollar Futures

For the month of November, we focus on New Zealand Dollar Futures (“Kiwi”).  We provide a monthly time-period analysis of 6NZ9.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Quarterly Trend    0.6640           
  • Current Settle       0.6416
  • Daily Trend           0.6382           
  • Monthly Trend      0.6361           
  • Weekly Trend        0.6354

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

In the monthly time-period, the “signal” was given in August 2019 to anticipate a two-month high within the following four to six months.  That two-month high can be realized in November 2019 with a trade above 0.6462.

Our first priority in performing technical analysis is to identify the beginning of a new trend, the reversal of an existing trend, or a consolidation area.  With that in mind, we chose to focus on Kiwi for the month of November.  Since its peak in 2Q2017, Kiwi has traded down in five of the previous eight quarters.  In the calendar year 2019, it has only traded up in three months out of ten.  But something caught our attention… Monthly Trend for November has “quietly tiptoed” beneath the market.  In our judgment, the risk-reward is favorable for anticipating a trend reversal.    

Support/Resistance:

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

  • M4         0.6627
  • M3         0.6558
  • PMH       0.6444
  • M1         0.6426
  • Close       0.6416
  • MTrend   0.6361
  • PML        0.6215             
  • M2         0.6169                         
  • M5           0.5968

Active traders can use 0.6361 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

 

Summary

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

15-Extreme Risks & How You Can Navigate Them

Willis Towers Watson’s Thinking Ahead Institute (TAI) recently revealed what it considers the 15-extreme risks facing investors for 2019, as well as for the years ahead. The risks run the gamut from climate change to nuclear contamination.

TAI’s research suggests, broadly, there are three hedging strategies available to institutions:

  • Hold cash. Over long historical periods cash has held its real value through both episodes of deflation and inflation but there is no guarantee that this will be the case in the future.
  • Derivatives. It is worth mentioning that cost and usefulness are often in opposition. The cost of derivatives protection can often be reduced by specifying more precise conditions – but the more precise the conditions, the greater the chance that they are not exactly met and hence the ‘insurance’ does not pay out.
  • Hold a negatively-correlated asset. There is no single asset that will work against all possible bad outcomes. Further, there is no guarantee that the expected performance of the hedge asset will actually transpire in the future event.

While we have regularly discussed the“value of holding cash,” and “hedging” within portfolios, for most investors there are only a limited number of options available. The problem becomes magnified by the lack of capital, and a disciplined investment strategy,  to delve into and manage more complex risk mitigation strategies. Therefore, investors are simply told to “buy and hold,” and hope for the best.

Since institutions are actively hedging capital risk, it should be clear “buy and hold” strategies do not. However, there are actions you can take to navigate not only short-term market risk, but also long-term fundamental, economic, and environmental risks.

Navigating the Risks

Many of the risks detailed in the TAI report are emotional in nature. For example, climate change is a very long-term issue but has become a political football for the upcoming election. While comments about the “world ending in 12 years” will certainly get headlines, they could also lead individuals into making emotionally based investment decisions that could negatively affect their financial wealth over the longer term.

So, what can you do?

All market cycles ultimately end. What causes those endings are often unexpected events that abruptly disrupt the financial markets.

Since the current bull market cycle has returned more than 300% from the financial crisis lows, it is quite likely that by going to cash today an individual would outperform someone who stayed invested in the years ahead. The next “mean-reverting event,” when it occurs, will destroy most if not all of the returns accumulated over the last decade. (That isn’t a theoretical assumption. It’s historical fact.)

It is true you can’t “time the market,” but you can manage risk by adjusting market exposure at times when risk outweighs the potential for further reward. What’s important to avoid is the “time loss” required to “get back to even.” In the long run, the mitigation of risk should allow the portfolio to reach your investment goals.

One way to visualize this is to use a moving average crossover as the trigger to increase or reduce exposure. The Timing Portfolio in the chart below is a simple switch between two assets. It invests in the Vanguard S&P 500 index when the market is above the 12-month moving average, and switches to the Vanguard Bond Fund when the market is below it. The Buy & Hold Portfolio stays 100% invested in the Vanguard S&P 500 for the duration. (You can run this backtest yourself at Portfolio Visualizer.)

It is very difficult for the average investor to manage a portfolio this way, but the chart shows the benefit of mitigating risk.

This is why we created RIAPro.net (Try FREE For 30-Days), where we provide investors with strategies for not only investment selection, but also risk management.

