Monthly Archives: March 2017

Currency was first developed about 4000 years ago. Its genius was in the ability to supplant barter thus greatly improving trade and providing a better means for storing value. As illustrated in our title, currency has taken on many different physical forms through the years. Given the recent advances in technology, is it any surprise the latest form of currency resides in the ether-sphere? In this article we explore the basics of cryptocurrencies and the important innovation they support, blockchain. We also offer an idea about whether or not Bitcoin, or another cryptocurrency, can become a true currency worthy of investment.

A Primer on Cryptocurrency and Blockchain

Cryptocurrency is an independent, digital currency that uses cryptology to maintain privacy of transactions and control the creation of the respective currency. While not recognized as legal tender, cryptocurrencies are becoming more popular for legal and illegal transactions alike. Bitcoin (BTC), developed in 2009, is the most popular of the cryptocurrencies. It accounts for over half the value of the more than 750 cryptocurrencies outstanding. In this article we refer to cryptocurrencies generally as BTC, but keep in mind there are differences among the many offerings. Also consider that, while BTC may appear to be the currency of choice, Netscape and AOL shareholders can tell you that early market leadership does not always translate into future market dominance.

Before explaining how BTC is created, acquired, stored, used and valued, it is vital to understand blockchain technology, the innovation that spawned BTC. As we researched this topic, we read a lot of convoluted descriptions of what blockchain is and the puzzling algorithms that support it. In the following paragraphs, we provide a basic description of blockchain. If you are interested in learning more, we recommend the following two links as they are relatively easy to understand.

The Ultimate 3500-word guide in plain English to understand Blockchain – Mohit Mamoria

A blockchain explanation your parents could understand – Jamie Skella

Blockchain is an open database or book of records that can store any kind of data. A blockchain database, unlike all other databases, is stored real time and is accessible for anyone to view its complete history of data.

The term block refers to a grouping of transactions, while chain refers to the linkages of the blocks. When a BTC transaction is completed BTC “miners” work to solve the cryptology algorithm that will enable them to link it to the chain of historical transactions. As a reward for being the first to solve the calculation, the miner receives “newly minted” BTC. As the chain grows, the effort needed to solve and verify the algorithms increase in complexity and demand greater computing power. As an aside consider the following statement by Bitcoin Watch (courtesy Goldman Sachs):

“BTC worldwide computational output is currently over 350 exaflops – 350,000 petaflops – or more than 1400 times the combined capacity of the top 500 supercomputers in the world.”

Needless to say, a tremendous amount of computing resources and energy are being used by BTC miners, and it is still in its infancy. Could these resources be better employed in other industries, and if so, how much productivity growth is BTC leeching from the economy?

The takeaway is that blockchain is an open, real-time database that provides anonymity to its users. It is not controlled or regulated (yet) by any government. BTC miners, driven by the incentive to earn BTC, and fees at times, verify and authenticate the database. Blockchain technology is incredibly powerful and will likely revolutionize data management regardless of whether cryptocurrencies thrive or disappear.


Bitcoin Mining (Creation): New Bitcoins are created as payment to BTC miners that solve the aforementioned calculations that verify transaction data and link it to the blockchain. This ingenious reward system incentivizes miners to compete to perform these calculations, enabling the blockchain to exist. Currently there are approximately 16 million bitcoins outstanding out of a proposed limit of 21 million. As the blockchain grows, the calculations required to mine BTC and add to the chain become more complex, making each bitcoin harder and more costly to earn than the prior one.

Obtaining and Storing Bitcoin: Other than mining Bitcoin, the only other way to obtain them is via transactions and exchanges. One can earn bitcoin by selling a product or service to someone willing to pay in BTC, or one can purchase them with traditional currency through a BTC exchange. BTC can be exchanged for cash or goods and services in a similar fashion. There are reportedly over 100 BTC exchanges, and BTC ATMs are gaining in popularity.  BTC’s are stored in a so-called “wallet”. Wallets may reside on a mobile phone or a desktop computer. The decision to use one versus the other largely comes down to a trade-off between security and ease of use.

Transacting with Bitcoin: Each wallet has a unique key which serves as a personal identifier. When one wishes to transact, the buyer and seller swap their personal keys and the transaction information is posted for miners to verify and post to the blockchain. The identity of the buyer and seller is never revealed. This is one reason that black market, money laundering and tax avoidance transactions are popular on BTC exchanges. While not 100% accurate, you can think of a BTC transaction process as similar to a debit card transaction, but instead of banks verifying, approving and transferring cash to fund the transaction, miners fill that role.

Valuing Bitcoin: Valuing BTC is just like valuing any other currency. One can compare BTC to U.S. dollars or to any other currency. One can also compare the value of BTC to its purchasing power or what one may buy given a set amount of BTC. Currently, BTC is rising rapidly versus all major currencies thus its purchasing power is following suit. As marginal interest in BTC versus sovereign nation currencies increases, the rise in value could continue.

In trying to provide a succinct summary of BTC, we left out many details which you may find pertinent and/or interesting. As blockchain technology represents an important innovation and will certainly find many other uses besides cryptocurrencies, we would encourage you to apply further rigor and read beyond the scope of this article.

BTC – Currency or Investment Fad?

Since BTC started trading in July of 2010, it has risen over 51,000 percent! This meteoric rise in the price of a bitcoin, as graphed below, has certainly attracted many traders and speculators to the cryptocurrency space. While price gains are certainly drawing short term players, others are buying it for its promise as an alternative currency. It is this aspect of BTC that we believe is most relevant.

Data Courtesy: Bloomberg

BTC is a pure fiat currency, meaning it is backed by nothing tangible other than the value users ascribe. Currencies, whether fiat or hard money (backed by something tangible of value) derive value from their utility and scarcity. As the Weimar Republic and many other nations throughout history have learned, economic disasters occur when governments ignore the value proposition and recklessly print money.

The U.S. dollar, also a fiat currency, is backed by the full faith and credit of the United States as well as a small amount of gold. While some may not ascribe too much value to “faith and credit”, almost 250 years of economic progress, military might, and the most powerful tax base in the world strongly argue otherwise. The dollar is globally accepted for almost any kind of transaction, and, despite recent actions of the Federal Reserve, dollars remain relatively scarce. Put another way, even billionaire Bill Gates would stop to pick up a dollar bill laying on the ground. Visit a third world nation and notice how many vendors not only accept U.S. dollars but encourage their use over the domestic currency.

The question investors, not short term speculators, are tasked with answering is, “Will enough people value BTC to make it a respected and often used currency?” In our opinion, the most crucial information needed to answer that question is understanding how governments will respond to the rise of BTC. Gaining a sense for what is at stake for existing currencies and the economies that employ those currencies offers keen insight into the future of BTC and its ability to become more than an afterthought in global trade.

The preamble to the U.S. Constitution states the purpose of the Federal government is to:

“…form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.”

In other words the government’s role is to protect the freedoms and liberties of its citizens. If the government has no ability to fund itself and is unable to provide defense and law enforcement it cannot uphold the Constitution. More precisely – the sovereignty of any nation, regardless of its form of government, rests upon the strength and integrity of its currency.

All transactions, and their participants, that occur with BTC are anonymous. Accordingly taxes cannot be efficiently assessed, black market transactions are made easier, and fraud can easily escape the eye of law enforcement.

If BTC continues to gain in popularity there is little doubt in our opinion the government will seek control or at a minimum the personal data from the transactions. In fact the SEC has recently opined on the matter claiming that “tokens” such as BTC can be deemed securities and may need to be formally registered. This is just a first step but given the potential threat, we envision government will impose a way to remove the secrecy BTC offers, allowing taxation and legal supervision to occur.

We strongly believe the government will not allow BTC to become a full-fledged currency, at least in its current form, but we think they are enamored with the technology. It is possible that a deeply regulated and controlled version of BTC or a new government cryptocurrency could at some point usurp the dollar as we know it today.

Before summarizing this article we leave you with a few pros and cons of BTC:


  • BTC is unregulated, allowing users to avoid taxes or any other kind of governmental, banking, and law enforcement scrutiny.
  • BTC is in limited supply which should help it to retain its value over time. We caveat that with the fact that there are many competitors, each with their own rules about creation.
  • BTC creation is not subject to the whims of central bankers that appear constantly looking to devalue their respective currencies via inflation.
  • Transacting in BTC is easy. As more sellers of goods and services accept BTC its flexibility improves.
  • Typically storing BTC is less expensive than most other national currencies as well as precious metals. Additionally, transaction fees and other banking costs are largely avoided.


  • Bitcoin is unregulated. Regulations to enforce market structure and prevent fraud are not available.
  • There are over 750 cryptocurrencies and the number is growing rapidly. Which one will emerge as the dominant currency beyond the first mover stage? Conversely, which ones will fail and leave holders with nothing?
  • BTC security is not fool proof. Wallets have been hacked on both desktop computers and mobile phones. Due to the anonymous nature of the exchanges, remediation of such actions is difficult.
  • Price volatility makes accepting BTC a risky proposition. Accordingly transaction fees are becoming popular by many merchants.
  • The energy costs and computing power associated with mining BTC is massive and will increase as the complexity of the blockchain and the number of users grow. Seemingly these resources could be put to better use.


The U.S., E.U., Japan, China and Great Brittan have devalued their currencies significantly over the past ten years. The recent success of cryptocurrencies is a meaningful sign that central banker actions have not gone unnoticed by the users of traditional currencies. While we applaud the concept of a currency that is scarce and avoids the whims of bureaucrats, we do not own, nor do we have plans to own cryptocurrencies in the future. The current market is one of significant volatility and heavy speculation. Additionally, the bigger concern is that global governments have the means to make or break cryptocurrencies. Until these powers more fully reveal their intentions on BTC, the risks are too speculative to warrant involvement.





“With every new wave of optimism or pessimism, we are ready to abandon history and time-tested principles, but we cling tenaciously and unquestioningly to our prejudices.”  ― Benjamin GrahamThe Intelligent Investor

I possess an extensive library that covers financial topics with an emphasis on market history.

My first guess is I own close to 150 hard copies – somewhere in that range. I page through at least 30 of them a few times a year. Some require handling with care as they’re first editions from the late 1800s like “Ten Years in Wall Street,” by William Chauncey Fowler (1870).

I consider it peculiar how when markets trend positively or become extended by the way of fundamental metrics, I pick up the pace on my study of the past. Molded pages are parched gold of worthy reminders of how stock prices can represent on occasion, more fiction than fact.

From approximately 5 years before retirement, through the initial phase (5-7 years) of a retirement income distribution cycle, the priority must be risk management when valuations are reaching extreme levels, like today.

Unfortunately, where you retire in a market cycle is primarily a spin of the roulette wheel. Basically, luck.

However, one truth remains – when attempting to produce a steady stream of retirement income from variable assets like stocks and to some extent bonds, then distributions must be consistently monitored and possibly adjusted depending on market head or tailwinds.

If I had to go out on a limb using current valuations as a guide, I am confident that those close to retirement or just beginning the journey are going to face greater obstacles to future returns.

The following must-see charts were created especially for you.

Heed Market Valuations With Respect To Future Returns:

A strong probability exists that a prolonged period of unfavorable or below-average returns will be a formidable obstacle for new retirees. One year of poor returns along with withdrawals is not worth the stress. A series of  poor return years strung together may require modification to withdrawal rates. I utilize rolling three-year portfolio gains and losses and compare to actual withdrawals to help retirees determine whether cash flow adjustments are required.

This chart should encourage a reduction in portfolio stock exposure early in or before retirement and less concern over missed opportunities.

Cash Deserves Respect, Especially Now

Cash isn’t about interest earned, it’s about the liquidity required to generate a retirement paycheck in addition to Social Security, possible pensions and for some, continued part-time or self-employment income.

It’s important to maintain cash or at the least, quality bonds of short duration to cushion a pre-retirement portfolio from exogenous events that may ultimately extend a planned retirement date.

As part of retirement preparation, partner with a fiduciary who can assist with a holistic rebalancing strategy to assess stock exposure and reduce it accordingly.

Where You Retire In A Long-Term Trend Is Luck

The chart above courtesy of, outlines secular (blue) or long-term market trends which lead to market highs. The red lines represent secular bears. The red uptrends are cyclical, or shorter-term positive moves imbedded within long-term negative periods.

Although Doug Short has implied the current cycle from the March 2009 bottom is the beginning of a new secular bull (since December 2011 marked a new market high on an inflation-adjust basis), it would be difficult based on current valuations, to validate the deduction.

Since 1877, secular bull years have totaled 80 vs. 52 for bears, which is a 60/40 ratio. Surprised? Bear markets happen more often than investors are led to believe. They usually occur at times of overvaluation which makes recent retirees or those close to retirement at greater risk of experiencing negative or poor future returns. Bad luck or rotten timing. Either way, it’s going to be important to remain cognizant of portfolio distribution rates, place renewed priority on risk management, and adjust spending accordingly perhaps over the next ten years.

Those who were proactive to minimize stock and high-yield bond portfolio risk (like several of the writers for Real Investment Advice), and redeployed capital into stocks at 13x earnings in the summer of 2009, helped new retirees at that time meet their retirement objectives. In addition, they have experienced a cyclical tailwind in stocks that has allowed greater distribution rates. Great luck!

Never Doubt Regression To The Mean

Stock market cycles are vast and span decades. Don’t stumble into a Recency Bias trap where you believe current complacent market conditions lay the path to a smooth, high-return future. Markets are mean reverting mechanisms. Cycles indeed change.

Usually, markets are more volatile with periods of 5 percent pullbacks occurring every 3-4 months. As investors, this year we’ve witnessed shallow retracements followed up by buys on the dips. An environment like this fosters overconfidence.

Volatility may excite traders and be helpful to those who are seeking lower prices to purchase risk assets. For those in retirement distribution mode, volatility and corrections have potential to place portfolio longevity in jeopardy.

“It’s A Reagan-Type Market,” More Fiction Than Fact

Sure, I miss the 80s. I had a chance to converse with President Reagan in 1985 as he gave the commencement speech at one of my alma maters. Being a reporter for the university newspaper, I wrote of how the campus was magical that day. I had a rare opportunity to be more close-up than most. Clear weather characterized by deep blue skies, youthful spirits high and a perspective of hope direct from the President, provided a cherished memory.

