Monthly Archives: April 2017

Viking Analytics: Weekly Gamma Band Update 4/12/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) finished the week with another strong rally, closing at new highs.  The Gamma Band weekly model[1] maintained a 100% allocation to the S&P 500 (SPX) all week, and the Gamma Flip level moved higher to roughly 3,990.  When the daily price closes below the “Gamma Flip” level, the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below the lower gamma level (currently near 3,800), the model will reduce the SPX allocation to zero.

Investors who keep an eye on the Gamma Flip level are more aware when market volatility is expected to increase.  The chart below shows how the length of daily candles tends to be longer when the market price is below or near the Gamma Flip level. 

The general idea behind this model is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

This is one of several signals that we publish daily in our SPX Report. Overall, we continue to rate the SPX options signals as “cautiously bullish.” Speculative investors are buying a lot of SPX protection at the moment, which in the past has continued a bullish regime.

A sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size daily based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics. He has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a B.S. in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space.  He is a former Managing Director at a multi-billion dollar hedge fund. Furthermore, he has deep experience with market data, software, and model building in financial markets. Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


March Jobs Report – Millions Missing From The Roles

Recently, the March jobs report showed a whopping 916,000 new jobs. Interestingly, there were some anomalies in the data and millions missing from the official count.

As shown, there has been a substantial reduction in the unemployment rate back to 6%. Historically, an unemployment rate of 5% was considered “full employment.” However, for the Federal Reserve to have “cover” to continue current monetary interventions, a new standard has been set at the previous lows of 3.8%.

The reality is there is a multitude of problems with how the entire series is “guessed at.” As noted previously by Morningside Hill:

  • The Bureau of Labor Statistics (BLS) systemically overstates the number of jobs created, especially during the last economic cycle.
  • The BLS has failed to account for the rise in part-time and contractual work arrangements, while all evidence points to a significant and rapid increase in the so-called contingent workforce.
  • Full-time jobs are being replaced by part-time positions, resulting in double and triple counting of jobs via the Establishment Survey.  (Examples: Uber, Lyft, GrubHub, FedEx, Amazon)
  • A full 93% of the new jobs added since 2008 came through the business birth and death model – a highly controversial model not supported by the data. On the contrary, all data on establishment births and deaths point to an ongoing decrease in entrepreneurship.

Most importantly, the jobs added to the roles are not “new” entrants into an expanding labor force but rather furloughed workers returning to work post-pandemic shutdown. In other words, jobs are not truly being “created” due to rising demand but rather “refilling” roles as businesses reopen.

Seasonal Anomalies

These “measurement problems” showed up in the latest report as reported by Mizuho Securities.

As they note, without the outsized seasonal “adjustments,” employment would have been far weaker. These adjustments are problematic over time as they tend to “over-estimate” employment. As I have discussed previously, a simple 12-month average of the non-seasonally adjusted data provides a more reliable assumption. To wit:

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

As shown, near the peak of employment cycles, the employment data deviates from the 12-month average and reconnects as reality emerges.

There is currently a 130,000 person unemployment gap between the smoothed non-seasonally adjusted data and the official “seasonally adjusted” data.

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

But there is more to this story.

A Problem Of Population Growth

A point overlooked when reporting on employment is the “growth” of the working-age population. Each month, new entrants into the population create “demand” through their additional consumption. Employment should increase to accommodate for the increased demand from more participants in the economy. Either that or companies resort to automation, off-shoring, etc., to increase production rates without increases in labor costs. The chart below shows the total increase in employment versus the growth of the working-age population.

The missing “millions” shown in the chart above is one of the “great mysteries” since 2009. Such is particularly a problem when the Federal Reserve talks about “full employment.” The disparity shows up in both the Labor Force Participation Rate and those “Not In Labor Force.”

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

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

There has undoubtedly been a recovery from the recessionary lows. However, when the economy does return to “full employment,” we will likely see fewer full-time jobs than before the past two recessions.

Baby Boomers Still Working

One of the arguments often given for the low labor force participation rate is that millions of “baby boomers” leave the workforce for retirement. While such may indeed be the case, it is hard to suggest that nearly 1/3rd of the population has retired.

Furthermore, that argument doesn’t carry much weight given that the “Millennial” generation, which is significantly larger, is simultaneously entering the workforce. The other problem, shown below, is that more individuals over the age of 55, as a percentage of that age group, in the workforce are rapidly rising back to pre-pandemic peaks.

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

However, for argument’s sake, let’s assume that every worker over 55 retires. If the “retiring” argument is valid, then the 25-54 employment participation rate should be near peaks. (Someone has to be working.) Such is not the case.

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

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

4-Million Missing

Another anomaly that showed up in the data is in the prime 25-54-year-old age group. In 2020, over 4-million individuals in that age group disappeared from the POPULATION.  

I did not say they disappeared from the “labor force.” The population of that age group rapidly shrank.

However, that decline has an important bearing on the “labor force” participation rate by reducing the calculation’s denominator.

A Long Way To Go

With the prime working-age group of labor force participants still at levels seen previously in 1985, it does raise the question of just how robust the labor market is?  All of this data suggests that the Federal Reserve is likely correct in not paying much attention to the official employment reports.

The actual “unemployment situation” remains in a fragile state. As Michael Lebowitz discussed previously:

“A calculation of the participation rate adjusted unemployment rate is revealing.”

‘When people stop looking for a job, they are still unemployed, but they are not included in the U-3 unemployment calculation. If we include those who quit looking for work in the data, the employment situation is quite different. The graph compares the U-3 unemployment rate to one that assumes a constant participation rate from 2008 to today. Contrary to the U-3 unemployment rate of 6.0%, this metric implies an adjusted unemployment rate of 13.0%.

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

Conclusion

As noted, the Federal Reserve is closely monitoring the alternative measures of employment for managing monetary policy. Furthermore, these weak participation rates remain a “deflationary” force on the economy, which is why the Fed is willing to allow short-term inflation to “run hot.”

The Federal Reserve’s problem is they remain trapped in a “stagflationary economy,” which will leave their policy tools primarily ineffective.

We know that demographics and debt are long-term deflationary drags on economic growth that short-term stimulus won’t cure. It is just a function of time until the financial markets figure this out as well.

Shedlock: Lacy Hunt & Expectations For Decelerating Inflation

Lacy Hunt at Hoisington Management has some interesting thoughts regarding the inflation debate and the potential for decelerating inflation.

Case For Decelerating Inflation

In its Quarterly Review and Outlook for the First Quarter of 2021 Lacy Hunt makes a case for decelerating inflation.

Contrary to conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year-end and undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.

After declining 5.2% in 2020, or the most since World War II, worldwide economists expect real per capita GDP to rise 4.7% in 2021. The United States will perform even better, rising 6.2% after a contraction of 4.9% in 2020. The U.S. growth rate could be the fastest since 1984 and possibly even since 1950 (Chart 1).

Five considerations suggest that such growth is not likely to lead to sustained inflation. 

Lacy said 5. I added a 6th bullet point from his discussion, then added 2 more points of my own. 

Six Reasons to Expect Disinflation

Inflation is a lagging indicator. The low in inflation occurred after all of the past four recessions, with an average lag of almost fifteen quarters from the end of the recessions.

Inflation Troughs Hoisington

Productivity rebounds in recoveries and vigorously so in the aftermath of deep recessions. This pattern in productivity is quite apparent after the deep recessions ending in 1949, 1958, and 1982. Productivity rebounded by an average of 4.8% in the year immediately after the end of these three recessions and unit labor costs were unchanged. The rise in productivity held down unit labor costs.

Sharp Economic Rebounds Hoisington

Deflationary Forces Abound

Restoration of supply chains will be disinflationary. Supply chains were badly disrupted by the pandemic. Low-cost producers in Asia and elsewhere were unable to deliver as much product into the United States and other relatively higher-cost countries. This allowed U.S. producers to gain market share. As immunizations increase, supply chains will be gradually restored. Thus, the pandemic cost the low-cost producer’s market share which was shifted to domestic producers. The pandemic did far more for domestic firm’s

Accelerated technological advancement will lower costs. Another restraint on inflation is that the pandemic greatly accelerated the implementation of inventions that were in the pipeline. Necessity is the mother of invention, as has been demonstrated in earlier crisis situations like wars. Thus, the technology du jour is not the same as the technology of a year ago. This will also serve to act as a restraint on inflation. Much of the technology substitutes machines for people, communication without travel, and work without offices.

Eye-popping economic growth numbers, based on GDP in present circumstances, greatly overstate the presumed significance of their result. This is where the fallacy of broken glass comes into play. Many businesses failed in the recession of 2020, much more so than normal. As survivors and new firms take over their markets, this will be reflected in GDP, but the costs of the failures will not be deducted.

The two main structural impediments to traditional U.S. and global economic growth are massive debt overhang and deteriorating demographics both having worsened as a consequence of 2020.

Mish Comments

Lacy is talking about “inflation” as measured by the BLS.

I am in 100% agreement with every point. 

Thus I expect bond yields to soon peak if they have not done so already.

Year-Over-Year Inflation Spike Coming

The above viewpoint is not incompatible with my March 12 post Inflation is Poised to Soar, 3% by June is “Almost Certain”

Year-over-year comparisons produce very large numbers, up and down, heading in and out of recessions.

I commented “It’s not that inflation will be rampant.  Rather, it’s the impact of year-over-year comparisons, goosed by a huge Covid-related dip in energy prices in April and May of 2020.”

I also commented A Producer Price Index Inflation Spike Is On The Way Too

The rationale is the same. And as noted Gas Prices Are Soaring, I Pay $3.28, How Much Do You Pay?

Hello Fed, Inflation is Rampant and Obvious, Why Can’t You See It?

On March 30, I commented Hello Fed, Inflation is Rampant and Obvious, Why Can’t You See It?

Q: Has my view change?
A: No.

Q: Is it inconsistent?
A: No.

Q: Why?
A: Lacy is talking about “inflation” as measured by the BLS. I addressed home prices in detail substituting home prices in the CPI for Owners’ Equivalent Rent (OER) in the CPI.

I stand by that measure of inflation and it’s out of control. 

The Fed blew another set of bubbles and did so on purpose. 

Two Bonus Reasons to Expect Lower Inflation

  1. Bubbles Pop
  2. Higher Taxes

Lacy came up with six excellent reasons to expect lower inflation. To those we can easily add two more.

Bubbles Pop

The expansion of bubbles is highly inflationary and popping is the reverse. 

Please note the Largest Increase in Margin Debt Since 2007 Fuels Stock Market

What happened in 2000 and 2007? I think you know the answer to that question.

Bubbles inevitably pop and the result, by definition, is not inflationary. 

Dow New Low, Markowski: Could The Dow See A New Low Before Recession Ends?

Higher Taxes

Tax hikes are hugely disinflationary. Look at where we are headed.

Not all of those tax hikes will pass but some of them will. 

Biden wants to increase the corporate tax rate to 28% from 21%. Look for a compromise at 25% or so. 

Progressives want huge tax hikes, via reconciliation, some of them will get through. 

These tax hikes are very recessionary and disinflationary.

Recovery in Low Paying Jobs

Finally, please note It’s Been One Heck of a Recovery in Low-Paying Zoomer Jobs

That’s not a big inducement to higher inflation either.

Add Things Up

Add it all up and you have 8 reasons to expect inflation will soon peak. 

Market Surges Back To Overbought As Investors Go “All In”


In this issue of “Markets Surges Back To Overbought As Investors Go ‘All In’

  • Market Review And Update
  • Investors Are All In
  • More Than One Cockroach
  • Portfolio Positioning
  • #MacroView: Biden Stimulus Will Cut Poverty For One-Year
  • Sector & Market Analysis
  • 401k Plan Manager

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



Catch Up On What You Missed Last Week

 


Market Review & Update

It seems like it was just last week that we were talking about adding exposure to portfolios. To wit:

“I suspect we may have some additional quarter-end rebalancing risk early next week. However, buying on Thursday next week, as second-quarter positioning gets underway, would not be surprising. As such, hold positions early next week and look for weaknesses to add to exposures as needed.

Such turned out to be the case as the markets slopped around early in the week. That changed as markets exploded to new highs on Wednesday and Thursday as portfolio managers charged back into the stocks sold off during the Archegos debacle.

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we are at full equity allocations, with a slight increase in the duration of bonds. Such leaves our portfolios at model weights in cash with bond durations shorter than our benchmark.”

While the rally was strong with the breakout to new highs, it also sent our “money flow buy signal” back to levels that previously coincided with market congestion (blue shaded area)

Importantly, the market is trading well into 3-standard deviations above the 50-dma, and is overbought by just about every measure. Such suggests a short-term “cooling-off” period is likely. With the weekly “buy signals” intact, the markets should hold above key support levels during the next consolidation phase. 

However, risks are building that has preceded more significant market declines in the past (5-10%.) As I noted in this week’s “3-Minutes” video, we suspect the timing of that correction will be mid-summer. Such a correction could indeed occur sooner, particularly if hopes for further Government spending fade, tax rates increase, or inflation surges more than expected.

Regardless, investors are more exuberant about markets than we have seen since the “Dot.com” craze.

Santa Claus Broad Wall, Technically Speaking: Will “Santa Claus” Visit “Broad & Wall”

Investors Are All In

There are two critical aspects to markets currently which keep us concerned near term. During “bear markets,” valuations are reversed from extremes as prices decline. However, “market corrections” do not reverse valuations as multiple expansions continue. 

That was the case following the “economic shutdown.” Due to the Federal Reserve’s extreme interventions, prices quickly reversed from long-term bullish trend lines, and valuations were never reset from extremes. As such, all valuation metrics remain near or at historical extremes. A case in point is the historical “price to sales” ratio.

Furthermore, during “bear markets,” investors generally exit markets only to return several years later. Given one of the worst economic recessions since the “Great Depression,” individuals still carry higher levels of equity allocations than at the “Dot.com” peak. Talk about F.O.M.O. (Fear Of Missing Out.)

More importantly, over the past 5-MONTHS, more money has poured into the equity markets than in the last 12-YEARS combined. 

  As Bob Farrell once quipped:

“Individuals buy the most at the top, and the least at the bottom.” 

Combine that market exuberance with more extreme overbought conditions, and the ingredients for a near-term correction are in place. 

Given that everyone expects an “economic boom” over the next several months, there is a lot of room for disappointment.

Earnings Peak?

So, what could disappoint market participants? Earnings growth is weaker than expected. Or, more importantly, downward revisions to earnings expectations in the months ahead. Neither would be surprising given that economists and analysts always overestimate outcomes.

Next week, I am publishing a more detailed report on earnings versus expectations. The critical point is that investors are currently paying record prices for year-end earnings that are significantly lower than initially estimated. As noted, given the analysts’ history of overestimating future earnings, it is likely next year’s earnings will be revised down rather markedly.

In a recent note, Jesse Felder pointed out our concerns about rising interest rates and inflationary pressures. (Higher corporate tax rates will also significantly reduce forward earnings estimates.)