The same strategies we provide our subscribers, are what you can do to take control of your portfolio and investment related risk. Having a defined set of guidelines, and a disciplined investment process, can help reduce risk and create returns over time.

Here are the rules of thumb we follow in our management process at RIAPro.net.

  1. Cut losers short and let winner’s run(Be a scale-up buyer into strength.)
  2. Set goals and be actionable. (Without specific goals, trades become arbitrary and increase overall portfolio risk.)
  3. Emotionally driven decisions void the investment process.  (Buy high/sell low)
  4. Follow the trend. (80% of portfolio performance is determined by the long-term, monthly, trend. While a “rising tide lifts all boats,” the opposite is also true.)
  5. Never let a “trading opportunity” turn into a long-term investment. (Refer to rule #1. All initial purchases are “trades,” until your investment thesis is proved correct.)
  6. An investment discipline does not work if it is not followed.
  7. “Losing money” is part of the investment process. (If you are not prepared to take losses when they occur, you should not be investing.)
  8. The odds of success improve greatly when the fundamental analysis is confirmed by the technical price action. (This applies to both bull and bear markets)
  9. Never, under any circumstances, add to a losing position. (As Paul Tudor Jones once quipped: “Only losers add to losers.”)
  10. Market are either “bullish” or “bearish.” During a “bull market” be only long or neutral. During a “bear market”be only neutral or short. (Bull and Bear markets are determined by their long-term trend as shown in the chart below.)
  11. When markets are trading at, or near, extremes do the opposite of the “herd.”
  12. Do more of what works and less of what doesn’t. (Traditional rebalancing takes money from winners and adds it to losers. Rebalance by reducing losers and adding to winners.)
  13. “Buy” and “Sell” signals are only useful if they are implemented. (Managing a portfolio without a “buy/sell” discipline is designed to fail.)
  14. Strive to be a .700 “at bat” player. (No strategy works 100% of the time. However, being consistent, controlling errors, and capitalizing on opportunity is what wins games.)
  15. Manage risk and volatility. (Controlling the variables that lead to investment mistakes is what generates returns as a byproduct.)

We agree with Tim Hodgson’s conclusion:

“To navigate through this complex world, we suggest investors need to be open-minded, avoid concentrated risks, be sensitive to early warning signs, constantly adapt and always prepare for the worst.” 

Investing is not a competition.

It is a game of long-term survival.

Major Market Buy/Sell Review: 11-04-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

This update focuses on the impact the “trade deal” announced on Friday will have on each market going forward.

S&P 500 Index

  • With the Fed’s QE back in play, the S&P 500 finally broke out to all-time highs this past week.
  • With a “buy signal” triggered, there is a positive bias and with the noted breakout, we simply need a reasonable entry point to add exposure. Look for a consolidation or pullback which reduces the short-term extreme overbought condition.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position with a bias to add to holdings.
    • Stop-loss remains at $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • DIA has not yet made new highs with conviction.
  • DIA has reversed its previous “Sell signal” and remains in an uptrend.
  • Hold current positions, but wait for confirmation of a breakout before adding more broad market exposure. With markets very overbought short-term a correction is likely before a further advance.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $260.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • The technology heavy Nasdaq also broke out to new highs this past week along with the S&P 500.
  • The “Sell signal” was also reversed, so positions can be added opportunistically.
  • QQQ is back to EXTREME overbought short-term so remain a cautious adding exposure. A correction is likely which will provide a much better entry point.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $185
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • One of the markets which historically perform the best under QE is small caps.
  • However, while small-caps have popped on a lot of short-covering, it failed to get above the resistance. With the index now back to overbought, be patient on adding exposure until a confirmed break above resistance is in place.
  • We are looking to potentially add a trading position but need confirmation the recent rally isn’t just another trap.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss previously violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY, unlike SLY, finally broke above downtrend resistance on Friday.
  • MDY has now registered a short-term “buy” signal, but needs to be confirmed by a solid break above resistance. That has yet to occur, so be patient for now.
  • MDY is back to overbought so, like small-caps, it is make or break if mid-caps are going to make a move higher.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. However, as noted last week, QE4 has pushed EEM sharply higher over the last week.
  • The current spurt higher is trying to break above resistance, but EEM is back to extremely overbought. So be patient on adding a position until we confirm the breakout is sustainable.
  • As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA also spurted higher.
  • EFA remains in a downtrend and is testing the top of that range. Like EEM, a buy signal has been triggered and is back to EXTREMELY overbought.
  • Be patient for now and wait for a confirmed breakout before adding exposure.
  • As with EEM, we closed out of previous trading positions due to lack of performance.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position.
    • Stop-loss was violated at $64
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • The week saw an uptick in oil prices as “speculation” returned to the markets from QE4. Commodities tend to perform well under liquidity programs due to their inherent leverage.
  • Don’t get too excited, there is not much going on with oil currently, but there is likely a tradeable opportunity approaching given the deeply oversold conditions.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position
    • Stop-loss for any existing positions is $54.
  • Long-Term Positioning: Bearish