This isn’t the 80s, although I believe ‘skinny’ ties have made a comeback.

As Michael Lebowitz wrote for Real Investment Advice:

“Equity investors betting on Reagan in 1981 were investing in an environment where the probabilities of success were asymmetrically high. With Cyclically Adjusted Price-to-Earnings (CAPE) ratios below 10, investors could buy in to a stock market whose valuation on this basis had only been cheaper 8% of the time going back to 1885. Current equity market valuations require investors to believe beyond all doubt that Trump’s policies can produce strong economic growth and overcome hefty economic and demographic headwinds. More bluntly, the risk-return profile of 1981 is the polar opposite to that of today.”

In his chart above, Michael outlines five-year forward returns and the maximum drawdowns that have occurred over the last 60 years at similar cyclically-adjusted price-to-earnings ratios.

If Michael is correct, investors should expect returns over the next five years, including dividends, to be near zero with a greater probability of double-digit loss. This conclusion can be devastating for those entering a retirement distribution period and no longer adding to investments through periodic savings programs.

Preparing for a smooth retirement transition requires caution, occasionally followed by a seismic dilution in portfolio risks. The perspective should be one of capital loss minimization, not a stretch for greater returns.

When valuations normalize, increased stock exposure should be considered. There’s absolutely nothing wrong with adding to riskier assets when prices and valuations warrant, regardless of age.

Don’t allow the story of “this time it’s different,” to derail your plans.

“While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.” – Benjamin Graham.


In this past weekend’s missive I wrote:

“So…Should I “Buy The F*$(@!# NOKO?”

My best guess currently is – probably. But not yet.”

“In our portfolios, we will wait for confirmation the current sell-off has abated before adding additional risk exposure to portfolios. In recent years, such market tantrums have been very short-lived and have provided opportunistic entry points for increasing equity related exposure. However, EVERY TIME is DIFFERENT, so it is always important to NEVER ASSUME the outcome will be the same as the last. That is how you wind up losing a lot of money. 

As shown in the chart above, with the market on a very short-term sell signal, and still very overbought, it will likely prove prudent to remain patient and see if the markets can regain more solid footing next week.”

Let me update that analysis.

On Monday, the market surged out of the gate as headlines suggested that “geopolitical risk” had subsided. I find this particular explanation hard to digest given the rising rhetoric of a potential trade war with China, violence in Charlotte over the weekend, no resolution with North Korea, etc., so forth, and so on.  I find little evidence of a global turn in geopolitical stresses currently.

The most obvious explanation is that “algo’s” went on a “buy the dip” frenzy which has been evident following every small dip in the markets over the last several months. Notice in the chart below, each dip to the red dashed bullish trend line, regardless of the risk (French election, Comey, Valuations, etc.) have all been met by a rash of buying. 

Monday’s “buy the dip” frenzy was no different. The question will be whether the market can both reverse the short-term “sell signal” and climb above the previous resistance of the old highs? Such a reversal would end the current consolidation process and allow for additional capital to be invested.

Importantly, this is very short-term analysis.

In this past weekend’s newsletter, I reviewed all of the S&P 500 sectors and the major markets for both risks and opportunities. Today, I want to also review of the positioning by institutions which reveal where “crowded trades” may exist for more contrarian portfolio positioning.

Positioning Review

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

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

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

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

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


The extreme net-short positioning on the volatility index suggests there will be a rapid unwinding of positions given the right catalyst. As you will note, reversals of net-short VIX positioning has previously resulted in short to intermediate-term declines. With the largest short-positioning in volatility on record, the rush to unwind that positioning could lead to a much sharper pickup in volatility than most investors can currently imagine.

Crude Oil

The recent attempt by crude oil to get back to $50/bbl coincided with a “mad rush” by traders to be long the commodity. For investors, it is also worth noting that crude oil positioning is also highly correlated to overall movements of the S&P 500 index. With crude traders currently extremely “long,” a reversal will likely coincide with both a reversal in the S&P 500 and oil prices being pushed back towards $40/bbl. 

While oil prices could certainly fall below $40/bbl for a variety of reasons, the recent bottoming of oil prices around that level will provide some support. Given the extreme long positioning on oil, a reversion of that trade will likely coincide with a “risk off” move in the energy sector specifically. If you are overweighted energy currently, the data suggests a rebalancing of the risk is likely advisable.

US Dollar

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

As shown above, and below, such negative net-short positions have generally marked both a short to intermediate-term low for the dollar as well as struggles for the S&P 500 as a stronger dollar begins to weigh on exports and earnings estimates.

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

Interest Rates

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. Apparently, traders in the bond market failed to get the “memo.” With the net positioning in bonds at some of the highest levels since the financial crisis, there is little reason to believe the “bond bull” market is over. Look for a reversal of the current positioning to push bond yields lower over the next few months.

Smart Vs. Dumb Money

While we have been looking at solely the large noncommercial traders above, they are not the only ones playing in the future markets. We can also dig down into the overall net exposure of retail investors (considered the “dumb money”) versus that of the major institutional players (“smart money”)

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

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

None of this analysis suggests that a market “crash,” or even a moderate correction, is about to occur tomorrow.

What it does suggest is that investor risk is elevated, with the majority of investors are all bunched up on “one side of the trade,” which has led to poor investor outcomes historically.

Of course, it is not just these issues noted above but also, as I have discussed previously, the issue of excess in:

  1. Leverage – both in margin and corporate debt.
  2. Bullish Sentiment
  3. Valuations
  4. The “High-Yield” Chase
  5. Market Capitalization Ratios

“Complacency” is the weapon of our own demise. It reminds me of the following quote:

Fair weather cannot always continue. The Economic Cycle is in progress today as it was in the past. The Federal Reserve System has put the banks in a strong position, but it has not changed human nature. More people are borrowing and speculating today than ever in our history. 

Sooner or later a crash is coming and it may be terrific. Wise are those investors who now get out of debt and reef their sails. This does not mean selling all you have, but it does mean paying up your loans and avoiding margin speculation. Sooner or later the stock market boom will collapse like the Florida boom. Some day the time is coming when the market will begin to slide off, sellers will exceed buyers, and paper profits will begin to disappear. Then there will immediately be a stampede to save what paper profits then exist.” – Roger Babson, September 5th, 1929.

The more things change…the more they remain the same.

Last week, I was having lunch with a prospective portfolio management client discussing the current market, economic backdrop, and the related risk to invested capital. During our appetizer of stone crabs and lobster-corn chowder, (if you ever drift into a Truluck’s restaurant I highly suggest both) he discussed how his father had bought a basket of stocks 25-years ago and essentially performed in line with the markets during that time.

Why shouldn’t he just do the same?

It’s a great question.

The most valuable commodity that we all have is “time.” While the markets may have recently hit “all-time” highs, for the majority of investors this is not the case. They didn’t sell at the previous peak, and they sure as heck didn’t buy at the financial crisis lows. In fact, the reality is quite the opposite as once again investors appear to be buying the market peak under the belief somehow “this time is different.”

The chart below shows, according to the American Association of Individual Investors (AAII), investors currently have the highest allocation to stocks, and lowest to cash, since the bubble in 2000.

But, even if investors have fully recovered from the financial crisis, or the “” bust, the time lost in getting back to even can never be recovered.

Unfortunately, for far too many Americans today, time will run out leaving them faced with the tough retirement choices of being forced to work far longer than they ever planned.

Yet, after two major market reversions, business remains brisk for fortune tellers, psychics and market analysts who continue to make guesses about the future. Amazingly, individuals still place too much faith in predictions of these future outcomes when it comes to their savings, and more importantly, their retirement.

I was listening to an interview by a leading asset manager who says that the market will end the year higher and you should remain fully invested in the market. This sounds great, and there is a decent possibility he will be right. However, this is the same prediction made every year, just as it was made in 2000 and 2008. The issue is that when these “prognostications” go wrong, it can be fatal to those retirement goals.

In order to be truly successful over the long term, and this is especially important if you are close to your retirement date, a focus on 1) capital preservation and 2) a rate of return sufficient to offset inflationary pressures are the most critical. The second part is the most important. People that try to build wealth by investing, rather than saving, tend to lose more often than not as they inherently take on excessive risk trying to “beat the market.”

The understanding, which has been lost in recent years by both advisors and investors, is the financial markets are a tool to make sure that your “savings” maintain their future purchasing power parity. In other words, your savings are adjusted for inflation over time.

It is important to remember this.

NONE OF US are investors.

Not in any sense of the word.

We are all SPECULATORS betting on the future price movement of the market. The difference, just as gamblers in a casino, that separates winners from losers is knowing the odds of success on each and every bet you make. If the odds of success are high then make a bet. If not, don’t.

I have never understood the rationale of individuals who tell me they “have to be invested”.


Investing just for the sake of having your money in the stock market is a fools bet. As the old adage goes:

“If you are sitting at a poker table and can’t figure out who the pigeon is…it is probably you.”

If you truly have 30 years to be invested before you retire, then you can ignore this article, buy a stock market index fund, stick 20% of income into it every month, and most likely you will be better off than most. However, if you are like me, and the millions of other Americans who are within 10-15 years to retirement, we don’t have the luxury of time on our side. Therefore, sudden market losses can be devastating to long term financial sustainability in retirement.

The most basic goal of investing is to “buy low” and “sell high.” This is the only way money is actually created out of the investment process. Unfortunately, this obvious rule is consistently disregarded as investors panic and sell at market lows, or greedily buy market tops. It is human nature, and emotionally based investing almost always results in losses. For those individuals willing to bet at the casino without even looking at their hand, they are most likely going to lose much more often than they win.

A Function Of Math

Let’s assume that you want to maintain an annualized return of 10% over the next 5 years. Here are the hypothetical market returns:  +10%, +10%, +10% -10%, +10%.  Those returns look stellar on the surface.  However, the impact on actual investment dollars is quite different.

While many individuals profess to regularly beat the market – the reality is that few do. Most investors tend to do well on the way up but fail to sell before the decline. However, for argument sake, we will assume that the average investor exactly matches market returns. The table shows an investment of $100,000 based on our hypothetical returns for the five-year period.

The important point is that it only takes one draw down over any one-year period to destroy compounded returnsIn our example, it would take an astounding 34% return in year 5 to return the portfolio to the original goal. Furthermore, the compounded annual growth rate is cut by almost half due to the one down year. This is why most investors real net returns since the turn of the century are far less than that of the actual market. Emotional mistakes of selling low, and buying high, have consistently put investors on the wrong side of their investment goals.

As Albert Einstein once stated:

“The most powerful force in the universe is that of compounding.”  

However, compounding of returns only works with investments that have NO downside risk. Price declines destroy the effect of compounding rapidly. This is why employing a more conservative approach to investing over the “long term” has a higher chance of success than chasing a random benchmark.

Back To Lunch

While my prospective client’s father had done very well by simply holding stocks and performing “in line with the market” over the 25-year period, my question was simple:

“How much better would he have done by avoiding some of the draw downs along the way?” 

This was a point I addressed recently:

“The chart below is the inflation-return of $1000 invested in 1995 with $100 added monthly. The blue line represents the impact of the investment using simple dollar-cost averaging. The red line represents a ‘lump sum’ approach. The lump-sum approach utilizes a simple weekly moving average crossover as a signal to either dollar cost average into a portfolio OR move to cash. The impact of NOT DESTROYING investment capital by buying into a declining market is significant.”

“Importantly, I am not advocating ‘market timing’ by any means. What I am suggesting is that if you are going to invest in the financial markets, arguably the single most complicated game on the planet, then you need to have some measure to protect your investment capital from significant losses.”

The difference to long-term returns by managing draw down risk is significant.

This brings up some very important investment guidelines that I have learned over the last 30 years.

  • Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.
  • Emotions have no place in investing. You are generally better off doing the opposite of what you “feel” you should be doing.
  • The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.
  • Market valuations (except at extremes) are very poor market timing devices.
  • Fundamentals and Economics drive long term investment decisions – “Greed and Fear” drive short term trading.  Knowing what type of investor you are determines the basis of your strategy.
  • “Market timing” is impossible – managing exposure to risk is both logical and possible.
  • Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.
  • There is no value in daily media commentary – turn off the television and save yourself the mental capital.
  • Investing is no different than gambling – both are “guesses” about future outcomes based on probabilities.  The winner is the one who knows when to “fold” and when to go “all in”.
  • No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

As an investment manager, I am neither bullish or bearish. I simply view the world through the lens of statistics and probabilities. My job is to manage the inherent risk to investment capital. If I protect the investment capital in the short term – the long term capital appreciation will take of itself.

After a week on vacation, I got the joy of coming back to an Administration threatening North Korea over nuclear weapons.

Now, you would suspect the possibility of nuclear war might just be the catalyst to send markets reeling, but looking at the market’s reaction on Thursday, I suspect there will be t-shirts soon reading:

“I survived the threat of nuclear war and the ‘great crash of 2017’ of 1.5%”

As shown, the market did register a short-term “sell signal” last Friday and downward pressure has continued to build all week. The sell off on Thursday led to a break of the 50-dma and is threatening the bullish trend support line which has existed since the beginning of the year. IF the market does not regain the 50-dma by close of the markets today, I would suspect we will likely be looking for a decline to 2400. Such a correction, a whopping 3.03%, would likely shock many investors who have become overly complacent in recent months due to the abnormally low levels of volatility.

The sell-off on Thursday also resulted in a sharp snapback in volatility which had recently touched historically low levels. While this is likely not the beginning of the next cyclical upswing in volatility just yet, it should serve as a good reminder of what will happen when volatility does return.

One interesting note was the consternation by the mainstream media and analysts over why stocks did not perform better in the recent earnings reporting season when it was so good. Well, despite the much trumpeted operating earnings growth of 7.67%, reported earnings (the actual earnings that matter) only rose by 0.51%. Furthermore, revenue, which is what happens at the top-line of the income statement, has remained mired at the same level as it was in Q4. With markets having already priced in much of the forward estimates, there seems to be little catalyst to push stocks higher at this point leaving investor risk elevated.