“Part of the runup in stock prices over the past year is due to the rebound in earnings we will see over the next few quarters. However, now that interest rates, oil prices and the dollar index have each been rising for some time, earnings growth will almost certainly peak and rollover next year, falling back into negative territory. As the stock market discounts fundamentals roughly 18 months into the future, according to Stan Druckenmiller, this bearish reversal in fundamentals could begin to affect stock prices relatively soon.”

The Rate Trigger

As we have discussed previously, rising rates have historically been a trigger for poor outcomes in markets. Jesse touches on our concerns as well. 

“Finally, as Mehul Daya has demonstrated, history shows that rising interest rates regularly act as a bearish catalyst for both markets and the economy. To the extent that low-interest rates and easy money have encouraged and incentivized the unprecedented amount of leverage supporting risk assets today, the reversal in rates, which is already more dramatic than anything we have seen in decades, threatens to reveal just how fragile markets and the economy have now become.”

As I have discussed in the past, in a heavily indebted economy, changes in rates have an almost immediate negative impact on consumption which is 70% of the GDP calculation. As stated, while there are incredibly optimistic expectations of booming economic growth, to support current valuations, higher rates and inflationary pressures will undermine that outlook.

With markets trading at extreme deviations from long-term means, the risk of disappointment remains elevated. Such is why we suggest managing for “risk” rather than “returns.”

Always More Than One Cockroach

Such brings me to an interesting point by Doug Kass on Thursday. 

“The market’s momentum has accelerated recently. That said, in yesterday’s, “There is Never Just One Cockroach,” I highlighted the market headwinds I see:”

  • Coincident with above-expected growth, and arguably fiscal and monetary excesses, are higher interest rates and inflation.
  • As we lap the excessive fiscal and monetary stimulation, the U.S. economy will revert to subpar growth.
  • Recent, current, and prospective stimulative fiscal and monetary policies will likely create a relatively short-lived (economic) sugar high. However, there will be little in the way of sustained gains in productivity or our labor force’s reskilling.
  • The consequences of rampant fiscal spending are rising corporate and individual tax rates, which are a cold headwind for stocks.
  • With the national debt at over $28 trillion, compared to $9 trillion 10 years ago and only $5 trillion 20 years ago, a 20 basis-point rate increase today is equivalent to about a 100 basis points rise two decades ago!
  • Investor sentiment is moving back to an extreme along with valuations that, based on historical metrics, are ALL above the 95th percentile.

You get the idea. The market remains very lopsided. Currently, with investors chasing momentum in a highly illiquid and leveraged market, there is a rather extreme risk of a price dislocation.

What would cause such an event? 

No one knows. While markets quickly dismissed the recent collapse of Archegos Capital, so were the collapses of Bear Stearns hedge funds that warned of systemic problems leading to the financial crisis. 

Maybe Archegos was an isolated event. Maybe not.

But as Doug warns, “there is never just one cockroach.”

Portfolio Update

As I concluded last week, there is only one fact to remember:

“All bull markets last until they are over.” – Jim Dines

Currently, we are maintaining our equity exposures with an ultrashort duration in bonds for the moment. With our “buy signals” returning to more extended levels, along with the overbought conditions of the market, it is likely we will need to start reducing risk as soon as next week.

Importantly, this does not mean “sell everything” and go to cash. We remain in the seasonally strong period of the year, psychology remains extremely bullish, and liquidity is still flooding markets. As such, we could well see the market consolidate within a range over the next few weeks. 

As noted above, there are more significant concerns around mid-year. We will likely see peaks in both earnings and economic data as year-over-year comparisons become more challenging. Also, by that point, we will have a better understanding of potential tax increases, reductions in liquidity, and just how “sticky” the employment picture is. 

With valuations elevated, prices well deviated from long-term means, and investor allocations very aggressive, there is no margin for error. 

Over the next few weeks, there is little reason to “bearish.”

Looking out over the next 12-24 months, we find it increasingly challenging to be “bullish.”


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

  


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 89.34 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 95.02 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • Table shows the price deviation above and below the weekly moving averages.


Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

If you didn’t read last week’s newsletter, here is the important passage.

“Blaise Pascal, a brilliant 17th-century mathematician, famously argued that:

“If God exists, belief would lead to infinite joy in heaven, while disbelief would lead to infinite damnation in hell. But, if God doesn’t exist, belief would have a finite cost, and disbelief would only have at best a finite benefit.”

Pascal concluded, given that we can never prove God’s existence, it’s probably wiser to assume he exists because infinite damnation is much worse than a finite cost. 

Risk does not equal reward. “Risk” is a function of how much money you will lose when things don’t go as planned. Even in healthy markets with fair valuations, risks exist. But in markets with high valuations, the risk of a reversion increase as time marches on.”

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we maintain full equity allocations. We have an ultra-short duration in bonds to offset the risks of rising rates. Lastly, we continue to carry a “barbell approach” in our portfolios. Such splits holdings between “reflation” trades such as Energy, Financials, and Materials and “growth” focused on Technology.

We understand the risks we are undertaking currently by exposing portfolios to the equity market. However, such is needed to ensure we reach the “required hurdle rates” of your financial plan. We also understand that capital preservation remains a key aspect of your long-term returns.

It is a difficult balance, but such is why we continue watching our indicators closely. 

Portfolio Changes

During the past week, we made minor changes to portfolios. We post all trades in real-time at RIAPRO.NET.

** Equity / ETF Portfolio – Trade Update ***

“We added 2.5% of IAU this morning in both models. Gold is setting up nicely on a technical and money flow basis with reliable stop-loss levels not far below. The trade also aligns with the thought that the market is looking beyond the next few months of strong economic data and questioning whether the reflation trade will still have legs come later summer and fall.” – 04/06/21

EQUITY & ETF MODELS

  • Initiate a 2.5% position in IAU / Stop-Loss is $16

“We sold TLT this morning in both portfolios. TLT remained on a tight leash and given strong economic data and money flows were rolling back over on TLT, we thought it best shorten-duration in portfolios back to previous levels. We are significantly underweight our benchmark weight in terms of bond duration at the current time.” – 04/05/21

EQUITY & ETF MODELS

  • Sell 100% of TLT

As always, our short-term concern remains the protection of your portfolio. We have now shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

Technical Value Scorecard Report For The Week of 4-09-21

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis (versus the assets benchmark) and on an absolute stand-alone basis. You can find more detail on the model and the specific tickers below the charts.

Commentary 4-09-21

  • Of the 12 S&P 500 sectors, we track, only three outperformed the S&P over the last week. They were Technology, Discretionary, and Communications. On average, all of the sectors lost .92% to the index.
  • This phenomenon is not just at a sector level. The bottom left relative graph shows that all factors/indexes are now trading slightly below fair value versus the S&P. The NASDAQ was the only factor/index to beat the S&P over the last week.
  • The relative scores show all sectors except for healthcare gravitated toward fair value versus the S&P. Despite the underperformance versus the S&P, the second set of absolute charts, shows that all sectors are decently above fair value.
  • The scatter plot, comparing relative scores and 20-day excess returns shows no correlation, similar to last week. This measure typically registers a very high level of correlation. This tells us that technical patterns of the past 200 days are not as predictive of returns as they had been.
  • The inflationary sector index is now slightly below fair value versus deflationary sectors. Deflationary sectors (XLP, XLU, XLK, and Growth (IWE), have outperformed inflationary sectors (XLB, XLE, XLF, and Value (IVE), by over 10% since early March. Over that period, the implied 5-year inflation rate stalled at slightly over 2.5%. Implied inflation remains a key data point to assess when allocating between sectors.
  • The absolute set of charts shows that most sectors and factor/indexes are well overbought. The score on the S&P 500, bottom right graph, is now as overbought, as at any time in the last ten months. The index is currently 2.30 standard deviations above its 50-day ma.
  • The third graph shows the relative score of gold miners (GDX) versus Gold (GLD). Typically miners lead the way, meaning they tend to outperform gold in the early stages of a gold rally and underperform as a downtrend is starting. The circled area shows that the score of GDX, relative to GLD, shot up and peaked well before the price of GLD peaked last summer. Currently, GDX is at a higher score than the aforementioned period, possibly signaling that Gold’s recent positive positive performance may be the start of something bigger. Since March 1st, GDX is up 12.3% and GLD is up less than 2%. That said, we remain cautious as gold has been in a prolonged downtrend for about 8 months.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum/minimum score, as well as on a normalized basis (sigma) for the last 200 trading days. Assets with scores over or under +/-60% and sigmas over or under +/-2 are likely to either consolidate or change trend. When both the score and sigma are above or below those key levels simultaneously, the signal is stronger.

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma represent a ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner the most bearish.

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Debt Fueled Spending Won’t Create Growth

More debt equals less growth. In October, I discussed the “2nd Derivative Effect” and the ongoing cost of the stimulus. With the passage of the $1.9 trillion “American Rescue Plan,” will the math of debt to growth change?

Now, even Deutsche Bank credit strategist, Stuart Sparks, got the memo.

“History teaches us that although investments in productive capacity can in principle raise potential growth and r* in such a way that the debt incurred to finance fiscal stimulus is paid down over time (r-g<0), it turns out that there is little evidence that it has ever been achieved in the past.

The chart below illustrates that a rising federal debt as a percentage of GDP has historically been associated with declines in estimates of r* – the need to save to service debt depresses potential growth. The broad point is that aggressive spending is necessary, but not sufficient. Spending must be designed to raise productive capacity, potential growth, and r*. Absent true investment, public spending can lower r*, passively tightening for a fixed monetary stance.”

Such is a logical conclusion, but one widely dismissed by economists and politicians. However, some fundamental analysis will underscore Mr. Sparks’ comments.

A Review

To keep some consistency in the analysis, let’s review the actions to date.

As the economy shut down in March of last year due to the pandemic, the Federal Reserve flooded the system with liquidity. At the same time, Congress passed a massive fiscal stimulus bill that extended Unemployment Benefits by $600 per week and sent $1200 checks directly to households.

In December, Congress passed another $900 stimulus bill extending unemployment benefits at a reduced amount of $300 per week, plus sending $600 checks to households once again.

Now, the latest iteration of Government largesse comes in a solely Democrat supported $1.9 trillion “spend-fest.” Out of the total, only about $900 billion goes to consumers in the form of $400 extended unemployment benefits and $1400 checks directly to households. The remaining $1.1 trillion will have little economic value as bailing out municipalities and funding pet projects doesn’t boost consumption.

Using current economic data, we can calculate estimates for the estimated impact of the economy’s stimulus through 2021. As shown in the chart below, in Q3, the inflation-adjusted GDP surged 29.91% from the Q2 reading of -35.94%. As stimulus ran out, Q4 GDP only increased by 3.95%. If we assume that Q1 will increase by the Atlanta Fed GDPNow estimate, GDP will show an 6.2% advance. That advance is the result of the $900 billion stimulus bill in December.

 

Add-In Federal Spending

If we assume the next round of direct checks to households hit by April, GDP will rise by 6.67% in the second quarter. In other words, the “2nd derivative effect” of a larger economy reduces the rate of change from the stimulus and its ability to create growth.

The chart below adds the percentage change in Federal expenditures to the chart for comparison. The 41% jump in expenditures in Q1 is from the combined $900 billion and 1/3rd of the latest stimulus bill. The remainder of the newest bill is then spread into Q2 and ending in Q3 of 2021. At such time Federal spending is assumed to return to is $4.5 trillion quarterly run rate.

We will revise these estimates as data becomes available. However, based on previous stimulus bills’ impact, we have a relatively high degree of confidence in our forecasts.

Trump's COVID Market Bounce, Trump&#8217;s COVID Infects The Market Bounce. Is It Over? 10-02-20

Estimated Impact

Economists estimate the latest stimulus bill could add nearly $1 trillion to nominal growth (before inflation) during 2021. While such a surge in growth would be welcome, it represents just $0.50 of growth for each dollar of new debt.

Such a high growth estimate also assumes that individuals will quickly spend their checks in the economy. The hope is that as vaccines become available, individuals will unleash their “pent-up” demand from the last year.

While that could indeed be the case, there are also other facts to consider.

For example, following the initial stimulus bill’s passage, following the shutdown of the economy, many workers assumed their job loss was temporary. However, a year later, unemployment remains high, and many temporary layoffs have become permanent. Such may well change individuals’ spending behavior, leading them to pay off debt, back rent, late mortgage payments, or save just in case employment remains elusive.

Furthermore, much of the “pent up” demand was already pulled forward by the previous two stimulus plans. We have already witnessed robust increases in manufacturing and services data suggesting consumers have been at work spending money over the last few quarters. The recent surge in retail sales confirms the same.

As discussed previously, while the next American Rescue Plan will be roughly the same size as the original CARES Act, its impact on the economy will be less.

The Second Derivative

Such is the “second derivative” effect we explained previously.

“In calculus, the second derivative, or the second-order derivative, of a function (f) is the derivative of the derivative of (f.)” – Wikipedia

In English, the “second derivative” measures how the change rate of a quantity is itself changing.

I know, still confusing.

Let’s run an example:

As Government spending grows sequentially larger, each additional round of expenditures will have less and less impact on the total. Going back to 2016, not including the CARES Act, the Government increased spending by roughly $50 billion each quarter on average. If we run a hypothetical model of Government expenditures at $50 billion per quarter, you can see the issue of the “second derivative.”

In this case, even though Federal expenditures are increasing at $50 Billion per quarter, the rate of change declines as the total spending increase.

More Leads To Less

The following chart shows how the “second derivative” is already undermining both fiscal and monetary stimulus. Using actual data going back to Q1-2019, Federal Expenditures remained relatively stable through Q1-2020, along with real economic growth. However, in Q2-2020, with our estimates through 2021, Federal Expenditures will double. However, economic growth rates will slow quickly after the stimulus expires.

The chart below shows the inherent problem. While the additional fiscal stimulus may boost short-term economic growth, its impact becomes less over time.

However, this is ultimately the problem with all debt-supported fiscal and monetary programs.

Trump's COVID Market Bounce, Trump&#8217;s COVID Infects The Market Bounce. Is It Over? 10-02-20

A Slower Growth Trend

As stated, even with the additional stimulus package, the outcome will be muted. If we assume our current estimates for GDP growth over the next 4-quarters, which align with mainstream consensus, growth will quickly fade back to long-term trends.

As noted above, it requires increasing levels of debt to generate lower rates of economic growth. The chart below shows the previous and estimated CARES Acts and their impact on GDP growth.

 

To understand this better, we can view it from how many dollars it requires to generate $1 of economic growth. Following the economic shutdown, when economic activity went to zero, each dollar of input had a more considerable impact as the economy restarted. However, going into 2021, economic activity has already recovered and started to stabilize at a slightly lower level than seen previously.

Given that stabilization of activity, it will require more dollars to generate economic growth in the future. As shown, it will need nearly $5.50 of debt-supported expenditures to create $1 of economic growth.