Gold

  • Gold got back to a slight oversold last week, and held. However, it is forming a bit of a downtrend from recent highs.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. We are moved our stops up and took half our position out of the portfolio previously.
  • Short-Term Positioning: Neutral
    • Last week: Hold remaining position.
    • This week: Hold position.
    • Stop-loss for whole position moved up to $137.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices rallied a bit this past week from the oversold condition.
  • We are close to registering a “sell” signal which could pressure bond prices lower, so be cautious for now and keep stops in place.
  • As with GLD, we are also moving up our stop-loss to protect our gains if the “risk on” trade gets some real traction.
  • With the oversold condition in place, we will likely be able to further add to holdings as we head into the end of the year. But we aren’t there yet, so be patient for now.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $137.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar had rallied to our $99 target which we laid out back in June of this year when we started tracking the dollar.
  • Despite hopes to the contrary, the dollar remains in a strongly rising uptrend. Given a “strong dollar” erodes corporate profits on exports (which makes up 40% of corporate profits overall) a strong dollar combined with tariffs isn’t great for corporate bottom lines. Watch earnings carefully during this quarter.
  • As noted last week, the dollar is back to the bottom of its uptrend and is very oversold. We suggested a rally in the dollar was likely, which we saw a bit of bounce last week. That could well continue this week, and a tradeable opportunity is available.
  • The “buy” signal keeps us dollar bullish for now.

RIA PRO: Fed Gives Up On Inflation, Welcome To The U.S. of Japan


  • Retest Confirms Bullish Breakout
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Retest Confirms Bullish Breakout

“If you are a bull, what is there not to love?”

That was the message from two weeks ago, and the reasoning behind increasing our equity exposure in portfolios as we head into the end of the year. With the Fed cutting rates on Wednesday, and companies winning the “beat the estimate game” as earnings season progresses, the markets finally broke out to new “all-time” highs this past week.

This breakout is consistent with the “revival of the bulls” which is needed as there is too much attention focused on a “recession” and “bear market.” (If a recession/bear market would have occurred it would have been the first time in history “everyone” saw it coming.)

“Over the last 30 years, when the Fed has implemented an ‘insurance’ rate cut policy of 75 basis points, the equity market has been ‘lights out’ as the S&P 500 has posted a 12-month forward return of ~23%, on average.” – Raymond James 

(H/T G. O’brien)

That’s the good news.

However, before you go jumping in with both feet, there are a couple of points to be made.

Concerning the chart above, you have to decide whether the recent rate cuts by the Fed are “mid-cycle adjustments” or “cuts entering a recession.” While most people only notice the tall black bars, given we are in the longest economic expansion in history, the short-blue bars may be important.

Again, since bear markets/recessions NEVER occur when everyone is expecting them, the breakout to new highs is exactly what is needed to “suck investors” back into the market at the potential peak. This is how bear markets have always begun in history.

On a shorter-term basis, whether you are bullish or bearish, the market is now more than 6% above its 200-dma. These more extreme price extensions tend to denote short-term tops to the market, and waiting for a pull-back to add exposures has been prudent.

The other concern is the weakness in overall participation in the market. Despite the markets pushing to all-time highs, the number of stocks trading above their respective 50, 150, and 200-dma’s remain in downtrends. These negative divergences have preceded short to intermediate-term corrections in the past.

How To Play It

As we have been noting over the last month, with the Fed’s more accommodative positioning, we continue to maintain a long-equity bias in our portfolios currently. We have reduced our hedges, along with some of our more defensive positioning. We are also adding opportunistically, to our equity allocations, even as we carry a slightly higher than normal level of cash along with our fixed income positioning.