While the markets can certainly remain “irrational” longer than logic would dictate, it only seems prudent to step back and the question of “what will likely happen next?”

For me that question has three outcomes:

  1. The bull market continues for another 12-18 months as “greed” and “exuberance” push asset prices to further extremes. The subsequent “reversion to the mean” wipes out the majority of gains from the 2009 lows resetting valuations and investor psychology for the next bull market.
  2. There is a mid-term correction within the next few months, like the beginning of 2016, which fails to shake out investors and sets the market up for the final leg of the bull market melt-up as the final capitulation of buyers makes its appearance. The subsequent “reversion to the mean” resets the market by 50-60%.
  3. The market drifts sideways for the next couple of months, and then, as the realization that legislative agenda is not forthcoming, the debt ceiling fight or some other political debacle sends investors rushing for the sidelines. The sell-off sends “algo’s” into a “sell the rally” mode and margin calls exacerbate the selling. The stampede to “sell everything” will result in the same “reversion to the mean” which will, as noted, wipe out 50-60% of investors portfolios as the next recession resets expectations to economic realities.

There is no case that be made that supports “the bull market will continue forever.”

When you are standing on the edge of cliff, looking at the ground far below, there is always that momentary desire to take a leap. Fortunately, for most, rationality takes hold.

Unfortunately, in the financial markets, irrationality historically prevails and very few investors survive the fall.  

So, with that said, here’s what I am reading this weekend.



Research / Interesting Reads

 “Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett

Questions, comments, suggestions – please email me.

According to the June 2017 snapshot from the Social Security Administration, nearly 61.5 million people were receiving a monthly benefit check, of which 68.2% were retired workers. Of these 41.9 million retirees, more than 60% count on their Social Security to be a primary source of income.

Of course, that dependency ratio is directly tied to financial insolvency of the vast majority of Americans.  According to a Legg Mason Investment Survey, US baby boomers have on average $263,000  saved in defined contribution plans. But that figure is less than half of the $658,000 they say they will need to retire. As noted by GoBankingRates, more than half of Americans will retire broke.

This is a huge problem that will not only impact boomers in retirement, but also the economy and the financial markets. It also demonstrates just how important Social Security is for current and future generations of seniors.

Of course, the problem is that according to the latest Social Security Board of Trustees report issued last month, those benefits could be slashed for current and future retirees by up to 23% in 2034 should Congress fail to act. Unfortunately, given the current partisan divide in Congress, who have been at war with each other since the financial crisis, there is seemingly little ability to reach any agreement on how to put Social Security on sound footing. This puts those “baby boomers,” 78 million Americans born between 1946 and 1964 who started retiring last year, at potential risk in their retirement years. 

While the Trustees report predicts that asset reserves could touch $3 trillion by 2022, implying the program is expected to remain cash flow positive through 2021, beginning in 2022, and each year thereafter through 2091, Social Security will be paying out more in benefits than it’s generating in revenue, resulting in a $12.5 trillion cash shortfall between 2034 and 2091. That is a problem that can’t be fixed without internal reforms to the pension fund due specifically to two factors: demographics and structural unemployment.

With respect to the demographic problem, it is a “one-two knock out punch” that will hit not only Social Security but also the country’s municipal and Federal pension systems. As I noted previously:

“One of the primary problems continues to be the decline in the ratio of workers per retiree as retirees are living longer (increasing the relative number of retirees), and lower birth rates (decreasing the relative number of workers.) However, this ‘support ratio’ is not only declining in the U.S. but also in much of the developed world. This is due to two demographic factors: increased life expectancy coupled with a fixed retirement age, and a decrease in the fertility rate.”

The structural shift in employment, due to the impact of technology and automation, is an overarching problem that few give little attention to.

While the mainstream media’s focuses their attention on the daily distribution of economic data points, there is a hidden economic depression running along the underbelly of the country. While reported unemployment is hitting historically low levels, there is a swelling mass of uncounted individuals that have either given up looking for work or are working multiple part time jobs. This can be clearly seen in the chart below which is the working age population of those between the ages of 16 and 54 as a percentage of that same age group. This strips out the argument of retiring baby boomers, who ironically, aren’t retiring not because they don’t want to, but because they can’t afford to.

These higher levels of under and unemployment have kept pressures on wages even as work hours have lengthened. The declines in real income are evident as the burgeoning “real” labor pool, and demand for higher wage work, is actually suppressing wages as companies opt for increasing productivity, continued outsourcing, and streamlining employment to protect corporate profit margins. However, as the cost of living is affected by the rising food, energy and health care prices without a compensatory increase in incomes – more families are forced to turn to assistance in order to survive.

Without government largesse, many individuals would literally be living on the street. The chart above shows all the government “welfare” programs and current levels to date. The black line represents the sum of the underlying sub-components.  While unemployment insurance has tapered off after its sharp rise post the financial crisis, social security, Medicaid, Veterans’ benefits and other social benefits have continued to rise.

Importantly, for the average person, these social benefits are critical to their survival as they make up more than 22% of real disposable personal incomes. With 1/5 of incomes dependent on government transfers, it is not surprising that the economy continues to struggle as recycled tax dollars used for consumption purposes have virtually no impact on the overall economy.

As millions of “baby boomers” approach retirement, more strain is put on the fabric of the welfare system. The exact timing of this crunch is less important than its inevitability.

There are two critical factors driving this inevitability. The first is that the number of “real” employees, while growing, is in lower income producing and temporary jobs, and the rate of job growth is substantially lower than the growth of the population. Since social security contributions are calculated as a percentage of income – lower income levels produce lower contributions.

The second factor, as shown above, is the ever larger share of personal incomes being made up of government benefits reduces social security contributions.

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

As millions of baby boomers begin to retire another problem emerges as well. Demographic trends are fairly easy to forecast and predict. Each year from now until 2025, we will see successive rounds of boomers reach the 62-year-old threshold. There is a twofold problem caused by these successive crops of boomers heading into retirement. The first is that each boomer has not produced enough children to replace themselves which leads to a decline in the number of taxpaying workers. It takes about 25 years to grow a new taxpayer. We can estimate, with surprising accuracy, how many people born in a particular year will live to reach retirement. The retirees of 2070 were all born in 2003, and we can see and count them today.

The second problem is the employment problem. The decline in economic prosperity, that we have discussed extensively, caused by excessive debt, reduction in savings, declining income growth due to productivity increases and the shift from a manufacturing to service based society will continue to lead to lower levels of taxable incomes in the future.

This employment conundrum is critical. Back in 1950, as the baby boom was just beginning to start, each retiree’s benefit was divided among 16 workers. Taxes could be kept low. Today, that number has dropped to 3-workers per retiree, and by 2025, it will reach–and remain at–about two workers per retiree. In other words, each married couple will have to pay, along with their own family’s expenses, Social Security retirement benefits for one retiree. In order to pay promised benefits, either taxes of some kind must rise or other government services must be cut. Back in 1966, each employee shouldered $555 dollars of social benefits. Today, each employee has to support roughly $18,000 of benefits. The trend is obviously unsustainable unless wages or employment begins to increase dramatically and based on current trends that seems highly unlikely.

The entire social support framework faces an inevitable conclusion where no amount of wishful thinking will change that outcome. The question is whether our elected leaders will start making the changes necessary sooner, while they can be done by choice, or later when they are forced upon us.

Thanks to Jesse Felder, we recently stumbled upon a measure of economic conditions that has reliably signaled every recession since 1948. The data point, Real Value Added, is currently in negative territory and may, therefore, be a harbinger of an economic downturn.  If it is a false signal, it would be the first in a 70-year history of observations.

720Global does not rely on any one data source to determine the pace of economic activity or to formulate recession probabilities. Instead, we analyze data from many different sources to help better understand the likely path of the economy. That said, when a single data source has an indisputable track record, we take notice and look for other corroborating evidence and bring it to your attention.

Gross Value Added (GVA) and Real Value Added (RVA)

GVA is a measure of economic activity, like GDP, but formulated from the production side of the economy. It measures the dollar value of all goods and services produced less all the costs required to produce those goods or services. For example, if 720Global buys $100 worth of wood, $20 worth of other materials and employs $30 worth of labor to build a chair, we have produced a good for $150. If that good is sold for $200, 720Global has created $50 of economic value.

Gross Domestic Product (GDP), the more popular measure of economic activity, calculates the level of commerce based on the dollar value of the final goods and services produced. It may help to think of GDP as economic activity measured from the demand side and GVA as measured from the supply side. Despite the differences, the levels of economic activity reported are remarkably consistent. Since 1948, nominal GDP has averaged annual growth of 6.55% while GVA has averaged 6.50%. It is important to note that, while they track each other very well over the longer term, they are less correlated quarter to quarter.

Economists prefer to measure economic activity without the effect of inflation. If inflation were rampant when making the chair in the example above, some of the incremental value was due to the general trend of rising prices and not value added by 720Global. To strip out the effect of inflation and compute a pure measure of value added, it is commonplace to subtract inflation from GVA. The result is Real Value Added (RVA = GVA less CPI).

Charting RVA

The graph below plots RVA since 1948. Periods deemed recessionary by the National Bureau of Economic Research (NBER) are denoted in gray.

Data Courtesy: St. Louis Federal Reserve (FRED)

Since 1948 there have been 277 quarters of data. RVA has only been negative during recessions or in proximity to periods leading up to and/or following recessions.


Currently, three of the last four quarters have produced negative RVA levels. Real GDP is not producing similar results, having averaged 2% growth over the same quarters. As mentioned earlier, RVA and Real GDP may not be well correlated over short time frames.

RVA is just one source of data arguing that economic trouble lies ahead, therefore, we would be wise not to read too much into this one indicator. Of concern, however, is that negative RVA readings have an impeccable pattern of signaling recession as a coincident indicator. Will this time be different? If not, then we would expect to see other economic indicators reflect similar weakness in the weeks and months ahead. Clinically, our efforts focus on finding valuable data that will allow us to help clients make prudent decisions. This is certainly one such piece of data.





Don’t believe this bull cycle is going to end, or at least pause?

Ready to believe this is closer to the fourth and not the ninth inning?

You’re not alone. Best to check yourself. Stay grounded.

The professional chatter is building. This is the big one. The stock market cycle that rivals 1982-2000 is upon us.

Well, perhaps it’s different this time. Hey, it could be, I hope it is, but I doubt it.

If you’re compelled to believe a narrative that the world has gone flat that of course is a personal decision.

For those who invest in risk assets, it’s best to stick to reality.

As stocks are currently inured to bad news and prices accelerate on good vibes or soft data primarily, especially from the auspices of the Fed, cycles such as these are indicative of positive herd behavior or momentum, which I’ll explain as I go further.

However, the “fundies” with clout or financial professionals who focus on fundamental analysis, are throwing up red flags everywhere. It’s a relentless and intelligent group. Their analysis is worth a read; although there’s still road and tread left to traverse this bull market cycle (my humble opinion), a realistic perspective of how the terrain underneath your portfolio is as more a layer of spirit and hope than it is real economic conditions is crucial at this juncture.

Today’s market behavior is generally anathema to fundamentalists and downright frustrating. Let’s face it – people aren’t wired for value investing. In a world of immediate gratification, nobody wants to plant a seed and wait for the tree to grow. We want to see the tree right up front right now. We then feel rewarded as the tree (hopefully) continues to prosper.

Those who focus on fundamental analysis are first about the integrity of the soil, not so much the tree. The logic is If the soil is dark with nutrients, then the tree will have a greater opportunity to thrive. A tree can grow in bad soil (take it from me I’m from Brooklyn. I’ve seen trees grow in the crevasses of muddy curb lines), but ostensibly will topple over and wreak all kinds of damage.

So, let’s not beat up on the soil people too much. Valuation measures are a downright lousy indicator of market performance but that doesn’t minimize their importance. Think of these indicators as the warning signs, yellow lights along your investment path.

In a recent missive, Howard Marks the legendary investor and co-founder of Oaktree Capital, outlines the following concerns regarding today’s investment environment.

To wit:

  • The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.
  • In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.
  • Asset prices are high across the board.  Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.
  • Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need

Michael Lebowitz for Real Investment Advice succinctly outlines 22 realities in 22 Inconvenient Truths On Investing, Economy & The Fed.

To make a case for positive stock performance, one can look no further than the work of a unique individual who understood how bat-sh*t crazy market participants can get.

In the spirit of mathematician, father of fractal trend analysis Benoit Mandelbrot, who believed market price changes are not as random as preached in financial orthodoxy, stock prices indeed possess memory that drives positive or negative momentum.

Modern systems of finance are built on cleanly-calculated outcomes that don’t match actual market behavior or in many cases, a retail investor’s experience. Life and markets are much more complex and fraught with risk. If well-read and invest on your own or work with a financial partner, odds are your wealth has succumbed to one or several of rotted chestnuts of suspect calculations.

A popular conjuring is the Efficient Market Hypothesis which states that stock prices reflect all relevant information and that a random walk is the best metaphor to describe such markets. Mandelbrot’s focus was more on observation, not abstract theories stretched to mollify fear and act as a false “Snuggie” so ostensibly, most people spend their investment experiences breaking even.

The widely-accepted modern portfolio theory which advocates a blind buy & hold philosophy, provides the financial industry (and subsequently you), a misguided sense of comfort or smoothness of risk that mostly falls within explainable, bell-curve shaped boundaries.

The problem is buy and hold (not many can time markets), has been bastardized by Wall Street driven group-think; the theory has morphed into willing complacency which allows big box financial retailers to monetize assets to boost profit margins and brainwash brokers who are too lazy to seek information beyond their firms’ biased research departments, to sell product and close shop at night with clean consciences.  It’s one big cognitive-biased mind meld. It’s confirmation bias from a group who advises you to avoid confirmation bias?

Let me ask you:  If Wall Street, robo-advisors with bloated valuations and big-time financial book sellers are such passionate advocates for buy and hold, and alternate theories, even those coming from academic thought leaders like Andrew Lo at MIT (an advocate for a sell discipline as markets deteriorate), are merely squelched whispers, do you truly believe it’s in your best interest as a retail investor?