Here is the exciting part. That is NOT a new thing. As I discussed previously, “The One-Way Trip Of American Debt,”  the economy requires $5.01 of debt to create $1 of growth. While not a great return on investment, it will worsen as debt continues to retard economic growth.

Trump's COVID Market Bounce, Trump&#8217;s COVID Infects The Market Bounce. Is It Over? 10-02-20

You Can’t Use Debt To Create Growth.

As Mr. Sparks states, more debt doesn’t lead to more robust economic growth rates or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.

Another way to view the impact of debt on the economy is to look at what “debt-free” economic growth would be. In other words, without debt, there has been no organic economic growth.

The economic deficit has never been more significant. For the 30 years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Such is why the Federal Reserve has found itself in a “liquidity trap.”

Interest rates MUST remain low, and debt MUST grow faster than the economy, just to keep the economy from stalling out.

The deterioration of economic growth is seen more clearly in the chart below.

From 1947 to 2008, the U.S. economy had real, inflation-adjusted economic growth than had a linear growth trend of 3.2%.

However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve provided policies that fostered even greater unproductive debt and leverage levels.

Following the 2020 recession, the economic growth trend will again decline below the previous growth trend. Even with our more optimistic assumptions about economic recovery, the trend of economic growth will weaken. Such is simply a function of the massive amounts of debt added to the overall system, which will retard future economic growth.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Pulling Forward Consumption Isn’t Sustainable.

Our conclusions from the initial analysis remain the same:

“The ‘trap’ that lawmakers, along with the Fed, have now fallen into is that ‘stimulus’ only pulls forward ‘future consumption.’ As we saw after the initial CARES act, as soon as financial supports evaporated, so did economic growth.

The hope over the last decade was the economy would eventually “catch fire” grow organically. Such would allow Central Banks to reverse monetary supports. However, such has never occurred. Each time Central Banks reduce monetary supports, the economy stalls or worse.

It is likely that “something has gone wrong” for the Federal Reserve. The ability to pull-forward future consumption through monetary interventions has been reached. Despite ongoing hopes of ‘higher growth rates’ in the future, such will likely not be the case until the debt overhang gets cleared.”

While the U.S. economy will indeed exit the recession in 2021, it may be a statistical result rather than an economic recovery leading to broader prosperity.

The most significant risk of the latest stimulus package is a surge in inflationary pressures, which undermines the stimulus’s benefit. That concern will manifest itself as a stagflationary environment where wages remain suppressed while costs of living rise.

Due to the debt, demographics, and monetary and fiscal policy failures, the long-term economic growth rate will run well below long-term trends. Such will only continue to widen the wealth gap, increase welfare dependency, and socialism continuing to usurp the “golden goose” of capitalism.

#WhatYouMissed On RIA This Week: 4-9-21

What You Missed On RIA This Week Ending 4-9-21

It’s been a long week. You probably didn’t have time to read all the headlines that scrolled past you on RIA. Don’t worry, we’ve got you covered. If you haven’t already, opt-in to get our newsletter and technical updates.

Here is this week’s rundown of what you missed.


RIA Advisors Can Now Manage Your 401k Plan

Too many choices? Unsure of what funds to select? Need a strategy to protect your retirement plan from a market downturn? 

RIA Advisors now has the capability to manage your 401k plan for you. It’s quick, simple, and transparent. In just a few minutes we can get you in the “right lane” for retirement.


What You Missed This Week In Blogs

Each week, RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus is the risks that may negatively impact our client’s capital. These are the risks we are focusing on now.



What You Missed In Our Newsletter

Every week, our newsletter delves into the topics, events, and strategies we are using. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how we plan to trade it.



What You Missed: RIA Pro On Investing

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now for 30-days free) If you are a DIY investor, this is the site for you. RIA PRO has all the tools, data, and analysis you need to build, monitor, and manage your own money.



Video Of The Week

What? You didn’t tune in last week. That’s okay. Here is one of the best clips from the “Real Investment Show.” Each week, we cover the topics that mean the most to you from investing to markets to your money.

Video Of The Week For 4-9-21

Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 4-9-21

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

See you next week!

The Post-Pandemic Retirement Survival Guide. Part 1.

Consider the post-pandemic retirement survival guide an awakening—a way to look at your retirement plan with a fresh perspective. At the least, I hope it serves as a reminder of how fragile a retirement planning strategy can be, and the ability to remain flexible in thought is so important.

Perhaps you’re one of the fortunate people not concerned about the viability of your retirement strategy. After all, markets predict that ‘normal’ is a quarter away (whatever normal happens to be). But be assured, the pundits say it’ll be magic.

They say that the pandemic and its after-effects will be poof: Gone. It’ll be like the global economies never experienced economically devastating lockdowns, a spike in mental health obstacles, and substance abuse. Also, let’s not forget the mind-blowing increase in extreme poverty.

I mean, just like that, the world’s economies will recover from the strange global quarantine of healthy people (never happened before). Oh, the lofty, idealistic haze of markets and its prognosticators drunk on fiscal and monetary stimulus.

What does post-pandemic financial recovery mean to you?

So, whatever ‘post’ pandemic means to you, keep in mind, retirees or those looking to retire anytime in the future, perceive economic recovery through a darker lens. In other words, a post-pandemic retirement may be a ‘no retirement.’ Due to personal financial setbacks, more retirees than ever are deciding never to retire.

“With the present economy due to Covid, I am afraid it will take several years to recover and for our retirement savings and investments to be enough for us to retire the way we originally set it up.”

National Institute of Retirement Security, February 2021.

Pew Research, a bipartisan research think tank, conducted a study of 10,334 adults in January 2021 and discovered that a quarter of adults 50 and older who have not yet retired, expect the coronavirus outbreak to affect their ability to retire.  This includes 7% who say they have already delayed their retirement and an additional 17% think they might have to delay it.

Don’t worry. We can work together to make sense of it all.

I truly hope your household possesses the resiliency to meet financial goals in a timely manner post-pandemic.

As part of a comprehensive Post-Pandemic Survival Guide, these three actions would be on the top of my list. My next three will appear in part 2.

Action #1: Be open to creating your own pension.

Dave Ramsey, the guru of debt management, penned a piece (or somebody did) for his blog in February 2021 titled Why a 401(k) is Better Than a Pension. Please read it for yourself. What do you think? Frankly, I found the information disingenuous, somewhat tone-deaf, and replete with paragraphs of incomplete information. It appears some staffer with limited knowledge or study of retirement trends cobbled it together.

For example, the post indicates the ‘average rate of return’ for a 401k is 12% and 7% for a pension without reference to how these numbers are derived. Seemingly, I assume that 12% is comprised of an all-equity portfolio that most investors could not stomach emotionally long-term. But, let’s say an aggressive investor does ride out the volatility and emotions are not an issue.

Are you the SPOCK of investing?

In other words, let’s imagine Science and First Officer, the highly logical, unemotional SPOCK stationed on the USS Enterprise, is a champ at socking part of his salary away in a 401k.  Even if he were an above-average investment picker (and we’re not even going to tackle 401k choices), a 12% average annual return is more science fiction than reality.

Per the chart below by Lance Roberts, markets don’t average 12% a year. Most retirement reality lies in the orange zone or gap between Dave Ramsey’s fantasy and actual portfolio returns.

Per the article’s table, one main difference between a 401k and a pension (true but vague) is the former creates an income ‘as ‘until the money is gone,’ vs. ‘your lifetime.‘  When it comes to retirement, we should seek to have the money last as long as we do! Lifetime vs. ‘until the money is gone’ sort of sums up the variability and unpredictability of a consistent stream of income from volatile assets such as stocks and bonds (unless you’ve been earning 12% a year over a lifetime). In that case, I’d like to interview or nominate you for an award!

Some investors can indeed retire comfortably on stock and bond portfolios. The maximization of Social Security (that lifetime income again), enhances the lifestyle spending of even the best of savers and investors. I know. We witness it all the time in our financial planning process.  Those fortunate enough to have pensions are able to consider retirement as early as age 55 and not be concerned about longevity risk. In other words, lifetime income options allow retirees to run out of life before they run out of money!

Dave Ramsey is out of touch.

It appears Dave is a bit out of touch with mainstream America. I understand. He’s a money celebrity. In all fairness, why would he understand the damage that has been done to retirement security due to the loss of pensions even though there are reams of studies making the case for them?

Per the National Institute on Retirement Security in a recent survey, When it comes to pensions, Americans have highly favorable views about their role in the retirement equation and see these plans as better than 401(k) savings accounts.

Seventy-six percent of Americans have a favorable view of defined benefit pensions. Seventy-five percent say that all workers should have access to a pension plan to be independent and self-reliant in retirement. Sixty-five percent agree that pensions are better than 401(k) accounts for providing retirement security.

Also, women are more receptive to guaranteed income solutions. Over 59% of women in another study, stated they would feel more secure with a portion of their portfolios invested in annuity structures that protect against market risks. It makes sense as outliving their nest eggs is a formidable concern.

Please understand, I’m a huge advocate for stock investing. I started at age 13 and never looked back. However, stocks are part of an overall retirement income plan. A variable portfolio is designed to supplement and guard a retirement income stream against inflation long-term. It’s never an all or none situation. For some, rolling over a pension to an IRA is the optimum choice. For others, it’s to take the pension to protect against longevity risk. It takes formal financial planning to decide the proper, personal path to follow.

Americans overall are finally beginning to understand how important guaranteed income is to a secure retirement future.

The NIRS study showcases the importance of Social Security to working-age people:

Americans are highly supportive of Social Security, and there is some support for expanding the program. The vast majority of Americans (79 percent) agree that Social Security should remain a priority of the nation no matter the state of budget deficits, with nearly half (49 percent) in strong agreement. Most Americans (60 percent) agree that it makes sense to increase the amount that workers and employers contribute to Social Security to ensure it will be around for future generations. And half support expanding Social Security, with 25 percent saying it should be expanded for all Americans and 25 percent saying it should be expanded except for wealthier households.

I suspect the popularity of guaranteed income options like single-premium immediate annuities will continue to grow.  Overall, investors purchase annuities without truly understanding how they work, or even if they do, they’re purchased without a plan to determine: when to buy, which to buy, how much to buy.

Do you have a retirement income strategy?

Work with an objective financial partner to determine if a guaranteed income product can augment your retirement income strategy. Be open to it, especially if there’s a shortfall based on you and your spouse’s life expectancy.

Dave Ramsey’s debt-management messages are honorable. His understanding of how guaranteed income can save a retirement is disappointing, to say the least. He’s talented and smart. He can do better.

Be open to creating your own pension if it’s necessary. The only way to find out is to complete a holistic financial plan.

Action #2: Hit the mental refresh.

According to the Retirement Insecurity Report 2021 from the NIRS, a third of workers polled believe the pandemic has compelled rethink retirement timing. Close to 18 percent have changed when they plan to retire, and 15 percent have considered a change. Close to 70 percent say they will retire later than expected. At our Retirement Right Lane class, we hear consistently from attendees who were forced to return to the ‘highway of work’ and postpone retirement due to an adverse economic event.

I’m not saying it’s easy to scrutinize your retirement plans with fresh eyes or start one. It can be a formidable mental challenge. However, after what we’ve all been through over the last year, it’s worth the effort to review goals, stress-test your retirement date and undertake an overall assessment of your household’s possible financial vulnerability in light of unprecedented fiscal and monetary stimulus that has greatly distorted the valuation of stock investments.

Psychological vs. financial. They both count!

This is as much a psychological event as it is financial, which is why most respondents in the illustration above don’t have a plan of when to retire. Why bother if it feels hopeless? Why consider a plan when retirement is a pipedream or it’ll require a household to greatly curtail a lifestyle?

It’s sort of similar to how I used to feel about annual physicals. Years ago, I believed ignorance was bliss. I knew I was eating badly and required vigorous exercise but candidly, I didn’t want to face the truth, expose my weaknesses and correct them.

I had to jump a hurdle and forge ahead mentally. Today, I complete blood diagnostics every three months and never miss my physical. I work out hard and four years ago completely changed my eating habits. In other words, I look forward to understanding what’s going on with my body because I’ve made changes to improve and expose my weakest links.

Formal financial planning sometimes doesn’t feel good.

For many, formal retirement planning equates to feeling financially vulnerable. However, a comprehensive plan and a bit of ‘soul searching’ over what’s truly important can lead to constructive results and a reasonable action plan of improvement.

Most likely, the pandemic has positively changed your habits, especially around spending and debt. Perhaps you run a tighter fiscal ship. Can you keep it up? The long-term change can help set more realistic lifestyle expectations in the future.

Now is a good time to micro-budget.  Micro-budgeting is a solid way to understand where household cash goes on a deeper level. Spend twenty minutes at the end of the day to inventory your spending. Don’t use tech either. Use pen and paper. I really like the Clever Fox Budget Book. It’s a compact notebook for expense tracking and organizing. Oh, another thing: Don’t have retail receipts e-mailed to you. Ask for them, store them in the notebook, total them at the end of the day. 

Visualize how your life will look in retirement.

Visualize the smallest you could live in retirement. What would it look like? Document what you see. Then with the help of a financial planner help to translate the lifestyle to concrete, attainable goals.

It’s no longer a time to hide from retirement planning. No retirement is perfect. Believe me, it’s a liberating experience to get started.

Action #3: Understand what drives the tailwinds to your portfolio gains.

Sorry. That wind in your investment sails isn’t investment prowess. It’s eye-popping, unimaginable monetary, and now, fiscal stimulus (and more is coming evidently)! Also, stocks are in demand, and investors are using credit to purchase them! Investors have borrowed a record $814 billion on margin to fuel the stock market rally.

So, valuations don’t matter. For now, anyway. I can show you years where stocks were cheap, and nobody wanted them. You see, stocks are the product investors want (until they don’t).

Speaking of valuations (just trying to keep your head out of the clouds, that’s all), here’s the latest update from Crestmont Research with analysis from Advisor Perspectives.

The Crestmont P/E 10 now stands at 38.8 or 166% above its long-term average. It’s now exceeded tech-bubble levels. I know. BORING. Nobody cares about valuations anymore (again, until they do). However, valuations eventually do matter, and regression to the mean does occur. I mean, unless it’s ‘different this time, and we all know it’s never truly different.

What should investors expect from stocks as we advance?

All I want readers to understand, especially pre-retirees, retirees, is that returns on risk assets may need to moderate or be reduced to account for euphoria witnessed today over the next ten to fifteen years. This means that paying attention to profit-taking, monitoring risk, along with portfolio withdrawal rates, remain important.

Don’t allow your emotions to become your investment or portfolio strategy. Remaining level-headed and humble in the face of massive liquidity assures you’ll still respect the risk that comes along with stock investing.

Inflation: Making the Complex, Simple – Part 1

Inflation: Making the Complex Simple Part 1

The quarterback signals for the Y receiver in the trips formation to shift left toward the right tackle. At the same time, the running back moves to the quarterback’s right. The slot Z receiver runs a fake jet sweep and doubles back. The left tackle and guard are ready to pull to the right, and the center will counter to the left. A safety creeps toward the line and the Sam yells to the strong-side linebacker to shadow the tight end.