We also realize that “all good things do come to an end.” While we are currently “riding the bull,” we are simply waiting for the “8-second buzzer” to prepare for our dismount. (That’s a Texas rodeo thing if you don’t know the reference.)

Therefore, make sure you have stop-losses in place on all positions and be prepared to execute accordingly. The worst thing investors consistently do over time is to turn a “winner” into a “loser” before they eventually sell. (And they always sell.)

While you will certainly reduce your tax liability with this method, it is not a strategy by which you will increase your wealth. Being “rich on paper” and having “cash in the bank” are two ENTIRELY different things.

The Fed Gives Up On Inflation

On Wednesday, the Fed cut rates for the third time this year, which was widely expected by the market.

What was not expected was the following statement.

I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns. – Jerome Powell 10/30/2019

The statement did not receive a lot of notoriety from the press, but this was the single most important statement from Federal Reserve Chairman Jerome Powell so far. In fact, we cannot remember a time in the last 30 years when a Fed Chairman has so clearly articulated such a strong desire for more inflation.

Why do we say that? Let’s dissect the bolded words in the quote for further clarification.

  • “really significant”– Powell is not only saying that they will allow a significant move up in inflation but going one better by adding the word significant.
  • “persistent”– Unlike the prior few Fed Chairman who claimed to be vigilant towards inflation, Powell is clearly telling us that he will not react to inflation that is not only well beyond a “really significant” leap from current levels, but a rate that lasts for a period of time.
  • “even consider”– If inflation is not only a really significant increase from current levels and stays at such levels for a while, they will only consider raising rates to fight inflation.

We are stunned by the choice of words Powell used to describe the Fed’s view on inflation. We are even more shocked that the markets or media are not making more of it.

Maybe, they are failing to focus on the three bolded sections. In fact, what they probably think they heard was: I think we would need to see a move up in inflation before we consider raising rates to address inflation concerns. Such a statement would have been more in line with traditional “Fed-speak.”

We have published  an article for our RIAPro subscribers (Try a FREE 30-Day Trial), which discusses our views on using Treasury Inflation-Protected Securities (TIPS), a hedge against Jerome Powell and the Fed getting inflation, or worse, failing and fostering deflation.

There is an other far more insidious message in Chairman Powell’s statement which should not be dismissed.

The Fed just acknowledged they are caught in a “liquidity trap.”

What Is A Liquidity Trap

Here is the definition:

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

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

  • Are the Central Banks globally injecting liquidity into the financial system? Yes.
  • Has the increase in liquidity into the private banking system lowered interest rates?  Yes.

The chart below shows the increase in the Federal Reserve’s balance sheet, since they are the “buyer” of bonds, which in turn increases the excess reserve accounts of the major banks, as compared to the 10-year Treasury rate.

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

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

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

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

While an argument can be made that the early initial rounds of QE contributed to the bounce in economic activity, there were several other more important supports during the latest economic cycle.

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

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

Welcome To The U.S. Of Japan

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

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

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

It is the only “trick” they know.

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

If interest rates rise sharply, it is effectively “game over” as borrowing costs surge, deficits balloon, housing falls, revenues weaken and consumer demand wanes. It is the worst thing that can happen to an economy that is currently remaining on life support.

The U.S., like Japan, is clearly caught in an on-going “liquidity trap”  where maintaining ultra-low interest rates are the key to sustaining an economic pulse. The unintended consequence of such actions, as we are witnessing in the U.S. currently, is the ongoing battle with deflationary pressures. The lower interest rates go – the less economic return that can be generated. An ultra-low interest rate environment, contrary to mainstream thought, has a negative impact on making productive investments and risk begins to outweigh the potential return.

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

Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled. Eventually, the void will be too great to fill.

But hey, let’s just keep doing the same thing over and over again, which hasn’t worked for anyone as of yet, and continue to hope for a different result. 

What’s the worst that could happen?  

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels

Sector-by-Sector

Improving – Healthcare (XLV), Industrials (XLI), Energy (XLE)

The relative performance improvement of Healthcare relative to the S&P 500 continued to improve this past week as money has rotated into underperforming sectors. Energy has also continued to improve as the rotation to “value” continues. It is still too early to get aggressive in the sector, but the improvement in relative performance puts it on our radar. Industrials, which perform better when the Fed is active with QE, broke out to new highs this past week, we are looking to add back to our position.