I know. I should be an agent for the X-Files.

Certainly, from day to day, prices are headline driven and random in nature. Over long periods, as Mandelbrot discovered, discernable trends emerge. There are bursts as I call them, or periods when “winds in the sails” indeed exist. Positive or negative, momentum effects are real. Prices indeed have memory.

In his comprehensive analysis, Mandelbrot created multi-fractal asset models, evidence that proved markets were far from efficient. Mainstream portfolio theories oversimplified how markets realistically behave. Most likely the intent of these shaky theories was (is) to securitize Main Street cash, push people into perpetual fee generators.

Mainstream portfolio theories are designed to easily explain how to contain risk and how that risk can fit neatly into bell curves that rarely represent how markets truly behave. Because as we know, markets are comprised of people and people are Spock-like rational when it comes to investment decisions. Readers will get the sarcasm.

You don’t require extensive study of Mandelbrot to feel in your gut that the nature of risk assets easily contained within explainable, quantifiable boundaries doesn’t add up.

Mandelbrot was a passionate believer in markets. However, he was in staunch opposition of how modern portfolio theory attempts to mold risk into neatly accountable statistical analysis.

The beauty of markets, every market, is willingness of buyers and sellers to transact upon a mutually beneficial or perceived beneficial, price based on current views of overall supply and demand. There’s no doubt, excluding fundamentals, that the demand for stocks remains at a fever pitch. Mandelbrot would advise to participate, however prepare for change – take the following three common misperceptions to heart.

Cash is never trash, especially at this juncture.

Daily, I meet with investors who lament about holding “too much cash.”  They share this information framed by such shame or regret. What is too much cash, anyway? Cash is indeed a part of an overall investment allocation; you may hold at all times 3-10% as a hedge against portfolio volatility. It’s the simplest stabilizer sleeve in a long-term investment program, the best hedge.

Cash is also best suited for emergency funds. Three months, six months. If your income is variable, erratic, perhaps a year or two of living expenses in cash optimum. Again, it’s a personal decision I don’t want you to stress over.

Are you attempting to reach a short-term financial life benchmark like a down payment on a house that needs to be met in two years or less? You said it: Cash. No need to over-think this decision.

The industry has permitted and communicated an enduring guilt message to fester over the maintenance of cash for extended periods. Why? Because brokerage firms lose fee revenue when you sit in cash and it irritates the heck out of their shareholders. Take it from me. These companies lose more money than you do in the long run when it comes to your cash. It burns a hole in their profit pockets. Not yours.

There’s some percentage between 0% cash and 100% that feels right to you. Stick with it.  A number that doesn’t cause you to make emotional mistakes with your invested dollars is worth whatever opportunity cost you’re going to endure.

Capital to invest at attractive valuations produces substantial outperformance over waiting for decimated capital to recover from losses. That’s just inarguable fact.

Lance Roberts:

The chart above shows the inflation-adjusted return of $100 invested in the S&P 500 (capital appreciation only using data provided by Dr. Robert Shiller). The chart also shows Dr. Shiller’s CAPE ratio. However, I have capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, I calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves back to cash at a ratio of 23x.

I have adjusted the value of holding cash for the annual inflation rate which is why during the sharp rise in inflation in the 1970’s there is a downward slope in the value of cash. However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises.

Dollar-cost averaging is usually sub-optimal, depending on how you use and perceive the process.

Let’s be clear: Dollar-cost averaging isn’t an investment strategy or a very good one, regardless of what you’ve been told. Don’t perceive it as such. It’s a method devised by Wall Street and touted by brokers to foster complacency.

Listen, a little complacency, a bit of auto-pilot can be positive to your bottom line; I agree that dollar-cost averaging is at the least a healthy financial habit.

Dollar-cost averaging is nothing special. It won’t do anything for your overall returns. If one seeks mollification to avoid regret bias or other emotional salve, then it’s fine. Continue. However, at least consider the ultimate placement of the dollars. It doesn’t necessarily need to be the stock market. DCA seems to get linked exclusively to stock investing. Go ahead and unlink your mind from the false narratives.

It would be impossible and unrealistic for the financial industry to comprehend that dollar cost averaging into the S&P 500 may be less effective than tucked underneath the Posturepedic.

Naturally, nobody is suggesting to literally use your mattress as a deposit box. However, the point is that dollar-cost averaging was designed to be a sales tool to sucker you into investing and forgetting.

Not cool.

“The truth is that many advisers are smart, and they are aware that dollar cost averaging is not a good idea. But rather than trusting people to learn, they are happy to get a second-best solution. After all, dollar cost averaging has such a good image, why not capitalize on it?” – Presh Talwalker, Author of The Joy of Game Theory – An Introduction to Strategic Thinking.

A disciplined investor’s approach would be to adhere to the process (because it is a good one), and establish a periodic investment plan where a specific amount of money is auto-deposited into a portfolio mix allocated based not on the time frame required to reach a financial benchmark, but on the current risk exposure required to achieve return at this stage of the current market cycle.

Plainly speaking, fund a conservative allocation temporarily – then initiate larger, lump sum investments into riskier asset classes as valuations improve.  How do you know when valuations improve? Well, that’s what a financial adviser is there for, isn’t it?

Recently, an individual I counsel who has been out of the market for five years decided on dollar-cost averaging 20 percent into stocks (split between U.S. and international), 30% in short-duration bonds, 20% in intermediate-term fixed income and the rest in cash.

She’s willing to give up some possible continued short-term upside and consider risk first, based on the valuation risk in stocks. Smart move. It’s a cake and eat it type of decision. If markets go higher, she participates. If they falter, her portfolio downside is muted.

Don’t eschew valuation warnings and become overconfident in the path of future returns.

Several market big-leaguers are warning of extended market valuations – Bob Shiller, Lacy Hunt, Robert Arnott the father of fundamental indexing, bond king Jeffrey Gundlach. Even Goldman Sachs Asset Management is chiming in on overvalued markets. Naturally, there are a slew of other pros molding the narrative to support the current stock valuations. Hey, this is what markets are all about, folks.

Nobody has a clue as to when markets will finally correct or enter a bear. However, wise investors strip out the noise and understand not to become blinded by Recency Bias. Reversion to the mean, whether it’s through a correction in price or time (read: Is Another Lost Decade Ahead?), the facts are the facts. It’s never different. Eventually, your portfolio returns are going to suffer and place financial goals in jeopardy, especially if the decision is to just ‘ride out’ the next bear cycle.

History shows that valuations above 25x earnings have dictated bull market peaks. I for one believe that this bull has further to go as structural conditions such as over indebtedness, low intermediate, long-term interest rates and dovish Fed action, continue to feed the TINA (there is no alternative) monster.

Never disregard valuations. Reversion is an inevitable event. It’s best to replace the word ‘investing’ with the word ‘trading’ for new money you commit to markets here as the aspiration should be to purchase high and sell or trim profits at higher prices.

It’s acceptable to take this road. The main thing is to objectively understand the terrain you’re traveling at this juncture and maintain keen awareness of changing conditions that would compel you to exit, protect capital, as time is a precious resource and the majority of investors spend it financially breaking even, not getting ahead.

Consider the writers at Real Investment Advice your navigators.

Over the last week, I was on vacation with my family taking a much-needed respite from the weekly workload.

The good news is that usually when I go out of town, the market crashes. Such was not the case, and in fact, the Dow Industrials hit all-time highs. I pay little attention to the Dow due to the limited number of holdings in the index, so, despite headlines of the Dow’s achievement, the S&P 500, a better representation of the economic backdrop of the country, made little progress. As I noted in the last weekly newsletter:

“Our existing client portfolios are fully allocated to the market in accordance with their model allocations. New client portfolios are being slowly allocated into their models as the market breaks out of consolidation levels to new highs.

All accounts have had stop limits raised to current running support trend lines.

The current advance continues to remain intact despite a lack of legislative action, weaker economic and inflationary data and less than inspiring forward guidance on the earnings front.”

“As shown in the bottom part of the chart above, on a very short-term basis the market currently remains on a ‘buy signal,’ however, the weakness of the market over the last couple of days has led to some deterioration. Furthermore, the market is struggling with recent resistance levels as the overbought condition continues to limit the advance.

If the market can pull back to support, and work off some of the overbought condition without triggering a broader ‘sell signal,’ we will add exposure to client portfolios.

We remain cautious, however, on the type of ‘risks’ we take on in portfolios. Capital preservation always remains our priority over chasing returns.”

So, in effect, nothing much has changed in the past week. However, while the market remains bullishly biased there are numerous “bearish signals” that should be paid attention to. While these signals do not necessarily suggest a bear market is imminent, these signals have all been present when previous bear markets have begun.

Bull Hopes, Bear Signals

Importantly, the “buy” signal that was registered following the November election, has now flipped back to a “sell” signal. These signals have usually been indicative of short-term corrective actions which can provide for better entry points for trading positions and rebalancing.

As shown below, on a longer-term basis the backdrop is more indicative of a potential correction rather than a further advance. With an intermediate-term (weekly) ‘sell’ signal triggered at historically high levels, the downside risk currently outweighs the potential for reward.

Internal measures of the market have also weakened substantially in recent months. The problem is while the stock market has pushed higher, both the ratio and number of stocks trading above their respective 50 and 200-day moving averages have continued to weaken.

This divergence will likely not last much longer, the only question is whether the internals will “catch up,” as the “bulls” currently hope?

Deviations from both intermediate and long-term moving averages have also reached levels that become problematic for further advances without a correction first. The first chart is the percentage deviation from the 200-day moving average. At almost 7%, it is one of the larger deviations over the last 3-years and, as shown, has always resulted in at least a short-term correction.

However, while the short-term corrections have been mild, and “buy the dip” opportunities which are always the case in a strongly trending market, the bigger concern comes from the deviation from the 3-year moving average as shown below. At 3-standard deviations, and 17% above the long-term moving average, the risk of a “mean reverting event” has risen markedly.

With the long-term “sell signal” very close to triggering, investors would be well-advised to administer some risk controls within their portfolio allocation models. The same can be seen below where the 21-month RSI has pushed into extremely overbought territory which has previously preceded more significant corrections and bear markets previously.

Of course, the run up in the markets which has created these more extreme deviations have come from the “bullish exuberance” of investors jumping into the markets at this rather late stage of the bull market advance. As shown below, courtesy of, both the bullish sentiment of professional advisors and fund managers has reached more exuberant levels.

And as noted by Tiho Babak just recently, even the Yale survey has exploded with bullish exuberance.

Of course, as the final chart shows below, while the bulls are clearly in charge of the market currently, and could be for quite a while longer, such deviations from the long-term growth trend do not last indefinitely.

Again, let me restate for those who insist I am bearish, the market is in a bullish trend currently and as such equity exposure should remain tilted to the “long” side. However, being allocated to the financial markets without an understanding and appreciation of the mounting risks is simply foolish. 

With the markets extended, and moving into the two months of the year that have seen more than their fair share of historical corrections, it is a good opportunity to clean up and reduce excess risk in portfolios. 

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Hedge portfolios against major market declines.
  3. Take profits in positions that have been big winners
  4. Sell laggards and losers
  5. Raise cash and rebalance portfolios to target weightings.

An important point to remember is that STOCKS DO NOT preserve capital, but BONDS do. Even if interest rates do reverse for some reason, while bond prices may fall the corpus is still returned to the investor at maturity along with all interest payments along the way. Such is not the case for equities.

Eventually, even the best house in a bad neighborhood is devalued. Globally low interest rates and falling inflationary pressures are not a function of financial market strength, but rather global economic weakness. There is only one way such a backdrop will end.

For now, the party rages on with little regard for the consequences of partying too long or too loudly. There are always a few who leave the party too early, but the consequences are substantially worse for those who stay too long.

“There is nothing riskier than the widespread perception that there is no risk.”  Howard Marks

When I was growing up my mother had a saying, or an answer, for just about everything…as do most mothers. Every answer to the question “Why?” was immediately met with the most intellectual of answers:

“…because I said so”.

Seriously, my mother was a resource of knowledge that has served me well over the years and it wasn’t until late in life that I realized that she had taught me the basic principles to staying safe in the world of financial investments.

So, by imparting her secrets to you I may be violating some sacred circle of motherhood knowledge, but I felt it was worth the risk to share the knowledge which has stood well the test of time.

1) Don’t Run With Sharp Objects!

It wasn’t hard to understand why she didn’t want me to run with scissors through the house – I just think I did it early on just to watch her panic. However, later in life when I got my first apartment I ran through the entire place with a pair of scissors, left the front door open with the air conditioning on, and turned every light on in the house. That rebellion immediately stopped when I received my first electric bill.

Sometime in the early 90’s, the financial markets became a casino as the internet age ignited a whole generation of stock market gamblers who thought they were investors. There is a huge difference between investing and speculating, and knowing the difference is critical to overall success.

Investing is backed by a solid investment strategy with defined goals, an accumulation schedule, allocation analysis and, most importantly, a defined sell strategy and risk management plan.

Speculation is nothing more than gambling. If you are buying the latest hot stock, chasing stocks that have already moved 100% or more, or just putting money in the market because you think that you “have to”, you are gambling.

The most important thing to understand about gambling is that success is a function of the probabilities and possibilities of winning or losing on each bet made.

In the stock market, investors continue to play the possibilities instead of the probabilities. The trap comes with early success in speculative trading. Success breeds confidence, and confidence breeds ignorance.

Most speculative traders tend to “blow themselves up” because of early success in their speculative investing habits. The speculative trader generally fails to hedge against the random events that occur in the financial markets. This is turn results in the trader losing more money than they ever imagined possible.

When investing, remember that the odds of making a losing trade increase with the frequency of transactions being made. Just as running with a pair of scissors; do it often enough and eventually you could end up really hurting yourself. What separates a winning investor from a speculative gambler is the ability to admit and correct mistakes when they occur.

2) Look Both Ways Before You Cross The Street.