The quarterback drops back and throws a pass up the middle for a 20 yard gain. What looks like a simple football play on television, is a complex choreography of 22 football players, coaches, and numerous strategies.

Humans constantly digest massive amounts of data. To make sense of our surroundings, we summarize data into simple packages. This survival skill is necessary, but it often results in a failure to appreciate life’s complexity.

Like a passing play, the price of a Big Mac may appear to be a simple number. However, the market forces determining its price are complex and often misunderstood. In fact, the most vital force has nothing to do with McDonald’s or its customers. It’s all about the supply and demand for money.

Upon reading this article, and its conclusion in a week, you will understand what drives inflation. Whether we are approaching an inflationary or deflationary environment, being a step ahead of the markets thinking is critical to investment success.

Part Two of this article will continue on the same themes as this article. The best-returning trades are those occurring when the market is proven wrong and offsides. In Part Three, we will share some market-based inflation measures to understand the market’s inflation view.

Who Remembers the ’70s?

Ask any investment professional what it was like to manage money in an inflationary environment, and you are likely to get a blank stare. The reason is an investment professional that worked through a period of high inflation in the U.S. is at least 65 years old. As such, experience managing wealth in such a volatile environment is hard to come by. The lack of real inflation era experience may increase price volatility if such an environment emerges. Accordingly, a trying investment environment will be even more challenging to navigate.

While we think the odds of sustained inflation are small, we must be prepared nonetheless. If inflation proves temporary and fades within months, assets being shunned today like long-term bonds and possibly gold offer sizeable returns. If we are wrong, investments that benefit from inflation like miners and energy companies should do well. Regardless, we are on guard for either scenario.

Preparation, first and foremost, involves understanding the drivers of inflation.

The Price of a Big Mac

The price of a McDonalds Big Mac is always expressed in relation to a currency. For instance, in the United States, the price is $4.25.

Like a football play, $4.25 is a simple summary of something more complex. To raise the complexity, we can fractionalize the price to 4.25/1. Whereas 4.25 represents the number of dollars required to purchase 1 Big Mac.

We can further expand on the numerator (dollars) and denominator (1 Big Mac) with the following formula: SD($)/SD(BM). The supply and demand for dollars over the supply and demand of Big Macs.

Now consider, regardless of the supply or demand for dollars and Big Macs, the denominator is always one. A dollar is always worth 1.00. Accordingly, the numerator (dollar price) changes to reflect fluctuations in the supply/demand functions of the dollar and/or the Big Mac.

What happens to the price of a Big Mac if the dollar is devalued by 50%? Despite the cheaper dollar, it is still worth $1. Therefore, only the numerator can change to reflect a price change. In this case, we would expect the price of a Big Mac to double.

fundamentals, The Death Of Fundamentals &#038; The Future Of Low Returns

In Aggregate

We could devote pages to the multitude of factors affecting the supply, demand, and pricing of a Big Mac. The exercise would explain why the Big Mac price rises or falls versus Burger King Whoppers and every other good and service available. Such analysis is critical to McDonalds, but often overemphasized from a macroeconomic perspective.

Economists cite increasing oil prices as a driver for inflation and stronger retail sales from time to time. They assume consumers will still buy everything they were consuming, yet pay an extra $20 at the pump each week. In reality, consumers often substitute goods and services based on their budgets and needs. Economists often fail to consider the extra $20 spent at the gas pump is $20 not spent elsewhere.

The price of oil may rise, but the price of oranges may fall as consumers spend less on oranges to compensate. What matters most from a macroeconomic perspective is the aggregate price change for oil, oranges, Big Macs, and every other good and service.

To correctly anticipate inflation, we must look beyond the supply and demand for goods and services. The truth lies in the supply and the demand for money. Unfortunately, the supply of money gets the headlines, while its demand is an afterthought.

The chart below shows the forthcoming evidence of inflation used by most inflationists.

The following graph captures monetary velocity for an appropriate view of inflation.

Inflation is a function of money supply but equally critical, the demand for money (velocity). For more on why we must consider both, please read our article, The Fed’s Inconvenient Truth: Inflation is M.I.A.

To Be Continued

#Technically Speaking: Despite Correction, Investors Are Exuberant

Despite the recent correction in the markets, leading to a hedge fund imploding, investors remain exuberant. The hopes for more stimulus, government spending, and Fed liquidity displace fears of a correction.

Before we get into the technical review of the markets, I thought Jason Zweig summed up the current environment well.

“This isn’t a bull market or a bear market. It’s a know-nothing market.

Bragging rights used to go to those investors who worked the hardest at learning the most. Now the glory often goes to those who know the least and don’t even care.

‘I don’t know what the f— I’m doing,’ a young man said in a TikTok video in January. ‘I just know I’m making money.’ He added that he’d been trading stocks for only three days, but ‘just like that, made $300 for the day.’ In the next few weeks that young man, Danny Tran, racked up roughly 500,000 followers on TikTok.”

That is the new investing world we live in. A world where individuals are getting investing “expertise” from young individuals on social media with huge followings. It is effectively the “blind leading the blind.”

Is there a risk to investing?  Absolutely.

But investors have been trained by the Federal Reserve to “buy the dips.” Importantly, even as valuations stretch suggesting lower future returns, investors continue to expect above-average results.  Such was the result of a recent Investopedia investor poll with readings expecting 5% or more and stocks and ETF’s over other asset classes.

In other words, it’s a “risk-on” market, baby!

Bull Markets Forgive Bad Mistakes

As Howard Marks noted in a recent Bloomberg interview:

“Fear of missing out has taken over from the fear of losing money. If people are risk-tolerant and afraid of being out of the market, they buy aggressively, in which case you can’t find any bargains. That’s where we are now. That’s what the Fed engineered by putting rates at zero.”

As is often the case, investors tend to pile into markets when the risk versus reward is out of their favor. However, during a raging bull market, investors are forgiven for buying fundamentally unsound companies. Currently, the number of “unprofitable” companies is at the highest level since the dot.com era.

For now, that hasn’t mattered as the number of companies trading above their 200-dma is at some of the highest levels on record as well. When virtually every stock in an index is in a bullish trend, it is usually a warning sign.

The Issue Of Margin Debt

This exuberance requires “fuel,” which brings us to margin debt. As I explained previously:

“Margin debt is not a technical indicator for trading markets. What margin debt represents is the amount of speculation occurring in the market. In other words, margin debt is the ‘gasoline,’ which drives markets higher as the leverage provides for the additional purchasing power of assets. However, ‘leverage’ also works in reverse as it supplies the accelerant for more significant declines as lenders ‘force’ the sale of assets to cover credit lines without regard to the borrower’s position.”

The last sentence is the most important. The issue with margin debt, in particular, is that the unwinding of leverage is NOT at the investor’s discretion. It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) When lenders fear they may not recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once, as falling asset prices impact all lenders simultaneously.

Leverage Extremes

Such is what we saw happen with Credit Suisse and Nomura Securities recently. As concerns over forced liquidations of a major hedge fund grew, positions were being liquidated “en mass” to try and stem the potential losses. The bloodletting, when this occurs, is always faster and deeper than most imagine.

Currently, the exuberance of investors is on full display. With a fresh round of “stimmy” checks reloading bank accounts, margin debt as a percentage of real disposable incomes has shot to record highs. (You may want to pay attention to previous peaks.)

If we apply a “stochastic indicator” to margin debt, such also confirms we are at extremes normally associated with lower future return rates. While such is not an immediate issue, which investors dismiss as “wrong this time,” it does suggest increased risk over the next few months.

Such is always the case with “margin debt.” It is NEVER an issue – until it is. 

Roaring 20's Fundamental Bullish, The &#8220;Roaring 20&#8217;s&#8221; &#8211; The Fundamental Problem Of The Bullish View

Margin Debt Confirms The Exuberance

As noted, when markets are rising and investors are taking on additional leverage to increase buying power, margin debt supports the advance. However, the magnitude of the recent surge in margin debt also confirms the current levels of investor exuberance.

The chart shows the rate of change from the lowest point of margin-debt over the last year. Increases in margin debt are primarily not an issue. It is when there are exceedingly sharp increases in debt that generally signal trouble for markets ahead.

That surge in margin debt is not the “cause,” but rather the reflection of the “bullish market mania” which has engulfed investors currently. We can see that exuberance in BofA’s indicator.

Such is also reflected in the extreme price deviations from the S&P 500’s two-year (24-month) moving average.

As noted in “Zen & The Art Of Risk Management” the highest correlation between stock prices and future returns comes from valuations.

“Short-term price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over longer periods, price changes become more dependent on valuations and less on supply and demand. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.”

Zen, Zen and the Art of Risk Management

“Stocks are extremely expensive. Regardless of whether you agree with our earnings model or not, drawdown risk is higher today than at almost any other time. The Goldman Sachs table below uses multiple valuation metrics and comes to the same conclusion.”

Zen, Zen and the Art of Risk Management

Roaring 20's Fundamental Bullish, The &#8220;Roaring 20&#8217;s&#8221; &#8211; The Fundamental Problem Of The Bullish View

This Time Is Different

As noted by Jason Zweig, this has indeed been a “stock ‘gamblers’ market.”

“You could have made good money even with bad stock picks. It was like being invited to bet on black, without limits, at a roulette wheel on which 37 of the 38 pockets were black.

Why waste time and energy educating yourself while sheer ignorance pays off so easily?”

Yes! This time is indeed different. But, so was every previous overly exuberant bull market in history. As Sentiment Trader summed up the last time we wrote on this topic, such is usually not the case.

Whenever some of this data fails to lead to the expected outcome for a few weeks or more, we hear the usual chorus of opinions about why it doesn’t work anymore. This has been consistent for 20 years, like…

  • Decimalization will destroy all breadth figures (2000)
  • The terror attacks will permanently alter investors’ time preferences (2001)
  • The pricking of the internet bubble will forever change option skews (2002)
  • Easy money will render sentiment indicators useless (2007)
  • The financial crisis means relying on any historical precedents are invalid (2008)
  • The Fed’s interventions mean any indicators are no longer useful (2010 – present)

All of these sound good, and for a time it seemed like they were accurate. Then markets would revert and the arguments would get swept into the dustbins of history.”

While this time is certainly different due to unprecedented interventions, we suspect the outcome will eventually be the same.

Roaring 20's Fundamental Bullish, The &#8220;Roaring 20&#8217;s&#8221; &#8211; The Fundamental Problem Of The Bullish View

Increasing Portfolio Exposure 

Here is where I throw you a curveball.

While I just laid out all of the longer-term risks, we just increased exposure to portfolios for the end of the seasonally strong period.

Such is the point that many miss about our analysis. While we are most definitely “bearish” in our views (both technical and fundamental) longer-term, we also understand over the next few days or weeks it is “sentiment” that carries the market.

As such, we increased exposure in some of our beaten-up growth stocks, while continuing to barbell those positions with the “reflation/recovery” momentum trade. Our job as portfolio managers is to make sure we are creating returns for our clients, with a strict set of “risk controls” in place to protect capital.

At the moment, it certainly feels as if the market is unstoppable. Such is usually the case in “heat of the mania.” As Warren Buffett once quipped:

“The market is a lot like sex, it feels best at the end.”

We remain “bullish” on the markets currently as momentum is still in play. However, it is likely that by mid-summer we will see a decent correction as the “peak” in the economic and earnings data becomes visible.

Such is why I agree with Jason’s conclusion:

Where ignorance is bliss, ‘tis folly to be wise,” wrote the British poet Thomas Gray. One of these days, perhaps sooner rather than later, stocks will stop going up and the importance of understanding what you own will reassert itself. For the time being, though, investors who used to think of themselves as wise may continue to look foolish.”

TPA Analytics: Weekly Market Summary Update 04-05-21

Weekly Market Summary Update – 04-05-21

Monday, April 05, 2021

THE U.S 10 YEAR IS HEADED TO 2% AND BIGTECH WILL KEEP UNDERPERFORMING

TPA said on 3/5/21 and 2/25/21 that “the next level of resistance is the December 2019 highs of 2.0%.”

On 3/5/21 TPA told clients that the most likely path was that the 10 Year Yield continues its rise and that “should mean a continued rotation away from Growth and towards Value.” The 10 Year is continuing its inexorable march to 2% (chart 1) and leaving growth stocks in its wake. The relative performance chart 2 shows that, as the 10 Year Yield has moved 38% higher, from 1.25% in mid-February to 1.73% at Monday’s close, the Internet ETF FDN has underperformed the SPY (S&P500) by 12.91%. That’s a big deal in just 6 weeks. Chart 3 shows that the trajectory of the ratio FDN/SPY is not good and that the ratio has fallen below its 13-month uptrend line. This break portends more relative weakness for TECH.

U.S. 10 YEAR YIELD – 2015-2021

TOP: RELATIVE PERFORMANCE SPY & FDN. BOTTOM: U.S. 10 YEAR YIELD – 2/12/21 TO 3/29/21

RATIO FDN/SPY – 18 MONTHS

Summary of Comments & Charts for Monday – Friday

03/31/21

SELL:

  • FTV fell below its steep, +120%, 10-month uptrend line in January. Since that break, FTV has traded sideways. FTV has low trend strength with an ADX of only 11 (chart 2). The lack of trend strength means that there is a low likelihood that FTV will break out of the current range. The next move should be lower. Unfortunately, FTV is also trading near the extreme of its 3-year trading range. This is also where FTV failed in 2018 and 2019 (chart 3). Finally, FTV is trading a rich valuation with a PE of 48 versus a 13-year average of 26 (chart 4).

FTV        Fortive Corp       70.4200                 Stop = 74.6452                 Target = 52.8150

  • ROL fell below its 7-month, +100% uptrend line in January. ROL is establishing a pattern of lower highs and lower lows=downtrend. Chart 2 shows that ROL broke down below support at 35 in late February. ROL is at or close to resistance from its newly formed downtrend line (zoom chart). A few days ago, ROL’s 50DMA traded below its 200 DMA. The last time this happened after a big rally was in June 2019 and resulted in an additional decline of about 17%.

ROL        Rollins Inc           34.1800                 Stop = 36.0599                 Target = 28.7112


BUY:

  • VIAC is now down 53% from the high of 100.43 on 3/22/21 just 5 days ago. VIAC dropped because of problems with one investment manager with concentrated positions.

VIAC moved above 18-month resistance in January and preceded to rocket 150% in just 3 months. The recent steep decline puts VIAC at support from the January breakout. The decline also puts VIAC close to support from its 1-year uptrend line that started at the March 2020 lows (charts 1, 2, and 3). Chart 4 shows that VIAC’s explosive rally in 2021 followed a breakout from several long-term downtrends. VIAC is trading at an attractive historical valuation with the current Price/Book Value is 1.8, while the 7-year average Price/Book Value is 4.7 (Chart 5).