Current Positions: Target weight XLV, 1/2 weight XLI

Outperforming – Financials (XLF)

Financials have been running hard on Fed rate cuts and more QE, but rate cuts are, longer-term, not great for net-interest income margins on banks. Combined with the high level of corporate debt on their books, we remain cautious on the sector. With the breakout to new highs, we will look for some consolidation to add exposure to the sector.

Current Positions: None

Weakening – Real Estate (XLRE), Staples (XLP), Technology (XLK), Discretionary (XLY)

As noted last week, Discretionary and Communications have turned higher and continue to consolidate in a broadening pennant pattern. Relative performance continues to lag the S&P 500 currently.

We continue to hold Staples, and are remaining patient to see how the market shakes out over the next couple of weeks as we head into the end of the year. Real Estate continues to flirt with highs but remain GROSSLY extended. We have taken profits, but remain long positions for now.

Technology broke out to all-time highs, which is bullish for now.

Current Position: Target weight XLY, XLK, XLRE, XLP

Lagging – Basic Materials (XLB), and Communications (XLC)

Basic Materials are improving as the trade war is resolved, and we expect to see better performance as money rotates into the sector. Communications has dragged lately as earnings have disappointed. However, if the overall market is going to move higher, we expect to see a turn higher in this sector as well.

Current Position: 1/2 weight XLB, Target weight XLC

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps continue to move higher and are testing the top of their respective consolidation ranges. If the market is going to move higher, it should pull small and mid-caps up, which would also be in line with what we would expect with the Fed engaged in QE. When we see a better entry point we will add exposure accordingly. Both markets are EXTREMELY overbought currently. Be patient for the right entry point.

Current Position: No position

Emerging, International (EEM) & Total International Markets (EFA)

The same advice goes for Emerging and International Markets, which we have been out of portfolios for several weeks due to lack of performance. These markets rallied recently on news of “more QE.” However, the overall technical trend is not great, so we need to see if this is sustainable or just another “head fake.” 

Both markets are EXTREMELY overbought currently. Be patient for the right entry point.

Current Position: No Position

Dividends (VYM), Market (IVV), and Equal Weight (RSP) – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with economic growth and inflation. Currently, the short-term bullish trend is positive, and our core positions are providing the “base” around which we overweight/underweight our allocations based on our outlook.

Current Position: RSP, VYM, IVV

Gold (GLD) – Despite the rally in the broader market, Gold turned higher last week after basing along the $140 level. Gold also broke above its 50-dma. We are still in a consolidation of the previous advance so be patient adding exposure for now.

Current Position: GDX (Gold Miners), IAU (Gold)

Bonds (TLT) – 

Bonds continue to work off its massive overbought condition from the previous run down in rates. This rise in yields was expected, which is why we added a “steepner trade” to our portfolios. Given that we improved our credit quality and shortened duration previously, we are holding our positions for now. We have tightened up our stops.

Stay long current positions for now, and look for an opportunity to add to holdings.

Current Positions: DBLTX, SHY, IEF

Sector / Market Recommendations

The table below shows thoughts on specific actions related to the current market environment. 

(These are not recommendations or solicitations to take any action. This is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)

Portfolio/Client Update:

Two week’s ago, we addressed the reasons (seasonality, trade, buybacks) for increasing our equity exposures in portfolios. To wit:

“Given the fact the Federal Reserve is back to providing liquidity into the markets, we have to remain cognizant of the market’s “perception” of what will happen with QE, versus what we expect to the outcome to be. In the short-term, the catalyst is likely a net positive to stocks so we need to adjust equity exposure slightly to take advantage of the potential upside bias as we head into the end of the year.” 

Last week, we noted that we have added some exposure in the Equity portfolio. However, given the short-term overbought status of the market we are waiting for a small correction to step into more exposure in the ETF portfolios. As noted, we are specifically looking to add exposure to small and mid-capitalization markets, basic materials, industrials, financials and energy.

These additions will increase our overall allocation towards equity risk as we head into the end of the year. These are NOT permanent additions, but rather opportunistic positions to potentially add some “alpha generation” to portfolios over the next couple of months. We will be carrying tight stops and re-evaluating the holdings regularly for adjustments.

As we move into next week, depending on how markets are acting, we will look to slowly increase our equity exposure modestly to “rent whatever rally” we may get from the “QE-4.” 

  • New clients: Please contact your adviser with any questions. 
  • Equity Model: Sold YUM, MDLZ. Bought KHC
  • ETF Model: No changes.