I grew up in a small town so crossing the street wasn’t as dangerous as it is in the city. Nonetheless, I was yanked by the collar more than once as I started to bolt across the street seemingly as anxious to get to the other side as the chicken that we have all heard so much about. It is important to understand that traffic does flow in two directions and if you only look in one direction – sooner or later you are going to get hit.

A lot of people want to classify themselves as a “Bull” or a “Bear”The smart investor doesn’t pick a side; he analyzes both sides to determine what the best course of action in the current market environment is most likely to be.

The problem with the proclamation of being a “bull” or a “bear” means that you are not analyzing the other side of the argument and that you become so confident in your position that you tend to forget that “the light at the end of the tunnel…just might be an oncoming train.”

It is an important part of your analysis, before you invest in the financial markets, to determine not only “where” but also “when” to invest your assets.

3) Always Wear Clean Underwear In Case You’re In An Accident

This was one of my favorite sayings from my mother because I always wondered about the rationality of it. I always figured that even if you were wearing clean underwear prior to an accident; you’re still likely left without clean underwear following it.

The first rule of investing is: “You are only wrong – if you stay wrong

However, being a smart investor means always being prepared in case of an accident. That means quite simply have a mechanism in place to protect you when you are wrong with an investment decision.

First of all, you will notice that I said “when you are wrong” in the previous paragraph. You will make wrong decisions, in fact, the majority of the decisions you will make in investing will most likely turn out wrong. However, it is cutting those wrong decisions short, and letting your right decisions continue to work, that will make you profitable over time.

Any person that tells you about all the winning trades he has made in the market – is either lying or he hasn’t blown up yet. One of the two will be true – 100% of the time.

Understanding the “risk versus reward” trade off of any investment is the beginning step to risk management in your portfolio. Knowing how to mitigate the risk of loss in your holdings is crucial to your long-term survivability in the financial markets.

4) If Everyone Jumped Off The Cliff – Would You Do It Too?

At one point or another, we have all tried with our Mom’s what every other kid has tried to since the beginning of time – the use of “peer pressure.” I figured if she wouldn’t let me do what I wanted, then surely she would bend to the will of the imaginary masses. She never did.

“Peer pressure” is one of the biggest mistakes investors repeatedly make when investing. Chasing the latest “hot stocks” or “investment fads” that are already overvalued and are running up on speculative fervor almost always end in disappointment.

In the financial markets, investors get sucked into buying stocks that have already moved significantly off their lows because they are afraid of “missing out.” This is speculating, gambling, guessing, hoping, praying – anything but investing. Generally, by the time the media begins featuring a particular investment, individuals have already missed the major part of the move. By that point, the probabilities of a decline began to outweigh the possibility of further rewards.

It is a well-known fact that the market works in what is called a “herd mentality.” Historically, investors all tend to run in one direction at one time until that direction falters, the “herd” then turns and runs in the opposite direction. This continues to the detriment of investor’s returns over long periods as shown by Dalbar investor studies.

This is also generally why investors wind up buying high and selling low. In order to be a long-term successful investor, you have to understand the “herd mentality” and use it to your benefit – which means getting out from in front of the herd before you are trampled.

So, before you chase a stock that has already moved 100% or more – try and figure out where the herd may move to next and “place your bets there.” This takes discipline, patience and a lot of homework – but you will be well rewarded for your efforts in the end.

5) Don’t Talk To Strangers

This is just good solid advice all the way around. Turn on the television, any time of the day or night, and it is the “Stranger’s Parade of Malicious Intent”. I don’t know if it is just me, or the fact the media only broadcast news that reveals the very depths of human sickness and depravity, but sometimes I have to wonder if we are not due for a planetary cleansing through divine intervention.

Back to investing – getting your stock tips from strangers is a sure way to lose money in the stock market. Your investing homework should NOT consist of a daily regimen of CNBC, followed by a dose of Grocer tips, capped off with a financial advisor’s sales pitch.

In order to be successful in the long-run, you must understand the principals of investing and the catalysts which will make that investment profitable in the future. Remember, when you invest into a company you are buying a piece of that company and its business plan. You are placing your hard earned dollars into the belief the individuals managing the company have your best interests at heart. The hope is they will operate in such a manner as to make your investment more valuable so that it may be sold to someone else for a profit.

This is also the very embodiment of the “Greater Fool Theory,” which states that there will always be someone willing to buy an investment at an ever higher price. However, in the end, there is always someone left “holding the bag,” the trick is making sure that it isn’t you.

Also, you need to be aware that when getting advice from the “One Minute Money Manager” crew on television – when an “expert” tells you about a company that you should buy – he already owns it – and most likely he will be the one selling his shares to you.

6) You Either Need To “Do It” (polite version) Or Get Off The Pot!

When I was growing up I hated to do my homework, which is ironic, since I now do more homework now than I ever dreamed of in my younger days. Since I did not like doing homework – school projects were almost never started until the night before they were due. I was the king of procrastination.

My Mom was always there to help, giving me a hand and an ear full of motherly advice, usually consisting of a lot of “because I told you so…”

I find it interesting that many investors tend to watch stocks for a very long period of time, never acting on their analysis, buy rather idly watching as their instinct proves correct and the stock rises in price.

The investor then feels that he missed his entry point and decides to wait, hoping the stock will go back down one more time so that he can get in. The stock continues to rise, the investor continues to watch becoming more and more frustrated until he finally capitulates on his emotion and buys the investment near the top.

Procrastination, on the way up and on the way down, are harbingers of emotional duress derived from the loss of opportunity or the destruction of capital.

However, if you do your homework and can build a case for the purchase, don’t procrastinate. If you miss your opportunity for the right entry into the position – don’t chase it. Leave it alone and come back another day when ole’ Bob Barker is telling you – “The Price Is Right.”

7) Don’t Play With It – You’ll Go Blind

Well…do I really need to go into this one? All I know for sure is that I am not blind today. What I will never know for sure is whether she believed it, or if it was just meant to scare the hell out of me.

When you invest in the financial markets it is very easy to lose sight of what your intentions were in the first place. Getting caught up in the hype, getting sucked in by the emotions of fear and greed, and generally being confused by the multitude of options available, causes you to lose your focus on the very basic principle that you started with – growing your small pile of money into a much larger one.

Putting It All Together

My Dad once taught me a very basic principle: KISSKeep It Simple Stupid

This is one of the best investment lessons you will ever receive. Too many people try to outsmart the market to gain a very small, fractional, increase in return. Unfortunately, they wind up taking on a disproportionate amount of risk which, more often than not, leads to negative results. The simpler the strategy is, the better the returns tend to be. Why? There is better control over the portfolio.

Designing a KISS portfolio strategy will help ensure that you don’t get blinded by continually playing with your portfolio and losing sight of what your original goals were in the first place.

  1. Decide what your objective is: Retirement, College, House, etc.
  2. Define a time frame to achieve your goal.
  3. Determine how much money you can “realistically” put toward your goal each month.
  4. Calculate the amount of return needed to reach your goal based on your starting principal, the number of years to your goal and your monthly contributions.
  5. Break down your goal into milestones that are achievable. These milestones could be quarterly, semi-annual or annual and will help make sure that you are on track to meet your objective.
  6. Select the appropriate asset mix that achieves your required results without taking on excess risk that could lead to greater losses than planned for.
  7. Develop and implement a specific strategy to sell positions in the event of random market events or unexpected market downturns.
  8. If this is more than you know how to do – hire a professional who understands basic portfolio and risk management.

There is obviously a lot more to managing your own portfolio than just the principles that we learned from our Mothers. However, this is a start in the right direction, and if you don’t believe me – just ask your Mother.

Just recently, the New York Post a very interesting article entitled “Millennials should start taking stocks seriously.” While I am sure the author is well-intentioned, it is a very misguided article in its assumptions.

The author jumps right in with both feet:

“Many millennials are missing the chance to accumulate significant assets.”

There are so many problems with that statement alone its tough to find a starting point.

First, the stock market is not, and never has been, the “solution” to building wealth. If you look around the world, there might be a very small handful that have actually built a fortune by investing alone. That is the exception, not the rule.

The real wealth builder, even for guys like Ray Dalio, Larry Fink, Warren Buffett and others, was not from just investing their own money in the financial markets but by building businesses that invested “other peoples money” in the financial markets from which they collected heavy fees and compensation over time.

In America, the great “wealth equalizer” is, and always has been, entrepreneurship. But, unfortunately, according to a recent Federal Reserve study, since the financial crisis business equity ownership has declined markedly.


Well, except for those in the top 10%.


(Important Note: This decline in business owner equity goes a long way in explaining why the employment reports don’t reflect economic reality. As I discussed in “Is The BLS Overstating Jobs,” if business owner equity is on the decline, the number of business “births” assumed by the BLS may have inflated employment by over 5-million jobs since the financial crisis. Such inflation would explain the lack of wage growth.)

Secondly, investing in financial markets was never intended to be a “wealth builder,” but rather an “inflation adjustment” for “savings” over time.

Wall Street has built vast fortunes for select individuals by effectively removing “the fools from their money.” The run-up in asset prices generates the “greed” necessary to entice individuals to “speculate” in the financial markets with their “savings.” The Wall Street media machine continues to push by continually producing more marketing material on why “you are missing out” on vast riches which keeps money in motion. “Money in motion, creates fees for Wall Street.”

Unfortunately, as shown by repeated Dalbar studies, due to a variety of psychological and other investment related mistakes like “chasing performance,” individuals do NOT win the long-term investment game.

Over a 30-year period, investors barely generated returns sufficient enough to offset the rate of inflation. Add-in the effect of taxation and the outcome was far worse.

Furthermore, what the author completely misses is the importance of “time” and the impact of “loss.” 

Individuals only have a finite amount of time to invest for retirement. While it is great to show 100 year plus charts of the return of an invested dollar in the financial markets, that is not reality. Most individuals, by the point in life that they have available capital, have at best 15-20 years to invest.

Notice that fees’ are not an issue. The real problem for individuals can be reduced to just two primary issues: a lack of capital to invest and psychology. I will not deny that costs’ are an important consideration when choosing between two specific investment options; however, the emotional mistakes made by investors over time are much more important.”

The lack of capital is hugely important in the ability to generate “wealth” from the stock market. There has not yet been an investment program invented that did not require actual capital to invest at the beginning. Even according to recent surveys:

“The survey found that 52% of Americans have no stock market holdings at all. None. In 2002, it was just 33%. Among those who don’t invest today, 53% said they don’t have the money, and 21% said they don’t trust advisers.”

The median value of financial assets for families has fallen sharply since the turn of the century. Note that there are nearly 60% MORE Americans with no stock market holdings today than in 2002. This aligns with the Federal Reserve study which showed a significant plunge in families with holdings.


Again, except for those in the top 10 percent of the population.


Of course, after two very nasty “bear markets” since the turn of the century is not surprising that few individuals have capital remaining to invest or trust the “financial advisors” who lost it for them.

The impact of a bear market is vastly important to future returns. I dug this article up by Sara Max from wrote:

“In fact, investors who’ve had the bad luck of getting in at the very top of a market have ultimately come out ahead – provided they stayed the course. Consider this analysis from wealth management tech company CircleBlack: An investor who put $1,000 in the Standard & Poor’s 500 index of U.S. stocks at the beginning of 2008 (when stocks fell 37%) and again in early 2009 would have been back in positive territory by the end of 2009.”

This is what my Dad would have called “PPA – Piss Poor Analysis.”

While it is true that someone who invested a $1 at the peak of the market in 2008 and another dollar at the bottom in 2009 would have now gotten back to even, unfortunately, they were not able to regain the 7-years to retirement lost in doing so. The importance of “lost time” can not be overstated enough.

While there have been massive breakthroughs in science and technology, no one has yet discovered the secret of “eternal youth.”

By the time that most individuals achieve a point in life where incomes and savings rates are great enough to invest excess cash flows, they generally do not have 30 years left to reach their goal. This is why losing 5-7 years of time getting back to “even” is not a viable investment strategy.

The chart below is the inflation-return of $1000 invested in 1995 with $100 added monthly. The blue line represents the impact of the investment using simple dollar-cost averaging. The red line represents a “lump sum” approach. The lump-sum approach utilizes a simple weekly moving average crossover as a signal to either dollar cost average into a portfolio OR move to cash. The impact of NOT DESTROYING investment capital by buying into a declining market is significant.

Importantly, I am not advocating “market timing” by any means. What I am suggesting is that if you are going to invest into the financial markets, arguably the single most complicated game on the planet, then you need to have some measure to protect your investment capital from significant losses.

While the detrimental effect of a bear market can be eventually be recovered, the time lost during that process can not. This is a point that is consistently missed by the ever bullish media parade chastising individuals for not having their money invested in the financial markets.

The reality is that most of these individuals have never lived through a real bear market, nor have they ever suffered the losses of significant wealth during the process. Their time will eventually come, and as anyone who has been around the financial markets for as long as I have (28 years) will tell you, your attitude about “risk” changes significantly when the “bear begins to maul you.”

In a recent post by Jeffrey Snider he made an important observation:

“In August last year, Dr. Krugman proved how little he has learned since March 2008 in chastising others for lack of growth. Writing as usual in the New York Times on what he called the Folly of Prudence, he said, ‘We’ve been living with low-rate, depression economics for 8 years now — and key players are still acting as if they’ve learned nothing.’ 

Yep. He thinks ‘austerity’ is holding everything back, when in truth it’s all the stuff he didn’t recognize a decade ago and still doesn’t now.  

In very general terms, the monetary system continues on unable to meet the modest demands placed on it by even the most modest of growth trends (forgetting recovery from the immense contraction). It, combined with other hidden monetary elements, qualifies in every way for Milton Friedman’s interest rate fallacy. The consistency of T-bills, bond rates, ‘secular stagnation’, etc., is breathtaking in that despite all that the world economy still lost a decade anyway and remains facing the very real prospects for another one. “

While Jeffrey is focusing on the importance of interest rates as they pertain to economic growth, something I have discussed more than once, there is also the issue of another “lost decade” ahead for investors as well due to this idea of “secular stagnation.” 