VIAC      ViacomCBS Inc Cl B         46.6100                 Stop = 43.5804                 Target = 65.2540

 

  • GRUB broke out of its 18-month downtrend in April, its 1-year downtrend in May, and its 6-month resistance at 60+/- in June (charts 1 and 2). The 20% decline this year puts GRUB at support from its June breakout. GRUB is also trading at a historic valuation with Price to Sales at 3 versus a 6-year average of 6.8.

GRUB    GrubHub Inc      59.8700                 Stop = 55.9785                 Target = 83.8180


4/1/21

SELL:

  • ADSK fell below its 12-month uptrend line in February and fell below medium-term support at the 278 level in March. ADSK already failed once at this level in March (zoom chart). The weekly chart shows that ADSK rocketed away from its long=term uptrend line starting in March 2020; making a new all-time high in April. The current break means that the next level of long-term support is the 2020 breakout level or 25% lower than Wednesday’s close. Valuation is also very high historically; Price to Sales is 16, while the 15-year average is 6.9 (chart 4).

ADSK     Autodesk, Inc    277.1500              Stop = 293.7790              Target =  221.7200

Viking Analytics: Weekly Gamma Band Update 4/5/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) finished a holiday-shortened week with another strong rally, closing at new highs.  The Gamma Band weekly model[1] maintained a 100% allocation to the S&P 500 (SPX) all week, and the Gamma Flip level moved higher to roughly 3,955.  When the daily price closes below the “Gamma Flip” level, the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below the lower gamma level (currently near 3,780), the model will reduce the SPX allocation to zero.

Investors who keep an eye on the Gamma Flip level are more aware of when market volatility is expected to increase.  The chart below shows how the length of daily candles tends to be longer when the market price is below or near the Gamma Flip level. 

The general idea behind this model is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

This is one of several signals that we publish daily in our SPX Report. Overall, we continue to rate the SPX options signals as “cautiously bullish.”  A free sample of the SPX report can be downloaded from this link.  Pleaes visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size daily based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics. He has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a B.S. in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space.  He is a former Managing Director at a multi-billion dollar hedge fund. Furthermore, he has deep experience with market data, software, and model building in financial markets. Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


Survey Of Retail Investors Shows The Blind Lead The Blind.

In retail investing, do the “blind lead the blind?” Such was a question I asked recently about young investors who are “Long Confidence And Short Experience.” However, a recent survey by MagnifyMoney dug much deeper into the subject.

Our previous article’s gist is that throughout history, markets have a way of separating investors from their money. Such is the reason every great investor in history has one rule in common: “Don’t lose money.” The reason, of course, is that if you lose your capital, you are “out of the game.”

As I noted, the market’s current speculative behavior is not uncommon throughout history.

“Bubbles are characterized by extreme predictions, tend to dominate conversations and induce people to leave their jobs. The warnings of bubble skeptics get invariably met with scorn and derision.” – William Bernstein

Today, more individuals are searching “google” for how to “trade stocks” than at any point in history. (If data was available back to 1999, I am sure it would be similar.)

Of course, this overconfidence grew from the repeated Federal Reserve interventions. Those interventions lofted asset prices and speculative confidence. Not surprisingly, as noted by CNBC:

“Young retail investors plan to spend almost half of their stimulus checks on stocks, Deutsche survey claims.”

Over-Confident

Every year, Dalbar Research does a study of retail investors. The latest study revealed retail investors tend to underperform markets due to a series of “behavioral biases.”

As the study showed, the biases lead equity investors to do worse than the index consistently.

Such is due primarily to the psychological pitfalls that occur from “herding” to “confirmation bias.” 

“When discussing investor behavior it is helpful to first understand the specific thoughts and actions that lead to poor decision-making. Investor behavior is not simply buying and selling at the wrong time, it is the psychological traps, triggers and misconceptions that cause investors to act irrationally. That irrationality leads to buying and selling at the wrong time, which leads to underperformance.” – Dalbar

Of course, since individuals don’t operate in a vacuum, where is the information coming from that promulgates these emotionally driven actions?

Blind Leading The Blind

A recent survey from MagnifyMoney, showed the youngest and least experienced investors use social media as the “most important” source of information.

We found that almost 6 in 10 Gen Z and millennial investors (age 40 and younger) are members of investment communities or forums, such as Reddit, and nearly half have turned to social media in the past month for investing research.” – MagnifyMoney

The findings:

  • Nearly 6 in 10 investors are members of investment communities or forums, such as Reddit or a group of like-minded investor friends.
  • YouTube is the top source for investing information among young investors, with 41% turning to the site in the past month. Other social media platforms are:
    • TikTok (24%),
    • Instagram (21%),
    • Twitter (17%),
    • Facebook groups (16%) and
    • Reddit (13%).
  • In all, 46% have used social media for investing information in the past month.
  • 22% of Gen Z investors say they were younger than 18 when they started investing, versus 8% of millennial investors. 
  • Only 36% of young investors plan to use that money for retirement. 35% will make additional investments, while 19% will use the funds to pay for a major purchase.
  • Nearly two-thirds (64%) of investors who are 40 and younger have withdrawn money from their investment accounts to spend. 

Considering that many of these individuals have never seen an actual “bear market,” such is the very definition of the “blind leading the blind.”

The biggest problem is the lack of research on investments. In many cases, investments get made on the recommendation of people who have a “large following.” The assumption is since they are “popular,” they are “smart.” Such is not necessarily the case.

Eventually, there will be a time to “sell.” Such is something most won’t learn from “social media” influencers.

Technological Pitfalls

One of the more significant disadvantages to investors today is changing the face of the investing process to gambling. While the speed and convenience of access to financial markets is a modern marvel, it is also problematic by leading to “risky behaviors” by tapping into the “dopamine effect.”

Not surprisingly, the younger the user is, the more gravitated they are towards investing “apps” and other technologies, which turns “investing” into a “game.”

While the advances in technology certainly provide many positives, they also breed behaviors that are an anathema to investor success longer-term.

An article in the Seattle Times noted the same:

“Online traders can experience a certain high when trading that is similar to what people experience when gambling, according to a recent study on excessive trading published in the journal Addictive Behaviors. The study noted that some investors choose short-term trading strategies that involve investing in risky stocks offering the potential for large gains but also significant losses. ‘The structure itself of the two activities (gambling and trading) is very close,’ the study concluded.”

In the current market environment, individuals have been fortunate to garner quick successes, making them overconfident in their actual abilities. Unfortunately, when the cycle turns, the losses mount just as quickly.

There is very little difference in today’s market between “trading” and “gambling.” Both hold the promise of significant financial rewards, but those rewards also come with great risk. That latter tends to get dismissed at the individual’s peril.

Selling Bottoms

No matter how committed people think they are about “buying and holding,” they eventually fall into the same old emotional pattern of “buying high and selling low.”

Investors are human beings. As such, we gravitate towards what feels good, and we seek to avoid pain. When things are euphoric in the market, typically at the top of a long bull market, we buy when we should be selling. When things are painful, we sell when we should be buying.

It’s usually the final capitulation of the last remaining “holders” that sets up the end of the bear market and the start of a new bull market. As Sy Harding says in his excellent book “Riding The Bear,” while people may promise themselves at the top of bull markets, they’ll behave differently:

“No such creature as a ‘buy and hold’ investor ever emerged from the other side of the subsequent bear market.”

Statistics compiled by Ned Davis Research back up Harding’s assertion. Every time the market declines more than 10% (and “real” bear markets don’t even officially begin until the decline is 20%), mutual funds experience net outflows of investor money.

Fear is a stronger emotion than greed.

Most bear markets last for months (the norm), or even years (both the 1929 and 1966 bear markets), and one can see how the torture of losing money week after week, month after month, would wear down even the most determined “buy and hold” investor.

But the average investor’s pain threshold is a lot lower than that. The research shows that it doesn’t matter if the bear market lasts less than 3-months (like the 1990 bear) or less than 3-days (like the 1987 bear). People will still sell out, usually at the very bottom and almost always at a loss.

If You Trade, Have Some Guidelines

Throughout history, individuals repeatedly jump into the more speculative stages of the financial market under the assumption that “this time is different.”

Of course, as we now know, with the benefit of hindsight, 1929, 1972, 1999, 2007, and 2020 were not different – they were just the peak of speculative investing frenzies. 

While many young investors are simply following other young investors, who lack the experience, skill, and knowledge to be successful over the long term, a select group of investors is revered for their success. While we idolize these investors for their respective “geniuses,” we can also save ourselves time and money by learning from their wisdom and their experiences.

That wisdom was NOT inherited but birthed out of years of mistakes, miscalculations, and trial-and-error. Most importantly, what separates these individuals from all others was their ability to learn from those mistakes, adapt, and capitalize on that knowledge in the future.

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

I have compiled a collection of rules, axioms, and wisdom to protect you from repeating mistakes that eventually destroy your wealth.

There is an old WallStreet axiom which states:

“A man with money meets a man with experience. The man with the experience leaves with the money, while the man with money leaves with experience.”

Such is the truth about markets and investing.

Experience tends to be a brutal teacher, but it is only through experience that we learn how to build wealth successfully over the long-term. Many young investors will eventually gain a lot of experience by giving most of their money away to those with experience.

It is one of the oldest stories on Wall Street.

Technical Value Scorecard Report For The Week of 4-02-21

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis (versus the assets benchmark) and on an absolute stand-alone basis. You can find more detail on the model and the specific tickers below the charts.

Commentary 4-02-21

  • We had to do a double-take when looking at the Sector Relative graph because it looked identical to last week. Staples, Utilities, and Industrials are the most overbought sectors and Technology remains the most oversold.
  • The scatter plot shows there is almost no correlation between excess returns and respective scores. Energy, Communications, and Financials are underperforming, while just about every other sector is outperforming the S&P 500.
  • Value is the most overbought factor while Momentum the most oversold. Interestingly, this is occurring despite our Inflation/Deflation gauge moving back to fair value. Value, Small/Mid Cap, and the Dow Jones have been doing better when bonds sell-off and the market skews toward an inflationary bias. Conversely, Momentum and the NASDAQ do better in periods where interest rates stabilize.
  • On an Absolute basis, everything is near fair value. As discussed last week, there is a slight downward slope to the Absolute Sector graph denoting that the non-inflationary sectors are outperforming. The S&P 500 remains above fair value.
  • The last graph shows that 5-year implied inflation expectations have stalled since mid-March around 2.50% and the performance of our Inflation/Deflation gauge has come under pressure. The takeaway is that sectors like energy and finance are currently highly dependent on rising inflation expectations.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum/minimum score, as well as on a normalized basis (sigma) for the last 200 trading days. Assets with scores over or under +/-60% and sigmas over or under +/-2 are likely to either consolidate or change trend. When both the score and sigma are above or below those key levels simultaneously, the signal is stronger.

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma represent a ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner the most bearish.

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

Increasing Equity Exposure As Money Flows Turn Positive


In this issue of “Increasing Equity Exposure As Money Flows Turn Positive.

  • Market Review And Update
  • Cognitive Dissonance
  • Valuations Dictate Long-Term Returns
  • Portfolio Positioning
  • #MacroView: Biden Stimulus Will Cut Poverty For One-Year
  • Sector & Market Analysis
  • 401k Plan Manager

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


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This Week 1-15-21, #WhatYouMissed On RIA This Week: 1-15-21

Catch Up On What You Missed Last Week


Market Review & Update

Over the last several weeks, we have discussed how the “negative money flow” environment was keeping a lid on prices short-term. To wit:

“As discussed last week, the ‘sell signal’ triggering on a short-term basis coincides with our concerns of quarter-end rebalancing for pension funds. I suspect we may have some additional quarter-end rebalancing risk early next week. However, buying on Thursday next week, as second-quarter positioning gets underway, would not be surprising.

As such, hold positions early next week and look for weaknesses to add to exposures as needed.

Such turned out to be the case as the markets slopped around early in the week. However, that changed as markets exploded to new highs on Wednesday and Thursday as portfolio managers charged back into the stocks sold off during the Archegos debacle.

As shown, the break out to new highs for the S&P 500 confirmed the positive turn in “money flows.” Notably, the breakout got further confirmation from combined “money flow” and “MACD” buy signals. 

Yesterday’s “3-minutes” video goes into more detail about the turn of the “money flow” indicators as we enter one of the stronger months of the year. 

Santa Claus Broad Wall, Technically Speaking: Will &#8220;Santa Claus&#8221; Visit &#8220;Broad &#038; Wall&#8221;

There Be Dragons

Given the confluence of those “buy signals” and “seasonality,” we did increase exposure to portfolios over the last two weeks. 

However, as we will discuss more in a moment, that increase in exposure does not come without risks.

As discussed last week, the dollar continued to gain strength and broke above the 200-day moving average. As shown below, sharp increases in the dollar tend to weigh on equity markets.

“The recent rotation to value has been primarily a function of a ‘weaker dollar,’ which boosts commodities. As noted, if economic growth does strengthen, leading to higher rates will attract foreign inflows into the dollar for a higher yield.Such also undermines corporate profitability, given that roughly 40% of corporate profits are from abroad.”

Secondly, the number of stocks trading above their 200-dma is at extremes. Historically, when the “rising tide lifts EVERY boat,” such has usually been near markets’ peaks.

Lastly, interest rates remain a key to much of the ongoing advance. Sharply rising interest rates have always, without exception, led to a market decoupling. It isn’t a question of “if” it will happen. It’s only an issue of “what rate” pops the speculation. 

I know. It isn’t apparent.

“If you think there are risks, why increase exposure?”

Great question.

Cognitive Dissonance 

As a portfolio manager for other people’s money, I get tasked with two primary jobs. 

  1. Generate returns per financial planning goals and objectives; and,
  2. Don’t lose money.

Therefore, I have to take measured “portfolio risk” to create returns but remain aware of the “risks” which could lead to a loss of capital. 

On Thursday, I tweeted, as noted above, that we increased equity exposure due to the confluence of buy signals and the seasonally strong month of April. A response to that tweet provides the basis for discussing “portfolio management in a high-risk environment.” To wit:

I certainly understand his dismay. With valuations at some of the most extreme levels seen only outside of the “dot.com” bubble, why would you invest capital now?

To clarify, we have to distinguish between time frames, risk, and expected outcomes.

What Is Risk?

What is the definition of “risk?” 

The chance that an investment will lose value

Increasing risk does not suggest a positive outcome? We can use a mathematical example of “Russian Roulette” to prove the point.

The number of bullets, the prize for “surviving,” and the odds of “survival” are shown:

, The Myths Of Stocks For The Long Run &#8211; Part X

The point is simply while “more risk” equates to more reward, the consequences of a negative result increase markedly.

Blaise Pascal, a brilliant 17th-century mathematician, famously argued that:

“If God exists, belief would lead to infinite joy in heaven, while disbelief would lead to infinite damnation in hell. But, if God doesn’t exist, belief would have a finite cost, and disbelief would only have at best a finite benefit.”