Note for new clients:

It is important to understand that when we add to our equity allocations, ALL purchases are initially “trades” that can, and will, be closed out quickly if they fail to work as anticipated. This is why we “step” into positions initially. Once a “trade” begins to work as anticipated, it is then brought to the appropriate portfolio weight and becomes a long-term investment. We will unwind these actions either by reducing, selling, or hedging if the market environment changes for the worse.


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.

401k-PlanManager-AllocationShift

The Fed Unleashes The Bull

Given the “bulls” have the upper-hand heading into the end of the year, we are increasing our equity exposure slowly. Given the markets tend to pullback just before Thanksgiving, and during the second week of December, we will have a better opportunity increase allocations if we are patient.

We need to see a bit of pullback to reduce the rather excessive extension of the market above the 200-dma, but a pullback that doesn’t break back below the previous highs. Such action will confirm the breakout and suggest our target of 3300 is attainable.

However, please direct your attention to the chart above.

The market is once again pushing above it’s cyclical bullish trend line and testing the cycle trend highs from 2007. This has been a point of failure for the markets each time previously, so some caution is advised until a breakout is confirmed.

This week, continue making adjustments to prepare to opportunistically increase equity exposure on a pullback which doesn’t fail at support levels.

  • If you are overweight equities – Hold current positions.
  • If you are underweight equities – rebalance portfolios to target weights
  • If at target weight equities, hold positioning and look for a pullback to increase exposure.

Understand this increase could well be short-lived. The markets have been in a very long consolidation process and the breakout to the upside is indeed bullish. However, we must counter-balance that view with the simple reality we are VERY long in the current economic and market cycle which is where “unexpected” events have destroyed capital in the past.

If you need help after reading the alert; do not hesitate to contact me.

401k Plan Manager Beta Is Live

Become a RIA PRO subscriber and be part of our “Break It Early Testing Associate” group by using CODE: 401 (You get your first 30-days free)

The code will give you access to the entire site during the 401k-BETA testing process, so not only will you get to help us work out the bugs on the 401k plan manager, you can submit your comments about the rest of the site as well.

We are building models specific to company plans. So, if you would like to see your company plan included specifically, send me the following:

  • Name of the company
  • Plan Sponsor
  • A print out of your plan choices. (Fund Symbol and Fund Name)

I have gotten quite a few plans, so keep sending them and I will include as many as we can.

If you would like to offer our service to your employees at a deeply discounted corporate rate, please contact me.

Current 401-k Allocation Model

The 401k plan allocation plan below follows the K.I.S.S. principle. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)


Model performance is based on a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. This is strictly for informational and educational purposes only and should not be relied upon for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril. 

#WhatYouMissed On RIA: Week Of 10-28-19

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

The Week In Blogs


The Best Of “The Lance Roberts Show”

Video Of The Week

What the Fed really said. Interview with Michael Lebowitz on latest Fed statement.

Our Best Tweets Of The Week

Our Latest Newsletter


What You Missed At RIA Pro

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

See you next week!

S&P 500 Monthly Valuation & Analysis Review – 11-1-19

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


The Market Soars As Corporate Profits Slump!

The SPX recorded new highs this week.  Investors appear to be excited about the U.S. – China Phase 1 trade agreement, which only goes so far in ending the trade war.  Plus, the Fed is cutting interest rates, injecting $100 billion in repo financing over the next month, and embarking on a new round of QE. So, is it clear sailing for corporate America? Maybe companies are not as financially viable as record SPX levels would indicate.

Let’s look at the lifeblood of a company, cash flow.  Goldman Sachs analysis of corporate cash flows shows that SPX companies are actually running, in aggregate, negative cash flow at 103.8% while keeping stock buybacks and dividends flowing to shareholders. Debt is up 8% squeezing corporate cash flow to the point where aggregate cash flows are down 15% versus the prior year.

Source: Goldman Sachs – 7/25/19

Cash is the lifeblood of a company, but a company can’t borrow money forever without being a viable profitable entity able to pay back debt.

Non-financial corporations have taken on record debt at 47% to GDP.  The last time corporations approached this level of debt was during the Great Recession.  Yet, default rates have not gone up.

Sources: Federal Reserve Bank of St. Louis, Edward Altman – 8/5/19

Is this time for debt payment defaults different?  It would seem this is a ‘benign credit cycle’ when defaults don’t rise.  However, a more likely cause is that corporate cash flows are being pumped up by low interest rate loans. This corporate financial cliff maybe one reason the Fed is moving quickly to keep overnight and interest rates low.  The Fed has said it is concerned about high levels of corporate debt.  What is wrong with corporate debt at 47% of GDP?