Research Affiliates has also discussed the importance of “secular stagnation” and a coming decade of low returns.

With slow GDP growth propagating negative or near-zero real interest rates, our message is that expected returns across most asset classes should be lower than their long-term averages. We currently expect about 0.7% average annual real returns over the next decade for both core U.S. bonds and core U.S. equities.”

That doesn’t sound good.

“But Lance, the markets have returned 10% on average over the last century, so RA is probably going to be wrong.”

Before you dismiss RA’s comments, it is important to put them into some context. When low rates of return are discussed, it is not meant that each year will be low but that the return for the entire period will be low. The chart below shows 10-year rolling REAL, inflation-adjusted, returns in the markets.

(Important note: Many advisors/analysts often pen that the market has never had a 10 or 20-year negative return. That is only on a nominal basis and should be disregarded as inflation must be included in the debate.)

There are two important points to take away from the data. First, is that there are several periods throughout history where market returns were not only low, but negative. Secondly, the periods of low returns follow periods of excessive market valuations. “This time is not different.”

There are two main drivers behind the concept of a “decade of low returns” – secular stagnation and valuations.

Secular Stagnation

While I have written many times in the past about the importance of secular stagnation, RA put a much finer point on the argument.

“Equally insidious is secular stagnation’s feeling of permanence; the trends at fault are slow moving and likely to persist well past the standard business-cycle horizon.

Deleveraging from our debt overhang will take decades. The impact of aging demographics across the developed world is only just beginning to slow both labor force growth and productivity, and this trend will only strengthen in the coming years.

Likely, we have entered a period of secular stagnation heavily impacted by lingering debt overhangs, persistent demographic shifts in savings preferences, and increased efficiency of capital…these longer-run trends, which are powerful and long lasting, and will impact our economic outlook for many years to come. Current deeply negative interest rates will likely shift back toward zero, but within our investment horizon are unlikely to return anywhere close to the historical averages. As Michael Corleone discovered, it is not easy to escape genetic or demographic destiny.”

The decline of demographics was clearly shown in “The Unavoidable Pension Crisis:”

“In 1950, there were 7.2 people aged 20–64 for every person of 65 or over in the OECD countries. By 1980, the support ratio dropped to 5.1 and by 2010 it was 4.1. It is projected to reach just 2.1 by 2050. The table below shows support ratios for selected countries in 1970, 2010, and projected for 2050:”

Despite optimistic views that Central Bank interventions can stimulate economic growth and inflation through monetary policies, the reality has been quite the opposite given the massive levels of global debt.

For the markets to generate a higher level of return in the future would require substantially higher levels of real growth. This is unlikely given the aging demographic trends, productivity increases which weigh on employment and wage growthand debt servicing that diverts dollars from productive investments. This is not just a domestic issue, but a global one.

It is interesting that even though Central Banks acknowledge that it was the ramp up in debt and leverage that led to our current economic problems, it is somehow believed that it can be resolved by simply shuffling debt from governments to central banks. Eventually, the global debt levels will have to be dealt with. Until then, economic growth, inflationary pressures, and interest rates will remain at historically low levels.


As investors, we are supposed to be investing for the “long term.” Therefore, we should be viewing valuations as a predictor of returns over the next 10, 15 or 20 years which is the typical investment/savings time frames for individuals. David Leonhardt penned a similar view:

“The classic 1934 textbook ‘Security Analysis’ – by Benjamin Graham, a mentor to Warren Buffett, and David Dodd – urged investors to compare stock prices to earnings over ‘not less than five years, preferably seven or ten years.’ Ten years is enough time for the economy to go in and out of recession. It’s enough time for faddish theories about new paradigms to come and go.

The chart below shows the long-term history of Shiller’s Cyclically Adjusted P/E Ratio versus forward 2-year total returns.

History shows that valuations above 25x earnings have tended to denote secular bull market peaks. Conversely, valuations at 10x earnings, or less, have tended to denote secular bull market starting points.

Furthermore, considering the U.S. is now in the 3rd longest economic expansion in history, with the lowest average annual growth rate, one should honestly question the ongoing “bull market” thesis.

As I discussed just recently, when using just about any metric currently, the outlook for investment returns is dismally low.

We can also prove this mathematically as well as shown.

Capital gains from markets are primarily a function of market capitalization, nominal economic growth plus the dividend yield. Using the “Hussman Formula” we can mathematically calculate returns over the next 10-year period as follows:

(1+nominal GDP growth)*(normal market cap to GDP ratio / actual market cap to GDP ratio)^(1/10)-1

Therefore, IF we assume that GDP could maintain 4% annualized growth in the future, with no recessions, AND IF current market cap/GDP stays flat at 1.25, AND IF the current dividend yield of roughly 2% remains, we get forward returns of:

(1.04)*(.8/1.25)^(1/10)-1+.02 = 1.5%

But there’s a “whole lotta ifs” in that assumption.

More importantly, if we assume that inflation remains stagnant at 2%, as the Fed hopes, this would mean a real rate of return of -0.5%.

This is certainly not what investors are hoping for.


Markets are not cheap by any measure. If earnings growth continues to wane, or interest rates rise, the bull market thesis will collapse as “expectations” collide with “reality.” This is not a dire prediction of doom and gloom, nor is it a “bearish” forecast.

It is just a function of how markets work over time.

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

This time is “not different.” The only difference will be what triggers the next valuation reversion when it occurs. If the last two bear markets haven’t taught you this by now, I am not sure what will.  Maybe three times really is a “charm.”

Currently, things could not be better.

Stocks are hitting all time highs. Confidence is at record levels, and investors are “all in.”

But maybe it is just for those reasons that we should take a pause. Records are records for a reason.

Every strongly trending bull market throughout history has ended, usually very abruptly and with little warning. Few ever foresaw the signs leading to the “Crash of 1929,” “The Great Depression,” the “1974 Bear Market,” the “Crash of ’87”, Long-Term Capital Management, the “” bust, the “Financial Crisis,” etc. These events are often written off as “once in a generation” or “1-in-100-year events,” however, it is worth noting these financial shocks have come along much more often than suggested. Importantly, all of these events had a significant negative impact on an individual’s “plan for retirement.”

I bring this up because I received several emails as of late questioning me about current levels of savings and investments and whether there would be enough to make it through retirement. In almost every situation, there were significant flaws in their analysis due primarily to the use of “online financial planning” tools which are fraught with wrong assumptions. I wanted to go through some very basic concepts that you need to consider when planning for your retirement whether it is in 5 years or 25 years and more importantly dispel a few myths.

The Market Does Not Return X% Per Year

One of the biggest mistakes that people make is assuming markets will grow at a consistent rate over the given time frame to retirement. There is a massive difference between compounded returns and real returns as shown. The assumption is that an investment is made in 1965 at the age of 20. In 2000, the individual is now 55 and just 10 years from retirement. The S&P index is actual through 2016 and projected through age 100 using historical volatility and market cycles as a precedent for future returns.

While the historical AVERAGE return is 7% for both series, the shortfall between “compounded” returns and “actual” returns is significant. That shortfall is compounded further when you begin to add in the impact of fees, taxes, and inflation over the given time frame.

The single biggest mistake made in financial planning is NOT to include variable rates of return in your planning process.

Furthermore, choosing rates of return for planning purposes that are outside historical norms is a critical mistake. Stocks tend to grow roughly at the rate of GDP plus dividends. Into today’s world GDP is expected to grow at roughly 2% in the future with dividends around 2% currently. The difference between 8% returns and 4% is quite substantial. Also, to achieve 8% in a 4% return environment, you must increase your return over the market by 100%. The level of “risk” that must be taken on to outperform the markets by such a degree is enormous. While markets can have years of significant outperformance, it only takes one devastating year of losses to wipe out years of accumulation.

Plan for realistic returns in the future as well as adjust and account for market swings that will impact the ending value of your money.

Most Likely You Aren’t Saving Enough

Here are some shocking statistics for you. The average salary in America is about $55,000 a year as per the US Census Bureau. A critical mistake that many individuals make is assuming that salaries will grow at some specific annual rate until you retire. As shown in the chart below, this is not necessarily a realistic assumption.

The other statistic that goes along with this is that the average American has ONLY about ONE year of salary saved up for retirement. The point to be made is that very few individuals have saved adequately enough to actual retire and live off the income their portfolio will generate.

However, for those that “THINK” they have adequate savings, they most likely need to rethink their plan. Given the highly indebted levels of the global economy today, it is impossible for interest rates to rise significantly in the future due to the impact of debt servicing requirements. This means that the old “4% rule of thumb” as a withdrawal rate likely needs to be tucked away in the history books. This also means that most individuals are not just undersaved for retirement, but grossly so. Example:

Mr. Smith needs $60,000 pre-tax to live on in retirement. At 4% interest rates he needs $1.5 million saved up. However, at 2%, that requirement jumps to $3 million.

In reality, most Americans are woefully unprepared for retirement and are hoping that Social Security, or their pension, will provide the social safety net they need to make it through. There is a real probability in the coming years that the massively underfunded status of these programs will lead to less than expected results for retirees.

Retirement Is More Costly Than You Think

Most people that I see are running around with the idea that they can retire on 70% of their current income. In reality, this will leave you far short of the retirement dream that you are hoping for. In a recent survey of 5000 retirees, the average difference between pre and post-retirement incomes was about 12%. The reason is that while your house may be paid off and your children gone at retirement – individuals tend to substitute other items that eat into the retirement budget such as picking up an expensive hobby like golf, traveling more, or spoiling grandchildren. However, the biggest bite out of retirement savings will come from the result of surging medical expenses and higher health care insurance costs.

To be safe, you should be planning on 100% of your current income stream for retirement. If you aren’t – you could find yourself coming up short, and you don’t want to find that out once you are already IN retirement.

Rules Of The Road

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

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

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

  1. The only way to ensure you will be adequately prepared for retirement is to “save more and spend less.” It ain’t sexy, but it will absolutely work.
  2. You Will Be WRONG. The markets cycle, just like the economy, and what goes up will eventually come down. More importantly, the further the markets rise, the bigger the correction will be. RISK does NOT equal return.   RISK = How much you will lose when you are wrong, and you will be wrong more often than you think.
  3. Don’t worry about paying off your house. A paid off house is great, but if you are going into retirement house rich and cash poor you will be in trouble. You don’t pay off your house UNTIL your retirement savings are fully in place and secure.
  4. In regards to retirement savings – have a large CASH cushion going into retirement. You do not want to be forced to draw OUT of a pool of investments during years where the market is declining.  This compounds the losses in the portfolio and destroys principal which cannot be replaced.
  5. Plan for the worst. You should want a happy and secure retirement – so plan for the worst. If you are banking solely on Social Security and a pension plan, what would happen if the pension was cut? Corporate bankruptcies happen all the time and to companies that most never expected. By planning for the worst, anything other outcome means you are in great shape.

Most likely what ever retirement planning you have done, is wrong. Change your assumptions, ask questions and plan for the worst. There is no one more concerned about YOUR money than you and if you don’t take an active interest in your money – why should anyone else?

November 30, 1989, I remember it like it was yesterday. I was 8 years old, in Miss Duke’s 2nd grade class at Inwood Elementary in Houston, TX. Little did I know how much that dreary day would impact the rest of my life. The rest of my family’s life. My mother, barely 34 years old was traveling to our family’s church to bring juice for an event.

Unfortunately, she never made it. As she crossed the intersection of North Houston Rosslyn and Breen Rd. a man on the run from the Harris County Sheriffs Deputy’s ran a red light and hit her car…head on…at 110 mph. The impact killed her instantly and changed the course of my family’s path forever.

Please take this for what it’s worth. I’ve never written these words or much less talked about this. It’s still hard to verbalize, but if my experience can help one family get their ducks in a row the pain of writing this is well worth it.

I think we all have a story like this to tell. Some maybe not with such an immediate impact, but painful and life altering all the same.

 You’re going to die

Yes, YOU.

Your spouse is going to die as well.

It is the admission of our own mortality as to why we delay the life insurance exam and put off writing the will. It is almost as if by writing the “will” it somehow ultimately seals our own demise.

All that separates us from the next life is one breath, just one.

It’s interesting how this seems like such a foreign concept to so many of us. This isn’t something we can will to not happen, yet we spend so much time, energy and money to delay the inevitable. Except in one regard, many put off conversations with loved ones on final wishes and just as important the transition of assets to your loved ones.

Your final wishes won’t magically appear in a dream to your spouse or kids and even if they did — try dying without a will. The courts will dictate who gets what.

Why delay and put the burden of planning such a stressful, emotional time on your loved ones? Do you want them to figure it out once you’re gone? Do you want your funds tied up in court? Your family fighting? Probably not.

According to a 2016 Gallup poll 55% of Americans don’t have a will. That number is up 7% over the last decade. The number is even higher for those without living directives.

Even the simplest of probates can take months, tack on not having a will and now you could be talking years.

This must stop. If you’re reading this there is still time.

3 Steps To Start

  1. Talk to your spouse and grown children today about your final plans. Nothing must be set in stone (today), but you should review your wishes. Make a date night out of it if needed. Here are a couple of topics to get you started: burial or cremation, do not resuscitate or resuscitate, power of attorneys, beneficiaries and guardians if you have small children. In my experience, consumers have the toughest time with decisions pertaining to a living directive. Don’t worry a non-profit Aging with Dignity has you covered from what you need to do, how to do it and even how to have conversations with your loved ones about your decisions.

These are all invaluable topics and must be covered to prevent your loved one’s from having to make a hard, emotional or rash decision.

  1. Another big topic that is easily missed is the “where are things conversation.” Where are your assets, investment accounts, life insurance, employer plans, your legal documents? Where are your usernames and passwords?
  2. Review your life insurance coverage. Everyone’s needs are different so there is no perfect amount of coverage, but a good rule of thumb is you need 7-10 times salary. Here is a sample Life Insurance Needs Worksheet that will give you an idea on how much coverage may be suitable for your family. In my next post we’ll explore the different types of insurance and who might benefit from each type, term, universal or whole.