Pascal concluded, given that we can never prove God’s existence, it’s probably wiser to assume he exists because infinite damnation is much worse than a finite cost.

Risk does not equal reward. “Risk” is a function of how much money you will lose when things don’t go as planned. The problem with being wrong, and facing the wrath of risk, is the loss of capital creates a negative effect to compounding that you can never recover.

, The Myths Of Stocks For The Long Run &#8211; Part X

There is an essential aspect to the “power of compounding” the media never discusses. It ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required. In reality, chasing returns is much less critical to your long-term investment success than is commonly believed. 

Even in healthy markets with fair valuations, risks exist. But in markets with high valuations, the risk of a reversion increase as time marches on.

Valuations Dictate Returns Long-Term

Understanding what “risk” takes us to this vital point made by Michael Lebowitz in “Zen And The Art Of Risk Management.”

“In the short-term, price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over long periods, price changes are dependent on valuations. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.”

Zen, Zen and the Art of Risk Management

“The correlation of ten-year forward returns and CAPE is statistically significant with an R-squared of .4803. In other words, valuation matters in the long run. Conversely, there is no correlation between quarterly returns and CAPE.”

Such is an important point relative to our reader’s comment. 

In the short-term, worrying about high multiplies isn’t conducive to creating portfolio returns from one month to the next. As such, it isn’t “cognitive dissonance” that we are increasing exposure in a month that has a very high statistical probability of positive returns over the next 30-days. 

Fully Invested Bears

The problem in discussing “investment risk” is that such commentary is summarily dismissed as being “bearish,” By extension, such means we must be either sitting in cash or short the market. In either event, I have “missed out” on the last advance. 

Such reminds me of something famed Morgan Stanley strategist Gerard Minack said once:

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

What you’ve had are fully invested bears.”

While the mainstream media continues to skew individual’s expectations by chastising them for “not beating the market,” which is impossible to doour job is to participate in the markets with a bias toward capital preservation. As noted, the destruction of capital during market declines has the most significant impact on long-term portfolio performance.

From that view, as a portfolio manager, the idea of “fully invested bears” defines the reality of the markets we live with today. Despite the understanding that the markets are overly bullish, extended, and valued, we must stay invested or suffer potential “career risk” for underperformance. 

Such is the consequence of the Federal Reserve’s ongoing interventions. Portfolio managers must chase performance despite concerns of potential capital loss. In other words, we are all “fully invested bears.” We are all quite aware this will eventually end badly. However, in the short-term, no one is willing to take the risk of being grossly underexposed to Central Bank interventions.

Portfolio Update

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we are at full equity allocations, with a slight increase in the duration of bonds. Such leaves our portfolios at model weights in cash with bond durations shorter than our benchmark. 

Furthermore, we added an “index trading position.” Having a single index position in the portfolio allows us to increase exposure to markets as needed quickly and promptly reduce exposure if required. 

Lastly, we continue to carry a “barbell approach” in our portfolios. Such splits holdings between “reflation” trades such as Energy, Financials, and Materials and “growth” focused on Technology.

Therefore, with the breakout to new highs, the markets will likely stretch towards our year-end target of 4100.

After this discussion, it seems apropos to remind you of Bob Farrell’s “10-Investment Rules:”

  • Markets tend to return to the mean over time.
  • Excesses in one direction will lead to an opposite excess in the other direction.
  • There are no new eras — excesses are never permanent
  • Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
  • The public buys the most at the top and the least at the bottom
  • Fear and greed are stronger than long-term resolve
  • Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
  • Bear markets have three stages — sharp down, reflexive rebound, and a drawn-out fundamental downtrend
  • When all the experts and forecasts agree — something else is going to happen
  • Bull markets are more fun than bear markets

There is only one fact to remember:

“All bull markets last until they are over.” – Jim Dines

Just remember, “risk” is always “risk.”


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 88.50 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 79.34 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • Table shows the price deviation above and below the weekly moving averages.


Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

      

Low P/B, High-Value Score, High Dividend Screen

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

I encourage you to read the full newsletter this week if you are concerned about why we increased equity exposure in light of the market’s fundamental long-term risks. 

However, let me repeat the critical paragraph for you:

“In the short-term, price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over long periods, price changes are dependent on valuations. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.”

We understand the “risks” we are taking and are doing so in a measured and pragmatic approach. We understand the importance of creating returns in the short-term and the implications of long-term returns from excess valuations. 

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we are at full equity allocations, with a slight increase in the duration of bonds. Such leaves our portfolios at model weights in cash with bond durations shorter than our benchmark. 

Furthermore, we added an “index trading position.” Having a single index position in the portfolio allows us to increase exposure to markets as needed quickly and quickly reduce exposure if required. 

Lastly, we continue to carry a “barbell approach” in our portfolios. Such splits holdings between “reflation” trades such as Energy, Financials, and Materials and “growth” focused on Technology.

As always, we continue watching our indicators closely. However, support at the 50-dma continues to hold, which negates some downside risk in the short term.

Portfolio Changes

During the past week, we made minor changes to portfolios. We post all trades in real-time at RIAPRO.NET.

** Equity / ETF Portfolio – Trade Update ***

“As noted yesterday, we added to individual positions yesterday within portfolio models, and today we added our “trading index” positions to all models. As noted, with the quarter-end rebalancing behind us, and with April being one of the strongest performance months of the year within the seasonally strong cycle, we are upping exposure short-term to participate with a breakout to new highs.” – 4/1/21

Both Models:

  • Reduced SHY to 10% of the portfolio
  • Added a 5% position in SPY

“With our S&P 500 “money flow” models turning positive, along with money flows, we are adding exposure to portfolios for what tends to be a historically strong April period.  We are doing this in two phases – adding individual positions today, and shortly, we will add trading index positions in SPY and QQQ.” – 03/31/21

Equity Model:

  • Increased ALB to 4% of the portfolio.
  • Initiated a 2% in NXPI
  • Started a 2% in F
  • Selling 100% of CRM

ETF Model

  • Added 1% to LIT, increasing weight to 4%

As always, our short-term concern remains the protection of your portfolio. We have now shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

#WhatYouMissed On RIA This Week: 4-2-21

What You Missed On RIA This Week Ending 4-2-21

It’s been a long week. You probably didn’t have time to read all the headlines that scrolled past you on RIA. Don’t worry, we’ve got you covered. If you haven’t already, opt-in to get our newsletter and technical updates.

Here is this week’s rundown of what you missed.


RIA Advisors Can Now Manage Your 401k Plan

Too many choices? Unsure of what funds to select? Need a strategy to protect your retirement plan from a market downturn? 

RIA Advisors now has the capability to manage your 401k plan for you. It’s quick, simple, and transparent. In just a few minutes we can get you in the “right lane” for retirement.


What You Missed This Week In Blogs

Each week, RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus is the risks that may negatively impact our client’s capital. These are the risks we are focusing on now.



What You Missed In Our Newsletter

Every week, our newsletter delves into the topics, events, and strategies we are using. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how we plan to trade it.



What You Missed: RIA Pro On Investing

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now for 30-days free) If you are a DIY investor, this is the site for you. RIA PRO has all the tools, data, and analysis you need to build, monitor, and manage your own money.



The Best Of “The Real Investment Show”

What? You didn’t tune in last week. That’s okay. Here are the best moments from the “Real Investment Show.” Each week, we cover the topics that mean the most to you from investing to markets to your money.

Video Of The Week For 4-2-21

Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 4-2-21

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

See you next week!

Cartography Corner – March 2021

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

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

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

GTA Users Guide


March 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESM1) during March 2021. In our March 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                4266.00

o M1                4056.25

o PMH             3959.25

o M3                3913.25          

o Close            3809.25      

o MTrend        3749.19

o M2                3660.50   

o PML              3656.50      

o M5               3450.75

Active traders can use MTrend: 3749.19 as the pivot, maintaining a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for March 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  Our isolated levels at MTrend: 3749.19 and PMH: 3959.25 essentially contained the realized range (settlement basis).

The first trading session of March conjured memories of the first trading session of February.  The market price rallied 89.50 points, 2.35%.  Sellers appeared in front of our isolated resistance level at M3: 3913.25, with the high for that session, realized at 3912.00.

Over the following three trading sessions, the market price declined 4.57% (March 4th intra-session low).  It achieved and exceeded our isolated pivot level at MTrend: 3749.19.  However, importantly, the market price did not settle below MTrend.            

The following seven trading sessions saw the market price rally, reaching our second isolated resistance level at PMH: 3959.25.  A cumulative rally from its low of 239.75 points, or 6.44%, amidst an interest rate environment that saw yields continue to rise.  Market participants appear to have forgotten about the inverse relationship between discount rates and the present value of long-dated cash flows, but I digress.         

Over the final twelve trading sessions of March, the market price essentially range traded between PMH: 3959.25 and M3: 3913.25.  Conservatively, active traders who bought against MTrend: 3749.19 realized a gain of 5.15%.  

Figure 1:

10-Year Treasury Note Futures

We continue with a review of 10-Year Treasury Note Futures (TYM1) during March 2021.  In our March 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4         138-18

o PMH       137-10

o M1         136-13

o MTrend  136-10

o Close      132-23

o PML          131-31               

o M3         128-13             

o M2         127-29                         

o M5           125-24

Active traders can use PML: 131-31 as the pivot, maintaining a long position above that level and a flat or short position below it.  

Figure 2 below displays the daily price action for March 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  Within the overall context of a continuing move to lower prices, the realized price action in March consisted of seven swings, four down and three up.  Our isolated pivot level at PML: 131-31 was the center point of the realized range. 

Down Swings:

  1. March 3 – March 5, 133-22 to 131-24
  2. March 11 – March 12, 133-01 to 131-23
  3. March 17 – March 18, 132-09 to 131-00
  4. March 25 – March 31, 132-10 to 130-26

Up Swings:

  1. March 5 – March 11, 131-24 to 133-01
  2. March 12 – March 17, 131-23 to 132-09
  3. March 18 – March 25, 131-00 to 132-10

Conservatively, active traders following our analysis got “chopped up”.  They executed six trades, with five losers, realizing a cumulative loss of 2-14 points.

Figure 2:

April 2021 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESM1).  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Current Settle         3967.50       

o Daily Trend             3955.75

o Weekly Trend         3912.55       

o Monthly Trend        3812.97       

o Quarterly Trend      3591.98

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for four quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Trend Up”, settling five months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, settling three weeks above Weekly Trend. 

Support/Resistance:

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

o M4                4311.00

o M3                4125.75

o M1                4008.25

o PMH              3983.75          

o Close            3967.50      

o MTrend        3812.97

o M2                3784.50   

o PML              3720.50      

o M5                3481.75

Active traders can use PMH: 3983.75 as the pivot, maintaining a long position above that level and a flat or short position below it.

Australian Dollar Futures

For April, we focus on Australian Dollar Futures (“the Aussie dollar”).  We provide a monthly time-period analysis of 6AM1.  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Weekly Trend       0.7716           

o Monthly Trend      0.7707

o Daily Trend           0.7621           

o Current Settle       0.7602           

o Quarterly Trend    0.7452

The relative positioning of the Trend Levels is bearish.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  As can be seen in the quarterly chart below, the Aussie dollar is “Trend Up”, having settled above Quarterly Trend for four quarters.  Stepping down one time-period, the monthly chart shows that the Aussie dollar is in “Consolidation”, after having been “Trend Up” for four months.  Stepping down to the weekly time-period, the chart shows that the Aussie dollar is in “Consolidation”, settling below Weekly Trend in four of the previous five weeks.

Figure 3 below, thankfully supplied to us by Michael Lebowitz of RIA Advisors, demonstrates the high correlation between the Aussie dollar and 5yr U.S. Implied Inflation.  As shown by the arrow in the graph, although generally coincident with Implied Inflation, the Aussie dollar led inflation’s turn lower in late 2017.  In our judgment, this is one example of the reflation/inflation narrative possibly having exhausted itself in market pricing.    

Figure 3:

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  The signal was given the week of March 22nd to anticipate a two-week high within the next four to six weeks (now, three to five weeks).  That high can be achieved this week with a trade above 0.78525. 

Support/Resistance:

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

o M4         0.8140

o PMH       0.7853

o MTrend  0.7707

o M1         0.7697

o Close      0.7602

o PML          0.7566                

o M2         0.7566             

o M3         0.7493                         

o M5           0.7123

Active traders can use MTrend: 0.7707 as the pivot, maintaining a long position above that level and a flat or short position below it.

Summary

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

S&P 500 Monthly Valuation & Analysis Review – 03-31-21

S&P 500 Monthly Valuation & Analysis Review – 03-31-21

Also, read our commentary on why low rates don’t justify high valuations.


Also, read our commentary on why low rates don’t justify high valuations.        J. Brett Freeze, CFA, founder of Global Technical Analysis. Each month Brett will provide you their valuable S&P 500 Valuation Chart Book. This unique analysis provides an invaluable long-term perspective of equity valuations. If you are interested in learning more about their services, please connect with them.

Shedlock: Inflation Is Rampant But Fed Dismisses It

Inflation is rampant but the Fed dismisses it. Year-over-year home prices are up 11.2%, some cities even more. The Fed does not see this, or count it, if they do. Let’s discuss why.

Home Prices Rise at Fastest Pace in 15 Years

Home prices are running rampant. The national level average year-over-year increase is 11.2%.

Prices have accelerated in the past few months. I discussed the year-over-year acceleration in Home Prices Rise at Fastest Pace in 15 Years

National and 10-city averages do not tell the full story as the lead chart shows. 

Inflation Disconnect

CS National Top 10 Metro CPI OER 2021-01

Owners’ Equivalent Rent

OER stands for Owners’ Equivalent Rent. 

Prior to 2000, home prices, Owners’ Equivalent Rent (OER), and the Case Shiller national home price index all moved in sync.

This is important because home prices directly used to be in the CPI. Now they aren’t. Only rent is. 

Yet, OER is the Single Largest Component of the CPI with a weight of 24.07%.

In effect, economists substituted rent for home prices in the CPI. Prior to 2000, this did not matter. Now it seriously distorts measures of inflation.

The rationale is home prices are a capital expense not a consumer expense. 

What Should We Measure?

What is it we are measuring or need to measure? 

I suggest we need to measure inflation, not just consumer inflation. 

Home Prices, OER, and CPI Percent Change

CS National Top 10 Metro CPI OER Percent Change 2021-01

Year-Over-Year Percent Changes

  • National Home Prices: 11.2%
  • 10-City Average: 10.9%
  • OER: 2.2%
  • CPI: 1.4%

The CPI allegedly is up a mere 1.4% from a year ago as of January 2021. Let’s calculate inflation by substituting home prices for OER in the CPI as it used to be.

I call the result CS-CPI for Case-Shiller-CPI.

CPI, CS-CPI National, CS-CPI Top 10

CPI, CS-CPI Percent Change 2021-01

Economists claim inflation is up a mere 1.4% year-over-year as of January 2021. 