The issue is when profits sink due to the trade war or as consumer spending slows, companies will no longer qualify for low interest loans. Banks and investors will hesitate to take on risky loans to companies raking up continuous losses.  Without low cost loans to provide needed cash flows, sales decline will result in a freeze on hiring, the layoff of full time workers, and a closure of offices and plants. Management will take these measures to try to keep the company open until sales turnaround.

The profit margin squeeze has been happening over the past 4 ½ years, well before the trade war started.  Profits were flat for the past nine years, supported by a huge corporate tax cut from the Tax Cut Bill of 2018. The contraction in profit margins has been the longest one on record since WWII. Note how recessions usually follow steep declines in profit margins at 1 to 4 years.

Source: Oxford Economics, The Wall Street Journal, The Daily Shot – 10/28/19

Why have margins been contracting?  Margins can be increased by investing in automation, lowering material costs, deploying productivity enhancements, and other efficiencies. Instead of investing in margin increasing activities, corporate executives have been spending available cash from profits and debt on stock buybacks totaling $1.15 trillion in 2018.  Stock buybacks are a way to boost corporate stock prices thereby increasing the income of shareholders and executives. Executives have squandered over the past ten years the opportunity to use profits for investments in research, productivity enhancements, raising wages, or cutting costs.  Management has focused on short term stock gains at the cost of long term corporate viability. The chickens are finally coming home to roost.

In addition, profit margins are declining due to declining international sales. It is difficult to maintain healthy margins when sales are falling due to base spending for sales, support, and transportation to reach a certain sales threshold of profitability. Major corporations face increasing trade headwinds.  For most S & P 100 corporations 50 to 60% of their sales come from overseas with prior growth rates from 15 – 25% per year in emerging markets.  The Asia – Pacific region is the fastest growing sales region for many companies. Yet, the accumulating tax of trade tariffs and trade uncertainty is stifling sales growth.

Sources: U.S. Census Bureau, Tariffs Hurt the Heartland, USTR Office, The Wall Street Journal, The Daily Shot – 10/28/19

Since January of 2018, U.S. companies have paid about $34 billion in tariffs. To hold price levels and market share, companies largely paid tariff costs themselves rather than passing them onto customers. Taking tariff costs onto corporate ledgers has squeezed profit margins. The loss of decent margins in high growth markets is creating a huge profit challenge for companies. 

While the Phase 1 agreement with China may provide a pause to the trade war, breaking up into two major trade blocks.  Corporations will have to navigate selling into two opposing markets with focused sales, support, and product features and pricing.  For more details, see our post Navigating A Two Block Trade World to see how companies plan on changing supply chains, and the implications for investors.

Corporate executives see a loss of profits and margin tightening in the future. A recent CEO survey showed confidence levels of SPX CEOs at recession levels.  The survey results indicate a possible SPX decline beginning as soon as four months from now.

Sources: USA CEO Confidence Survey, Macrobond, The Wall Street Journal, The Daily Shot – 10/18/19

The concerns that CEOs see in revenue and profitability were borne out in 3rd quarter reports of 40% of S &P companies.  Companies with more than 50% of sales in international markets report a 9.1% decline in profits and a 2.0% decline in revenue.  All S &P companies report a 3.7% slip in earnings thus far for 3rd quarter of 2019.

Source: Factset – 10/25/19

Are equity markets recognizing the decline in profits for corporations?  The chart below shows the SPX rising despite flat national corporate profits since 2013, with a huge divergence emerging in the past four years. The SPX soaring to new heights tells us that stock market complacency is at record levels in appraising stock valuations versus actual corporate profits. The chart below shows how wide the gap has become which is about twice the gap size just before the Dotcom decline into 2002 from a peak in 2000.

Source: Soc Gen – Albert Edwards – Marketwatch – 10-28-19

The economic storm corporate executives see on the horizon is likely to be a future economic reality, and not liquidity fueled soaring valuationsExecutives are closest to economic reality because they have to make the economic system work for their company day in and day out. A reversion of equity valuations to the reality of falling corporate profits is coming.  The only question remaining is: when will the SPX reversion happen?

Patrick Hill is the Editor of The Progressive Ensignhttps://theprogressiveensign.com/ writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.