Does your spouse stay at home? Guess what, they need insurance as well. Don’t neglect the monetary impact the death of a stay at home mom. You also can’t afford to neglect the impact the death of a child can have on a family as well. That one just hurts to write, now come up with thousands of dollars to take care of an untimely death. The average funeral costs between $7,000-$10,000. According to a 2016 GOBankingRates survey, 69% of Americans have less than $1,000 in their savings accounts and even scarier is 34% have $0 savings.

Take the extra precautions to protect your family. Have your advisor or estate planner review, update or draft your wills, power of attorney and trust documents. Find a fee only advisor to review your life insurance coverage.

Luckily for my family, my mother primarily stayed home with me and worked part time for my grandfather’s construction business. She was not the bread winner and she and my father planned accordingly by purchasing life insurance, having a will and a power of attorney. For me personally, being raised by a great family (it took a village) was the biggest blessing. By my parents taking care of the little stuff, the tedious and monotonous things, it allowed me to be a kid and never feel the monetary effect on my family.

The immediate impact was devastating, still is, but I hope my experience can be used as a reminder that life is short, life is precious and with a little planning we can make life a whole lot easier on our loved ones.

If it can happen to my family, it can happen to yours.

I know…I know…

There seems to be absolutely nothing that can derail the current bull market.

  • Geopolitical conflict – NOPE
  • Political intrigue – NOPE
  • Fed Reserve reducing liquidity to the markets – NOPE
  • Lack of expected tax cuts, reform, and infrastructure spending – NOPE, NOPE, and NOPE.

With markets near records, investors seem to have very little to worry about.

But maybe, it is the very fact that everything seems so ebullient that we should take a bit of a contrarian position. As I wrote previously:

First, “record levels” of anything are records for a reason. It is where the point where previous limits were reached. Therefore, when a ‘record level’ is reached, it is NOT THE BEGINNING, but rather an indication of the MATURITY of a cycle. While the media has focused on employment, record stock market levels, etc. as a sign of an ongoing economic recovery, history suggests caution.  The 4-panel chart below suggests that current levels should be a sign of caution rather than exuberance.”


However, while economic data suggests we may closer to the end of the current economic cycle than the beginning, data related specifically to the stock market may also be suggesting the same.

Let’s take a look:

1 – Confidence Levels at 107

The chart below a COMPOSITE confidence index consisting of both the University of Michigan and Conference Board indices. At 107, the index is currently at levels that have historically denoted the end of an economic cycle. (This should be expected as it is the point in the economic cycle where everything is now “as good as it gets.”)

2 – Bullish Sentiment Hits 126 – Greed Levels

The following chart is a composite sentiment index which includes the National Association Of Investment Managers Index, the American Association of Individual Investors and the VIX. Given the combined composite is pushing extreme levels, a bit more caution is likely well advised.

3 – Market Vane Bullish Sentiment: 64%

The Market Vane bullish sentiment index is a yardstick for traders as it measures the number of traders that are long a certain commodity. In this case the S&P 500 index. Currently, at 64%, as with the other indicators above, it is currently reflecting levels of bullishness that have historically been associated with corrective actions.

4 – CBOE’s equity volatility index (VIX) @ 9.79 — The S&P’s 65-day rolling volatility (inverted scale) is at levels which typically occur ahead of a corrective phase.

The volatility index shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward-looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the “investor fear gauge.”  When the gauge is at extremely low levels it suggests that investors have little fear of a market reversion. From a contrarian standpoint, this is when corrections have tended to occur.

I noted last week the record levels of short positions currently outstanding on the Volatility Index.

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

The chart below shows the 13-week moving average (65-day) of the volatility index versus the S&P 500. I have inverted the index to provide a clearer relationship between the two indices. From a contrarian viewpoint, the index currently suggests the risk of a correction outweighs the potential for a further advance.

5 – 2-Year Forward P/E multiples: 17.67x S&P 500, 17.81x S&P 400, 18.86x S&P S&P 600 and 24.01x for Russell 2000. All are above long-term means and forward estimates are subject to large downward revisions. 

Of course, valuations matter, even for Millennials:

Over any 30-year period the beginning valuation levels, the price you pay for your investments has a spectacular impact on future returns. I have highlighted return levels at 7-12x earnings and 18-22x earnings. We will use the average of 10x and 20x earnings for our savings analysis.”

“As you will notice, 30-year forward returns are significantly higher on average when investing at 10x earnings as opposed to 20x earnings or where we are currently near 25x.

The point to be made here is simple and was precisely summed up by Warren Buffett:

‘Price is what you pay. Value is what you get.’” 

6 – NYSE Put/Call Ratio: 0.94

One way to interpret the put-call ratio is to say that a higher ratio means it’s time to sell and a lower ratio means it’s time to buy. However, traders also view this as a contrarian indicator. Traders know that derivatives are used to do more than place bets; they are used as insurance. If there’s a lot of insurance being placed to the sell side, it means traders are worried about prices falling. Some traders will buy when the put-call ratio is above 1, meaning the market is out of balance to the sell side, and sell when the put-call ratio is below 1, meaning the market is out of balance to the buy side. These traders are looking to make money on the correction.

7 – The 14-week RSI (Relative Strength Index) has moved to 72.05, above the 70 level widely viewed as being an “overbought” threshold. 

As shown, on a weekly basis there are only a few points where the markets have been this overbought on a weekly basis. With the exception of the 2013-2014, during the $85-billion per month QE program, each previous occasion has triggered a short-term correction or worse. 

8 – The S&P 500 has now gapped up nearly 7% above its 200-day moving average, another sign of an overextended stock market.

As I have explained numerous times in the past, moving averages are like “gravity.” Prices can only move so far above the longer-term average before the gravitational force exerted causes prices to “revert to the mean.” 

The problem, is these cyclical bull markets are quickly believed to be the beginning of the next secular multi-decade bull market. However, as discussed previously, this is currently unlikely the case given the lack of economic dynamics required to foster such a secular period.

The chart below brings this idea of reversion into a bit clearer focus. I have overlaid the 3-year average annual real return of the S&P 500 against the inflation-adjusted price index itself. 

Historically, we find that when price extensions have exceeded a 12% deviation from the 3-year average return of the index, the majority of the market cycle had been completed. While this analysis does NOT mean the market is set to crash, it does suggest that a reversion in returns is likely. Unfortunately, the historical reversion in returns has often coincided at some juncture with a rather sharp decline in prices.

9 – Earnings expectations have significantly lagged market price action — in fact, according to S&P data, analyst EPS projections for 2017 have declined sharply from $121.09 to $117.20/share since the beginning of the year. 

While there is much hope that earnings will eventually play “catch up” to stock prices, there is a significant risk to that outcome. As shown below, sales per share is roughly at the same level as it was in Q4-2012, but stock prices have risen by 65.7% during the same period. With stock prices already “priced to perfection,” any shortfall will likely be problematic.

10 – The S&P 500 has already climbed above year-end targets for well over half of the Wall Street strategists out there.

As I laid out at the beginning of this year in “The Problem With Forecasts”, even the most bullish analysts weren’t as optimistic as the market is now.

“Since optimism is what sells products, it is not surprising, as we head into 2017, to see Wall Street’s average expectation ratcheted up another 9.43% this year. Of course, comparing your portfolio to the market is a major mistake, to begin with.”


The problem is that since there is never an expectation the markets can go down, it is just that belief which eventually ensures an investor error.

I recently did a very thorough study showing that even dollar cost averaging from current valuation levels is likely to be disappointing over the next few years. To wit:

“So, with this understanding let me return once again to the young, Millennial saver, who is going to endeavor at saving their annual tax refund of $3000. The chart below shows $3000 invested annually into the S&P 500 inflation-adjusted, total return index at 10% compounded annually and both 10x and 20x valuation starting levels. I have also shown $3000 saved annually in a mattress.”

“I want you to take note of the point made that when investing your money when markets are above 20x earnings, it was 22-years before it grew more than money stuffed in a mattress.”

When I returned the study and my findings back to the media outlet, I immediately received a message back stating:

“This is not a message that we want to project.” 

In other words, they wanted an article suggesting that Millennials should just “buy everything.” 

Maybe that is an indicator within itself.

There is an increasing amount of commentary which suggests this time is different. Active management of portfolios is no longer needed, as Central Banks continue to be supportive of the markets, so join in on the “passive indexing” sweeping the country.

Of course, such commentary has always the case near the peak of a cyclical “bull market” as the psychological drive to “not miss out” erases the pain of the previous losses. This “exuberance” is what tends to lead individuals into making poor investment decisions as it relates to their long-term outcomes.

I was asked recently why an individual with 30-years to retirement should not just buy an index, invest money, and forget about it? With a 30-year horizon, they surely don’t need to worry about market volatility right?

Maybe they should.

Let me use the example for a previous study on the impacts of valuations and long-term outcomes. (See the full analysis here.)

“So, with this understanding let me return once again to the young, Millennial saver, who is going to endeavor at saving their annual tax refund of $3000. The chart below shows $3000 invested annually into the S&P 500 inflation-adjusted, total return index at 10% compounded annually and both 10x and 20x valuation starting levels. I have also shown $3000 saved annually in a mattress.”

“I want you to take note of the point made that when investing your money when markets are above 20x earnings, it was 22-years before it grew more than money stuffed in a mattress.”


The mathematical analysis suggests, at current valuation levels, individuals may be just as well off storing money in cash rather than investing in the markets. That is just the math.

The financial markets will do one of two things to your future financial security:

  1. If you treat the financial markets as a tool to adjust your current savings for inflation over time, the markets will KEEP you wealthy. 
  2. However, if you try and use the markets to MAKE you wealthy, your capital will be shifted to those in the first category.

Let’s focus on the first one.

Financial Security: More Than Just The Financial Markets

Financial security is not only about investing correctly, but also the things that are important to long-term capital preservation. The following are some thoughts in this regard and cover both rules of investing as well as rules of capital preservation.

1. Buy low, sell high.

As obvious as this seems it is the one thing that most investors do exactly the opposite of. Your ability to consistently buy low and sell high, will determine the success, or failure, of your investments. The simple reality is that 100% of your rate of return is determined by when you enter, or leave, the stock market.

2. The price of the stock market is always right.

The only thing that truly matters in investing is the price. If prices are rising – then you are long the market. If they are falling; you are in cash or short. What you ‘think’ the market should be doing at any given time is irrelevant. With all things being equal, the longer you stay on the right side of the stock market, the more money you will make. The longer you stay on the wrong side, the more money you will lose.

3. Every market or stock that goes up will go down and vice versa.

The more extreme the move up or down, the more extreme the movement in the opposite direction once the trend changes. This is also known as the “trend always changes” rule.

4. Your career provides your wealth.

You most likely will make far more money from your business or profession than from your investments. Only very rarely does someone make a large fortune from investments, and it is generally those that have a business investing wealth for others for a fee or participation. (This even includes Warren Buffett.)

5. Don’t assume you can replace your wealth.

The fact that you earned what you have doesn’t mean that you could earn it again if you lost it. Treat what you have as though you could never earn it again. Never, take chances with your wealth on the assumption that you could get it back.

6. The trend is your friend.

Since the trend is the basis of all profit; understanding both the long and short-term market trends are useful in understanding the risks versus the reward in putting capital at risk. Contrary to the short-term perspective of most investors today, all the big money is made by catching large market moves – not by day trading or short term stock investing.

7. You must let your profits run and cut your losses quickly.

This is the key to investing success. Trading discipline is a necessary condition of investment success. If you do NOT have a highly disciplined approach to trading – you will not make money over the long term.

8. Traditional technical and fundamental analysis alone may NOT enable you to consistently make money in the markets.

Successful market timing is possible but not with the tools and analysis most people employ. The problem with most analysis is it is biased to sell product and, therefore, is optimized, employs data mining, subjectivism, or other such statistical tricks to promote a specific perspective, opinion or objective. Focus on what the data is telling you rather than what you want it to be.

9. The worst thing an investor can do is take a large loss on their position or portfolio.

You can avoid making that huge mistake by avoiding buying things when they are high. It should be obvious that your starting point is critical in determining your total return, if you buy low, your long-term investment results are irrefutably better than someone who bought high.

10. The most successful investing methods require changes at the margin.

A strong investment discipline requires patience, discipline, and work. However, once a portfolio is built and operational maintenance is a function of changes at the margin. Investing is a long-term process with a view towards changes of trend. Such a portfolio requires very few changes between major trend changes. If you are trading regularly – you are speculating and will eventually wind up losing more money than you made.

11. Don’t use leverage.

When someone goes completely broke, it’s almost always because they used borrowed money. Using margin accounts, or mortgages (for other than your home), puts you at risk of being wiped out during a forced liquidation. If you handle all your investments on a cash basis, it’s virtually impossible to lose everything—no matter what might happen in the world—especially if you follow the other rules given here.

12. Whenever you’re in doubt, it is always better to err on the side of safety.

If you pass up an opportunity to increase your fortune, another one will be along soon enough. But if you lose your life savings just once, you might never get a chance to replace it. Always err on the side of caution. Always ask the question of what CAN go “wrong” rather than focusing on what you “HOPE” will go right.

13. Create a bulletproof portfolio for protection.

A portfolio of low-risk investments, fixed income and a healthy level of cash will ensure that no matter what happens in the markets, or in your life, you will be in a financially sound position to handle it. A portfolio should be able to survive any uncertainty that arises and in today’s world, there are plenty of uncertainties to choose from. It isn’t difficult, or complicated, to build a portfolio that can deliver lower volatility, income, and capital preservation.

It is easy to get sucked into the “hype” particularly at the latest stages of a rampant bull market advance. We all want to be able to under-save today for tomorrow’s needs by hoping the markets will make up the difference. This is the same bit of logic every major pension fund in America has utilized for the last 25-years and are now facing the underfunded consequences of believing the markets will generate 7-8% every single year.

Trust me. I get it.

It’s not too late to start making better choices.

Ah…yes. It is FINALLY that time of the year when I take a week off with the family for our summer vacation.

Don’t worry, I have been fiendishly writing for the past two weeks and have blog posts all ready to go for next week. You won’t left hanging.

However, let me just leave you today with one parting thought.