If we substitute home prices for OER as it used to be (and is far more accurate as well), inflation is up 3.8% from a year ago. 

Having calculated inflation far more accurately than widely believed (yet still understated), we can calculate real interest rates

Real Interest Rates

Real Interest Rates CPI as of 2021-01

To determine “real” interest rates, subtract CPI from the Fed Funds Rate.

  • Real Interest Rate as Touted: -1.31%
  • CS-CPI 10-City: -3.59%
  • CS-CPI National: -3.67%

Q&A

Q: With real interest rates close to -4% is it any wonder asset prices and speculation are booming?
A: No
Q: Why can’t the Fed see this?
A: Possibly the Fed can see this. If so it’s on purpose. 

The Fed wants inflation and numerous Fed members are openly in praise of it.

Easy Money Quote of the Day: Fed “Won’t Take the Punch Bowl Away”

On March 25, I noted the Easy Money Quote of the Day: Fed “Won’t Take the Punch Bowl Away”

Numerous Fed presidents made speeches. I awarded gold, silver, and bronze medals for the best “easy money” quotes.

San Francisco Fed President Mary Daly won the gold medal. She said the central bank would show at least “a healthy dose” of patience. ”We are not going to take this punch bowl away,” said Daly.

Does the Fed Understand What They Are Doing?

I don’t know. Either the Fed is blindly ignorant of what’s going on, or it’s on purpose. Take your pick.

The result is a big set of bubbles, whether the Fed sees them or not. 

Dow New Low, Markowski: Could The Dow See A New Low Before Recession Ends?

2% Inflation Target

The Fed’s 2% inflation target is monetary insanity.

Full speed ahead with the stimulus in search of inflation that would be visible to anyone who was not wearing groupthink blinders.

I have a set of questions for Fed Chair Jerome Powell on inflation. Please read them: Hello Jerome Powell We Have Questions.

Historical Perspective on CPI Deflations

A BIS study of deflations shows the Fed’s fear of deflation is foolish.

Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” concluded the study.

For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They?

Japan has tried what the Fed is doing now for over a decade, with no results.

Yet, Powell hell bent on producing more than 2% inflation until the strategy “works”.

I discuss numerous ways Powell is on the Bank of Japan’s path in Is the Fed Blindly Following Failed Policies of the Bank of Japan?

What Would I Do?

For the answer, please see Reader Question: What Would I do Differently Than the Fed?

Patrick Hill: The Twilight Zone Economy

The Twilight Zone Economy

“It is a dimension as vast as space and as timeless as infinity. It is the middle ground between light and shadow, between science (reality) and superstition (bubbles), and it lies between the pit of man’s fears and the summit of his knowledge (fundamentals). This is the dimension of (economic) imagination. It is an area which we call The Twilight Zone.” Rod Serling, introduction to the TV series, 1959  [our comments in ( )]

Our economy has entered the twilight zone. Today, economic leaders base policies on a hoped-for utopia with bubbles called ‘growing markets’ and greed termed ‘good valuations’. The twilight zone economy is a place where fundamentals have disappeared. It is a utopian world of no moral hazard for business, financial or economic mistakes.  In the last year, the Federal Reserve has injected over $4.1T into the banking, hedge fund, Wall Street complex of the financial elite. Vast injections of dollars have sent stock valuations to record highs.  Yet, the pandemic-driven economy is real for 19M Americans out of work, others who lost 540,000 loved ones, and millions carrying housing debt due to missed rent and house payments.

Policymakers Disconnected From the Real Economy

Yet, policymakers continue to become further disconnected from the real economy where people work and spend.  These leaders imagine an economy of full employment forever, risk assets continually rising in price (not value) with virtually no market corrections. It is an economic wonderland for corporations to use low-cost debt to finance infinite profits and stock buybacks.   Wall Street is only too pleased to hype this corporate financial engineering.  Goldman Sachs forecasts a GDP surge to 8% in the 4th quarter of this year due to the $1.9T American Rescue Bill. Bond king Bill Gross predicts interest rates surge to 3 – 4 % by year end. Does all this monetary and fiscal stimulus result in a healthy solid economy or the most catastrophic inflationary bubble in modern times? Our post identifies the dimensions of the Twilight Zone Economy.

Astronomical Public Debt Drags Growth

The country is drowning in low-interest debt. But, this liquidity ‘soma’ drug is putting investors to sleep, thinking everything will be ok.  Now, public debt is at levels not seen since WWII and projected to go to 200% of GDP by 2051.

Source: CBO, The Daily Shot – 3/15/21

Sources: Blackrock, IMF, OECD, The Daily Shot – 3/15/21

During WWII, debt supported production capacity for building weapons, planes, and infrastructure to support the war effort. When the war was over, the US was the only major economy intact, leading to a high growth productive economy. The investment in productive industries increased the standard of living for most Americans.

Are the present monetary debt and fiscal stimulus programs of relief payments resulting in productive investment?  This chart, by Lance Roberts, shows how increasing public debt has resulted in a continuing decline in real economic growth.

Source: RIA, Lance Roberts, 3/17/21

Public debt not used for solid investments in infrastructure, basic research for innovation, or productivity has resulted in an ever-growing debt level to achieve a continuing decline in economic growth.  This cycle of low-cost ballooning debt to finance debt service and transfer payments will likely result in economic stagnation or worse.

Negative Yielding Debt Triggers Speculation

Sovereign negative-yielding debt reached a record high of $17.8T last month.  Thus, a massive level of worldwide debt is not repaying the entire principal to debt holders. Correlated to soaring negative-yielding debt is the meteoric rise of trader speculation in Bitcoin and other cryptocurrencies.

Sources: Daily Feather, Bloomberg – 3/22/21

Such parabolic moves in debt and speculative digital currencies like Bitcoin are candidates for a significant reversion in value at some date in the near future.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Equity Markets Are In An Alternate Reality

Why is a firm like Tesla valued at the same level as the next six largest car companies or the oil industry’s total market capitalization? Isn’t Tesla’s valuation in the economic twilight zone? Analysts value Tesla at $1M per vehicle produced versus GM at $5000 per vehicle. While VW is building six battery factories in the EU, and vows by 2025 to produce over 1.2M EVs in 2022, matching Tesla’s total output. VW has now taken over the dominant market share in Europe and is opening EV plants in Asia and North America.

There are 15 major car manufacturers, including GM, Ford, Toyota, Honda, Nissan, BMW, Mercedes, investing billions into EV production plants and battery facilities. Tesla may have a first-mover advantage in the EV market, but it may wind up like Yahoo, losing out to Google in the internet search sector. The following chart shows S&P valuations at Dotcom Crash levels in 2000.

Source: Topdown Charts, Refinitiv Datastream. – 3/17/21

The following chart shows the record valuation of stocks as a percentage of GDP back to 1952!

Sources: Charles Schwab, Bloomberg – 12/31/20

Traders are using ever-increasing levels of margin to buy stocks.  Corporate executives with record levels of cash are resuming stock buybacks as the Dow and S&P continue to set new record highs.  Yet, corporate sales and economic fundamentals don’t support this extreme valuation case.

This chart from Real Investment Advisors notes the divergence of stock valuations growing to 164% versus corporate sales growth of 42% and GDP growth at 22% since 2007.

Source: Real Investment Advisors – 3/20/21

Investors, executives, and the Federal Reserve are addicted to low-interest rates. And just like physical addiction, the time will come when the zero-interest economic drug won’t work anymore, and withdrawal sets in spiraling into a market crash.

Bubbles Bubbles Everywhere

Another sign of an alternative reality is bubbles in non-financial markets.  For example, Christie’s just sold a digital work of art by an artist known as Beepie for $69.3M with a non-fungible (exchangeable) token (NFT) when the bidding started at just $100. NFT collectible prices have sky rocked, providing the buyer with ownership rights indicating their purchase is authentic.  Beepi knows he’s riding a soaring market, observing, ‘Absolutely it’s a bubble, to be honest.”

An NFT buyer purchased 351 Top NBA Shot videos for $5,000 last January in the video clip market. Based on social media chatter, Momentranks.com values the videos at $67,000 today. Sneaker reselling has soared as the collectible marketplace, StockX, announced that Nike Dunks sold for $33,400 two months ago. StockX disclosed that a Tom Brady rookie trading card sold for a record $1.3M in January.  Even innocuous things like Twitter CEO Jack Dorsey’s first tweet sold for $2.9M. Venture capitalists Marc Andreessen and Ben Horowitz note what motivates mania buyers at a collectible forum:

Andreessen: “A big part of the entire point of life is aesthetics. The way that we live and the design of things around us and artistic creativity.”

Horowitz: “It’s a feeling. You’re buying a feeling. And what’s that worth?”

Writer Ben Carlson notes in his analysis of bubble markets that:

            “We’re emotional. We lead with our feelings. We’re superstitious.”

Superstition is a characteristic of the Twilight Zone Economy.

Core City Life Is Changed Forever

Many think life will go back to the way things were in February 2020. We disagree.  Life has changed forever in America. The lack of commuters changes core city life where they are the heartbeat of neighborhoods surrounded by office towers.  Millions of small businesses and restaurants dependent on commuter patronage are scrambling to survive. When they had the opportunity, millions of workers worked from home and found they could perform successfully remotely.  Hundreds of thousands of workers left cities to move to another less costly city or region. Some analysts think 99% of commuters will come back to city offices.

Yet, surveys show that from 20 – 25 % of professionals in dense city centers like New York and San Francisco want to work from home at least 3 – 4 days a week or work from home full time. Based on remote worker management experience companies are restructuring their reporting hierarchy. Global corporations to startups are moving to a distributed worker organization, further flattening the reporting structure for improved performance and business agility.

The lack of office workers leaves 20% of offices in core cities vacant, putting banks and commercial office space landlords at risk for billions of dollars in lease income.  Plus, small businesses in these core cities have lost 50- 60% of their sales. Business owners hold billions of dollars in lease debt which must be paid off even after 80% of commuters return. Innovative new small businesses and restaurants will emerge to support these commuters. Plus, new attractions and business models will bring back visitors crucial for the leisure and hospitality sectors.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Millions of Workers Are Long Term Unemployed

About 19M workers collect continuing unemployment, of which 39.5% have been unemployed over 27 weeks.  These permanently unemployed workers will have a difficult time finding their next job.  While Indeed reports that job openings are up 3.7 % from January 2020, millions of workers are still unemployed. Many of these workers do not have the job skills to be hired for many new manufacturing and services jobs. Bank of America completed an analysis of unemployment pre – COVID to the trajectory of employment post COVID showing a lingering decline in the labor force.

Sources: Bank of America, CBO, Zerohedge, Real Investment Advisors – 2/12/21

The BofA analysis shows a permanent loss of employment in labor force size in Phase 3 of the recovery. The reality of the economy that workers and consumers will likely live in is an economy of debt dragging economic growth with poor job prospects. Job prospects for millions of workers will be limited by their lack of marketable skills.  A major workforce segment faces a long financial recovery time from either the loss of their business or job. Lack of consumer spending by the permanently unemployed will slow the recovery.

 Corporate Executives Join In the Party

In the 1950s, CEO pay to average worker pay was 50 times. Today, CEO pay is 350 times average worker pay, with Wall Street applauding stock buybacks totaling 1.4T in 2019. While buybacks fell to $450B in 2020, Bloomberg forecasts stock buybacks to resume $150B per quarter in 2021. Stock buybacks create overvalued markets. Ned Davis Research estimates the SPX as overvalued by at least 20% due to stock buybacks distorting prices in 2019.  A company gooses prices by using cash to purchase shares in the open market, thereby reducing the stock pool for public investors.  If demand stays the same, prices go up.

Yet, the company has not increased in substantive value. Many executives used low-cost debt to make stock purchases that saddle the company with major debt obligations. Executives must refinance these debt obligation or pay them off in the near future.   In January 2020, corporate debt hit a 30-year record 49% of GDP, while interest rates were low.  Fitch forecasts a jump in corporate loan defaults in 2021 to 8 – 9% from a 2020 default range of 5 – 6%.

Sources: Fitch Ratings,  Vuk Vukovic – 9/22/20

A significant default storm looms in the coming years as interest rates rise.

Another cash flow squeeze is developing in profit margins. Prices paid for goods and services are increasing at a rate far faster than corporations can raise end customer prices in the following chart.

Sources: Mizuho Securities, The Federal Reserve Bank of Philadelphia, The Daily Shot – 3/19/21

Note the gap between prices paid and prices received in 2009 just before the 2009 fall.  A similar cash flow squeeze seems to be strengthening.

Policy Makers Are Missing Solid Economic Landmarks

To pilot a ship along a coast and into a safe harbor, a captain needs recognizable landmarks and beacons. Our policy – captains are in a twilight zone fog. Many key economic indicators do not actually measure what policymakers tell us they do.  Stock earnings per share reports are financially manipulated by stock buybacks misleading investors as to the actual earnings per share compared to pre-buybacks.  The Fed holds interest rates artificially low with the resulting liquidity injections distorting debt markets.  Unemployment rates are not accurate when the Bureau of Labor Statistics shows a rate of 6.7%. But, according to state unemployment reports, 19M workers are on continuing unemployment. Thus, the unemployment rate is more like 12.6%.

The Fed’s inflation consumer price index figures exclude ‘volatile energy and food prices, which are expenses consumers experience every day.  Since the federal government in 1999 changed to a ‘consumer lifestyle buying pattern’ approach rather than a standard price comparison, inflation has consistently been under-reported.  In 1998 the Bureau of Labor Statistics shifted to an ‘owner equivalent rental cost’ for homeownership. Using the Case-Shiller Home Price Index since 2019 shows the BLS OER-based approach understates CPI dramatically at 1.0% vs. the Case-Shiller model at 2.5%.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Industry Research On The Real Economy Is More Accurate

Chapwood Investments publishes a biannual index including 50 cities comparing consumer goods and services prices on 500 consumer items. Their analysis showed the top ten cities in the US with an average inflation rate of 10% in the second half of 2020.  A marketing industry research firm compared price changes for 220 often purchased consumer products at Target and Walmart comparing 2018 to 2019 prices on average, the increase was 5 – 6% for both stores.  Corporate marketing executives must have accurate information to make reasonable sales forecasts and plans for investment.  Our policy leaders can learn from their example.

The Way Out of the Twilight Zone

To leave the Twilight Zone grip requires policymakers to recognize financial and real economy fundamentals. They need to drop the no economic pain utopia model.  Policymakers need to get real with their statistics and tracking systems to base their policy initiatives on the real economy. Analysts need to use fundamentals for stock market and financial valuations. The Fed should stop rescuing failing hedge funds, zombie companies and end the addiction to low-cost debt. Washington can start paying for new spending programs with increased focused taxes, ending government waste and lower spending. The focus needs to be on a monetary and fiscal set of policies sustaining entrepreneurship, hard work, and allowing the economic consequences of business failure to run their course.