The chart below is the S&P 500 on a WEEKLY basis going back to 1992. While it is clear the bullish trend is currently intact, which suggests the markets could indeed rise further, the deviation from the 1-year moving average is pushing more historical extremes.

Furthermore, the two circles on the lower part of the chart show the longer-term “buy/sell” signals which have been historically accurate in adjusting risk in portfolios. As you will notice, just like in late 1998 and early 1999, there was a sell signal which was reversed WITHOUT the market dropping into a bear market. The subsequent rally pushed asset prices and valuations to extremes in early 2000.

I don’t need to remind you what happened next. 

Currently, we see the same build up in exuberance, leverage, and speculation. The sell signal in 2015/2016 has been reversed following the Trump election. More importantly, just like in 1999, the indicators are running at historically very high levels.

I probably don’t need to remind you what will happen next. 

It is just a function of time.

In the meantime, the bullish trend remains intact. So, we participate for now but we do so with a high level of caution and very tight stop losses.

So, with that said, this is what I will be reading on vacation.



Research / Interesting Reads

 “Sometimes buying early on the way down looks like being wrong, but it isn’t.” – Seth Klarman

Questions, comments, suggestions – please email me.

As a portfolio manager, I start each morning by consuming copious amounts of a heavily caffeinated beverage and a data feed from a litany of web and blog sites. Over the last few days, as asset prices have set new records, there have been numerous articles on whether the market is currently in a bubble. Here are a few I grabbed from a Google search:

Well, you get the idea. First, like a “watched pot never boils,” bubbles occur when no one is looking for them. Bubbles are a function of greed running rampant combined with a mass hypnotic state the current ride will never end. The shear fact that multitudes of articles are being written about “market bubbles” is a sign that we are likely not there…just yet.

However, as a shot of caffeine hits my brain, I read with interest a WSJ article entitled Tech Is No Bubble, But The Market Might Be which I have summarized for you:

  • Technology stocks have finally surpassed the 17-year old peak.
  • 80% of the gains in the technology sector has come from just 8-companies.
  • A measure of dispersion in performance shows little excess from the long-run average.
  • While there may be an “everything bubble,” technology stocks don’t look especially frothy.

While these are certainly some interesting arguments, the comparison between now and the turn of the century peak is virtually meaningless. Why? Because no two major market peaks (speculative bubble or otherwise) have ever been the same.

Let me explain.

In late October of 2007, I gave a seminar to about 300 investors discussing why I believed that we were rapidly approaching the end of the bull market and that 2008 would likely be bad…really bad. Part of that discussion focused on market bubbles and what caused them. The following two slides are from that presentation:



Every major market peak, and subsequent devastating mean reverting correction, has ever been the result of the exact ingredients seen previously. Only the ignorance of its existence has been a common theme.

The reason that investors ALWAYS fail to recognize the major turning points in the markets is because they allow emotional “greed” to keep them looking backward rather than forward.

Of course, the media foster’s much of this “willful” blindness by dismissing, and chastising, opposing views generally until it is too late for their acknowledgement to be of any real use.

The next chart shows every major bubble and bust in the U.S. financial markets since 1871 (Source: Robert Shiller)

At the peak of each one of these markets, there was no one claiming that a crash was imminent. It was always the contrary with market pundits waging war against those nagging naysayers of the bullish mantra that “stocks have reached a permanently high plateau” or “this is a new secular bull market.”  (Here is why it isn’t.)

Yet, in the end, it was something that was unexpected, unknown or simply dismissed that yanked the proverbial rug from beneath investors.

What will spark the next mean reverting event? No one knows for sure, but the catalysts are present from:

  • Excess leverage (Margin debt at new record levels)
  • IPO’s of negligible companies (Blue Apron, Snap Chat)
  • Companies using cheap debt to complete stock buybacks and pay dividends, and;
  • High levels of investor complacency.

Either individually, or in combination, these issues are all inert. Much like pouring gasoline on a pile of wood, the fire will not start without a proper catalyst. What we do know is that an event WILL occur, it is only a function of “when.” 

The discussion of why “this time is not like the last time” is largely irrelevant. Whatever gains that investors garner in the between now and the next correction by chasing the “bullish thesis” will be wiped away in a swift and brutal downdraft. Of course, this is the sad history of individual investors in the financial markets as they are always “told to buy” but never “when to sell.”

For now, the “bullish case” remains alive and well. The media will go on berating those heretics who dare to point out the risks that prevail. However, the one simple truth is “this time is indeed different.”  When the crash ultimately comes the reasons will be different than they were in the past – only the outcome will remain same.

Below are 22 realities to explain why 720Global does not recommend following the herd.

Equity/Bond Valuations

  • The S&P 500 Cyclically Adjusted Price to Earnings (CAPE) valuation has only been greater on one occasion, the late 1990s. It is currently on par with levels preceding the Great Depression.
  • CAPE valuation, when adjusted for the prevailing economic growth trend, is more overvalued than during the late 1920’s and the late 1990’s. (LINK)
  • S&P 500 Price to Sales Ratio is at an all-time high
  • Total domestic corporate profits (w/o IVA/CCAdj) have grown at an annualized rate of .097% over the last five years. Prior to this period and since 2000, five year annualized profit growth was 7.95%. (note- period included two recessions) (LINK)
  • Over the last ten years, S&P 500 corporations have returned more money to shareholders via share buybacks and dividends than they have earned.
  • The top 200 S&P 500 companies have pension shortfalls totaling $382 billion and corporations like GE spent more on share buybacks ($45b) than the size of their entire pension shortfall ($31b) which ranks as the largest in the S&P 500. (LINK)
  • Using data back to 1987, the yield to maturity on high-yield (non-investment grade) debt is in the 3rd Per Prudential as cited in the Wall Street Journal, yields on high-yield debt, adjusted for defaults, are now lower than those of investment grade bonds. Currently, the yield on the Barclays High Yield Index is below the expected default rate.
  • Implied equity and U.S. Treasury volatility has been trading at the lowest levels in over 30 years, highlighting historic investor complacency. (LINK)

U.S. Economy

  • Real GDP has grown 1.97%, .83% and .69% over the last 3, 5, and 10 years respectively.
  • The Federal Reserve forecast for real GDP is 2.05% and 1.90% for 2018 and 2019
  • Federal Government Debt to GDP is 105.86%, almost 2x higher than year-end 2000. 720Global optimistically forecasts it to be 130% within ten years. (LINK)
  • Government deficits are forecast to grow at 3x the rate of GDP through 2027
  • At $8.6 trillion, corporate debt levels are 30% higher today than at their prior peak in September 2008
  • At 45.3%, the ratio of corporate debt to GDP is at historical highs having recently surpassed levels preceding the last two recessions.
  • Total Government and private debt per household is $329,000 (LINK)
  • Productivity growth (TFP) continues to fall and is quickly approaching zero. It is currently in decline in many developed economies.
  • In 2016, the first baby boomers turned 70 marking an acceleration point for retiring workers and those taking retirement distributions. 10,000 boomers are now retiring daily, which adds pressure to fiscally unstable government programs such as Medicare and Social Security.
  • Massively underfunded state and local pension funds. According to a Hoover Institute study published in May 2017, current pension shortfalls total over $3.8 trillion versus the GASB cited shortfall of $1.3 trillion. (LINK) (LINK)

Federal Reserve

  • Fed Funds have been pinned at or below 1% since 2009. Prior to this time period, it had only been below 1% for one quarter in the 1950’s.
  • The Fed’s balance sheet remains almost six times larger than the pre-crisis levels which serves to distort the price of money and the transmission mechanism between borrowing, lending and Fed policy.
  • Despite having exited “crisis conditions” long ago, Fed policy remains far too accommodative via ultra-low rates and a disfigured balance sheet encouraging vast misallocation of global capital. (LINK)
  • Based on formal published documents from the Federal Reserve regarding policy strategy and goals, the Fed remains incoherent on their objectives and the means used to achieve them. (LINK) (LINK)

Paying soaring valuations in such an environment is, to put it mildly, complacent. 





Super savers march to a different drummer. Impetuous financial decisions are not in their DNA. They exist outside the mainstream of consumerism.

These hyper-savers have a unique ability to delay gratification. Frankly, they prefer to consider the future first. Uncommon for many Americans whose attitude is live for today, super savers consistently save for tomorrow.

Principal Financial defines super savers as Americans who are socking away at least 90 percent of the annual employee contribution limit to their 401(k) plans. In 2016, Principal surveyed 2,424 retirement plan participants whose ages range from 23-51.

Interestingly, the study debunks a myth that Millennials are profligate spenders; a majority of this group (91%), identified saving for retirement as a priority. Perhaps living through the Great Recession and observing the impact on friends and family has something to do with their conservative attitudes.

Super savers are driven by a mission. A passion to master security one financial decision at a time. The more they save, the greater they yearn to raise the bar. Undeniably, saving money acts as an endorphin. Cash inflow over outflow is a key contributor to their sense of well-being.

Like a physical exercise regimen, shifting into super-saver mode takes small, consistent efforts that build on each other.

So, what lessons can be learned from this elite breed? How can we be part of the super-saver generation?

First, they find reasons to control what they spend and associate positive feelings with saving.

Super-savers think backwards, always with a financially beneficial endgame in mind.

They have evolved to consider the cumulative impact of monthly payments on their bottom line, which is not common nature for the masses (Read: People Buy Payments, Why Rates Can’t Rise). They internalize the opportunity cost of every large or recurring expenditure.

Super savers weigh the outcome of every significant purchase, especially discretionary items, which invariably increases their hesitancy spend. This manner of thought provides breathing room to deliberate less expensive alternatives and thoroughly investigate the pros and cons of their decisions.

A focus is on the opportunity costs of using credit and paying interest (resources that could have been otherwise directed into investments earmarked for long-term goals like retirement).

Tip for the super-saver in training: Sever the mental connection between monthly payments and affordability. How? First, calculate the interest cost of a purchase. For example, let’s say you’re looking to purchase an automobile. First, never go further than 36 months if you must make payments. Why? Because longer loan terms like 48 to 72 months is a payment mentality that will undoubtedly increase interest costs.

For example, let’s say an auto purchase is financed for $23,000. At 3.49% for 36 months, the payment is roughly $674 with total loan interest of $1,258. For 72 months, naturally there’s a lower monthly obligation – $354. However, total loan interest amounts to $2,525.

A super saver’s consideration would be on the interest incurred over the life of a loan, not the affordability of monthly payments. An important difference between this manner of thinking and most, is to meet a lifestyle, it’s common for households to go for the lowest monthly payment with little regard to overall interest paid. Super savers will either consider a less expensive option or adjust household budgets to meet higher payments just to pay less interest in the long run.

Super-savers experience enriching lives, but always with an eye on the future.

Members of the super crowd don’t live small lives -a big misnomer. I think people are quick to spread this type of narrative to ease personal guilt or envy. Certainly, a fiscal discomfort mindset is part of who they are when they believe personal financial boundaries are breached.

However, super savers thrive below their means. Extending themselves with new cars and big mortgages is uncomfortable and inhibits quality of life. Super-savers are not compelled to spend to gain social status and not motivated by keeping up appearances.

Tip for the super-saver to be: Give thought to the future before the present.  Make it an obsession. In other words, delay some of today’s gratification for tomorrow’s security. There is a painless way to accomplish the task.

Super-savers are programmed to pay themselves before everything else. They proactively adjust their household expenditures so that company retirement and or emergency savings accounts are funded first. Payroll deductions or some form of automatic deposit feature make it easy to create and stick with an aggressive saving and investment program.

Make an initial bold move. A financial leap of faith: This week take a step to super-saver status and immediately increase your retirement payroll deduction to 15%. Don’t even think about it, just do it. Before consideration to your household spending.

Micro-track expenses for the month after the new deduction is in effect. Adjust spending to meet the new, increased deduction. Then work on the necessary cuts to expenses to continue the 15% or possibly adjust even higher, to 20%.

My thought is you’ll be amazed to see how quickly the change is accepted and the impact minimal to the quality of life. Only as I’ve witnessed how this action alters thinking to attach good feelings and reward to savings vs. spending. You’re now working super-saver muscles you didn’t even know you had.

Super-savers are a year late but rarely a dollar short.

No, super-savers don’t own the latest smart-phones, nor do they consider automobiles as luxuries. They’re merely for transport. Nearly half of “super savers” are driving older vehicles (47 percent) in order to direct dollars to their retirement savings per the study by Principal Financial.

The super-savers I interviewed are at least one or two smart-phone iterations behind (it works fine), and will investigate pre-owned autos over new. They’ll maintain and keep these automobiles for as long as they’re operational, well into hundreds of thousands of miles.

They’re not house poor.

Cars aren’t the only carefully considered big ticket purchases. “Super savers” often choose to live in modest homes (45 percent) and, among millennials, 18 percent are renting vs. buying. Read RIA’s rule for taking on mortgage debt.

According to the Core Logic Case-Shiller Home Price Index, house prices in Texas are growing faster than the national average. For example, San Antonio has gained 7.8% year-over-year compared to a national gain of 3.7%. Home prices are up across the country at the minimum, 5% above fair value.

The lesson? Super-savers are either going to wait (until prices moderate, as they’re disciplined, not emotional), or save for a larger down payment. Anything to avoid being saddled with a big mortgage that jeopardizes savings goals.

Super savers sacrifice current vacations for the permanent vacation fund.

Principal Financial discovered super savers are prioritizing retirement savings over vacation funding. Many say they are traveling less than they’d prefer (42 percent).

The key is to re-define travel and become financially savvy while doing so. Super savers explore vacation adventures close to home, take frequent day trips and travel to popular destinations in the off-season when expenses can be 15-25% less.

Studies show that super savers are independent thinkers. Working to maintain a current lifestyle that rivals their neighbors is anathema to them.

Now, as a majority of Americans are utilizing debt to maintain living standards, super savers set themselves apart as a badge of courage. No doubt this group is unique and are way ahead at creating a secure, enjoyable retirement.

Whatever steps taken to join their ranks will serve and empower you with choices that those with overwhelming debt cannot consider.