To avoid the inevitable market crash, these programs need to be phased in over several years to allow for investors, executives, and consumers to make adjustments to their portfolios.  It is as if economic leaders have sent investors up an infinite ‘wall of price’ like a free solo climber, with no safety rope leaving them to the inevitable fate of fundamental economic gravity.

Patrick Hill is the Editor of The Future Economy, https://thefutureconomy.com/, the site hosts analysis of the real economy, ideas on a new economy, indicators, and posts to start a dialog. He writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677, email: patrickhill@thefutureconomy.com.

Zen and the Art of Risk Management

Zen and the Art of Risk Management

“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.” –Seth Klarman

Growing wealth occurs over a long time horizon, including many bullish and bearish market cycles. While making the most out of bull markets is important, it is equally important to avoid letting the inevitable bear markets reverse your progress.

Making this task much more difficult are extreme market environments and inane investor beliefs at such times. When markets are frothy and grossly overvalued, greed takes over, leading to lofty performance expectations and excessive risk stances. Equally tricky is buying when fear grips the markets.

In both extremes and all points in between, we must maintain investor Zen. The best way to accomplish such mindfulness and awareness of market surroundings is to understand the risks and rewards present in markets. Zen-like awareness allows us to run with the bulls and hide from the bears.

Measuring Risk

The price of every almost every asset represents the cost to receive cash flows in the future. With equities, for instance, we are buying future earnings.

When someone buys Apple stock, they are an owner of Apple. Like every company, public or private, Apple has options with what they can do with their earnings. The decision frequently boils down to paying them out as a dividend or reinvesting them into the company. At times they may hold cash, effectively delaying the decision.

The chart below compares the rolling ten-year average dividend yield and earnings yield for the S&P 500. As shown, half to two-thirds of earnings get paid out as dividends.

When determining the valuation for a company or index, we must understand that future earnings are what we are valuing. The reinvestment or dividend distribution decision is secondary. 

Do Valuations Dictate Returns?

Short term price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over longer periods, price changes become more dependent on valuations and less on supply and demand. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.

The correlation of ten-year forward returns and CAPE is statistically significant with an R-squared of .4803. In other words, valuation matters in the long run. Conversely, there is no correlation between quarterly returns and CAPE. The graph below further highlights valuations become a more critical measure of risk and reward over time. 

The use of valuations is often rebuked because they serve little purpose in daily trading. That is a fair statement. However, whether we are flipping stocks daily or holding for years, valuations provide an essential gauge of risk.

To be clear, just because we may evaluate a company using a long duration doesn’t mean we have to hold it for an extended period.  

Earnings Trends and Expectations

GDP and corporate earnings trend linearly over long periods. That said, short-term earnings fluctuate wildly. It is these vacillations from the trend that makes equity valuation harder than it needs to be.

Since earnings are what we are buying, comparing historical earnings trends to market-implied earnings is a shrewd way to value a company or index. This method allows us to assess if we are paying more or less than what we should expect to receive?

Such a comparison serves well for stable, mature companies. However, it becomes a difficult task for companies whose earnings grow or shrink in a non-linear fashion.

Fortunately, many broad market indexes, such as the S&P 500, have linear earnings growth trends over long periods. This happens because the index’s large sample size and industry diversification reflect broad economic trends.

fundamentals, The Death Of Fundamentals &#038; The Future Of Low Returns

Implied Earnings

The price to earnings (P/E) ratio of an index or stock coupled with an assumed holding period, is all we need to calculate the market-implied future earnings growth rate. For instance, if the P/E is 20 and we assume a 40 year holding period, we expect earnings growth of 7.78%. Earnings, compounding at a 7.78% rate, entails shareholders will receive enough earnings to pay back their initial investment in 40 years. If 7.78% is an acceptable 40-year return compared to other assets, the stock or index is fairly valued.

The graph below compares five-year rolling S&P earnings growth rates and their trend (dotted blue line) with implied earnings growth rates (orange). More often than not in the last 30 years stock prices have higher implied earnings than the market has delivered.

Current Valuations

Currently, the S&P 500 implies earnings growth of 9.25% over the next 40 years. The actual historical trend earnings growth is 5.85% and trending lower. The last time real earnings growth exceeded the current implied level (9.25%) was in the early 1980s.

Our use of a 40 year duration is subjective. Much of what we have read on the topic prefer shorter periods. The longer the period, the lower the implied growth. As such, we believe our assumption is conservative.

Understanding investors’ lofty expectations is the first step to understanding risk. The second step is to equate it to value and put it into context with prior periods.

The black line in the following graph quantifies how much the S&P 500 would change if implied earnings revert to trend earnings.

The S&P has to fall 73% for implied earnings to equal trend earnings growth. We admit the calculation may be exaggerated. As such, we think it wise to compare the current level versus those in the past. A return to the average change required (green dotted line) still involves a decline of nearly 50%. A 40% decline matches the average of the last 20 years. A drawdown of 40% is not farfetched considering the previous three major drawdowns, 2000, 2008, and 2020 had sell-offs in that neighborhood.

Stop, Sit and Breathe

You may frightfully read the paragraphs above and think about selling immediately. Stop, sit, breathe, and relax. Now is the time for investor Zen.

The market is grossly expensive, but as we stated valuations have poor predictive ability to help gauge what will happen in the next few weeks or months. Despite extreme valuations, we can ride the market higher with other greedy investors. However, unlike most investors, we are aware that the risk of significant losses is not minimal.

Quantifying downside risk allows us to have a plan in place to reduce or hedge risk when technical indicators and other signals alert us to potential changes.

When the market is more reasonably priced, we can be more relaxed, and our finger will not be tightly wound around the trigger. Today, however, valuations provide little cushion to be wrong.

Summary

Stocks are extremely expensive. Regardless of whether you agree with our earnings model or not, drawdown risk is higher today than at almost any other time. The Goldman Sachs table below uses multiple valuation metrics and comes to the same conclusion.

In a recent article Bloomberg states: “The so-called Buffett Indicator. Tobin’s Q. The S&P 500’s forward P/E. These and others show the market at stretched levels, sometimes extremely so. Yet many market-watchers argue they can be ignored, because this time really is different. The rationale? Everything from Federal Reserve largesse to vaccines promising a quick recovery.”

If hope that this time is different is your risk management plan carry on. For the rest of us we advise having a strategy with actionable signals.

Find your inner investor Zen!

#Technically Speaking: Bulls Run As Liquidity Floods Market

As liquidity floods the market, the bulls continue to run the market. However, was the recent consolidation enough to reset market exuberance?

Over the last few weeks, I discussed the weekly “sell signals.” Such suggested upside would be somewhat limited for markets near-term. However, that flood of liquidity also limited the downside. Such has indeed been the case, as volatile markets made little headway since February, but dips continue to get bought.

With “stimmy” checks hitting bank accounts, “retail trading” stocks should get a boost as former gamblers and “pandemic lock-ins” return to Robinhood.

Furthermore, the surge in liquidity from the CARES Act last March is now working its way back into the economy as well. Those Treasury balances are getting drawn down to fund expenditures such as extended unemployment benefits.

Unsurprisingly, all this liquidity is finding its way into the markets.

Such has pushed equity allocations to nearly “Dot.com” level highs.

In other words, the bulls see “no risk” in being invested in “risk” assets.

Stock Buybacks Return With A Vengence

As I noted in “Powell’s Easy Money Promise,” stock buybacks have returned with a vengeance.

“No, this is not the ‘cash on the sidelines’ argument which I debunked previously. Following the pandemic, corporations drew down credit lines and hoarded cash due to economic uncertainty. Now, with expectations of recovery, corporations are once again beginning to deploy that cash.”

Powell's Easy Money Promise 03-27-21, Market Rallies On Powell&#8217;s &#8220;Easy Money&#8221; Promise 03-27-21

As I said then, while the mainstream media hope is all this cash will be flowing back into the economy, the reality is that it will primarily go to stock buybacks. Again, while not necessarily bad, it is the “least best” use of the company’s cash. Instead of expanding production, increasing sales, acquiring competitors, or making capital investments, the money gets used for a one-time boost to earnings on a per-share basis.

This past week, share buybacks hit a new record.

Not surprisingly, the most prominent players in buybacks are the ones that need to subsidize their earnings the most to beat estimates; technology and financials.

Net Purchases

While share buybacks primarily are for the benefit of corporate insiders “cashing out,” it does have the effect of supporting asset prices as well. As I discussed in 2019, when stocks were hitting records amid record share repurchases:

“What is clear, is that the misuse, and abuse, of share buybacks to manipulate earnings and reward insiders has become problematic. As John Authers recently pointed out:

‘For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.’

In other words, between the Federal Reserve injecting a massive amount of liquidity into the financial markets, and corporations buying back their own shares, there have been effectively no other real buyers in the market.”

Powell's Easy Money Promise 03-27-21, Market Rallies On Powell&#8217;s &#8220;Easy Money&#8221; Promise 03-27-21

I bring this up for two reasons:

  1. The buybacks ARE SUPPORTIVE of asset prices in the short-term; and,
  2. We just had to “bailout” these companies because they couldn’t weather an economic downturn as they have spent years piling into debt and buying back shares.

While Janet Yellen is okay with the buybacks, as she thinks the banks are healthier now, why doesn’t anyone ask the question:

“If banks are so healthy, why do they need a constant monetary stimulus to remain in business and a bailout every time the economy declines?”

It doesn’t sound very healthy to me. But for now, there is only one headline that matters:

The Risk Of “No Risk”

The problem of assuming there is “no risk” is that it leads to “investor complacency.”  As discussed in “Willful Blindness:”

“Willful blindness, also known as willful ignorance or contrived ignorance, is a term used in law. Being ‘willfully blind’ describes a situation where a person seeks to avoid civil or criminal liability for a wrongful act by keeping themselves unaware of the facts that would render them liable or implicated. 

The phrase ‘willful blindness’ also means any situation in which people avoid facts to absolve themselves of their liability. 

‘Investors regularly dismiss the ‘facts’ which run contrary to their current opinion. In behavioral investing terms this is ‘confirmation bias.’ 

As markets rise, investors take on exceedingly more risk with the full knowledge that such actions will have a negative consequence. However, that ‘negative consequence’ is dismissed by the ‘fear of missing out,’ or rather F.O.M.O.

As ‘greed’ overtakes ‘fear,’ investors become emboldened as rising markets reinforce their convictions. When the negative consequence occurs, instead of taking responsibility, they blame the media, Wall Street, or their advisor.”

This currently where we are in the markets today.

As discussed, with investors fully allocated, the risk remains that markets are trading at near-record extensions of longer-term means. The monthly chart below shows the current deviation from the long-term mean. Two things to note:

  • The market is exceptionally overbought longer-term; and,
  • The negative divergence in relative strength is highly concerning.

It is generally near market peaks when investors are the most complacent about risk. While I certainly agree in the shorter-term, the liquidity flood has mitigated downside risk; it only exacerbates longer-term consequences.

Another Surge Coming

Currently, investors are very exuberant about markets, although they can get more so.

With the flood of stimulus into the market, another surge higher would not be a surprise. Such would correspond both with the peak of liquidity inflows and the peak in earnings and economic growth expectations. From a technical perspective, this also aligns with the weekly “money flow” index, turning positive. Typically, these weekly “buy” signals last roughly two to three months before reversing.

Note the blue vertical dashed lines below. Those lines are the weekly “buy” and “sell” signals overlaid on the daily chart. The blue boxes show where the daily and weekly sell signals converged previously.

When both indicators align on “sell signals,” blue boxes, market volatility rises markedly. However, markets tend to increase when both indicators align with “buy signals.”

With both “buy” signals close to aligning, I would not be surprised to see markets make another advance higher near term. However, focusing back on longer-term market dynamics, the deviation from the longer-term mean is extreme.

Reversions always occur when least expected, and always for a reason “no one sees coming.”

Buy Now, Sell Later

With markets still in the “seasonally strong” period of the year, lots of liquidity, and plenty of exuberance, this is not a time to be “bearish” on markets.

We are using recent weaknesses to add to positions we took profits in recently, such as energy and financials. We will also add to beaten-up “growth” names that have strong earnings trajectories and strong fundamentals.

It should be evident that an honest assessment of uncertainty leads to better decisions.

The problem with “Eternal Bullishness” and “Willful Blindness” is that the failure to embrace uncertainty increases risk, and ultimately loss.

We must be able to recognize and be responsive to changes in underlying market dynamics. If they change for the worse, we must be aware of the portfolio model’s inherent risk. The reality is that we can’t control outcomes. The most we can do is influence the probability of specific outcomes.

Focusing on risk not only removes “willful blindness” from the process, but it is also essential to capital preservation and investment success over time.

In other words, “buy now,” just don’t forget to “sell” later.

Biden’s Stimulus Will Cut Poverty By 40% – For One Year.

President Biden’s stimulus bill “will cut the number of children in poverty by 40%,” according to the Center on Budget and Policy Priorities.

“The current Child Tax Credit and EITC together lift more children above the poverty line, 5.5 million, than any other economic support program. This level of poverty reduction was achieved through multiple expansions of the EITC and Child Tax Credit since their respective enactments in 1975 and 1997. The House’s proposal — with one significant change to the Child Tax Credit — would lift another 4.1 million children above the poverty line, cutting the remaining number of children in poverty by more than 40 percent.” – CBPP

The NY Times also jumped on Biden’s stimulus package to tout how “transformative” Biden will be to the U.S. economy. To wit:

“The list of new policies goes on. There is money in the American Rescue Plan to expand food stamps, bolster state welfare programs, and increase federal support for child and dependent care. Put all this together and the bill is expected to reduce overall poverty by more than a third and child poverty by more than half. It is, with no exaggeration, the single most important piece of anti-poverty legislation since Lyndon B. Johnson’s Great Society, itself the signature program of a man who sought to emulate F.D.R.”

Here’s the problem. Unlike the New Deal, which benefitted the economy for decades, the American Rescue Plan will only help the poor for one year. As is always the case with such socialistic policies, they sound great in theory, but they rarely work as expected in reality.

The Poor Do Need Help

“More money in people’s pockets will lead to stronger economic growth.” – J.M. Keynes

I certainly agree with trying to help those in need. Such is why we have charitable organizations that do everything from providing housing, meals, and even job placement. These charities do formidable, challenging, and meaningful work and should have access to funding to do what they do best.

However, the Federal Government is not one of these charities, and throwing money at the problem does more harm than good in the long-term.

Let me explain.

Using data from the Census Bureau, we can look at the bottom 20% of the population’s historical incomes since 1967. As shown, there has virtually been no substantive increase in median incomes for that income group since 1980.

The problem is more apparent when viewed against the other income quintiles.

The problem of “government handouts” should be readily apparent. Since the 1960’s the U.S. has expanded access to social security, welfare, food stamps, tax credits, and a litany of other programs directly targeted to help the most deficient 20% of Americans.

Nothing has changed. Even if the current one-year subsidies are made permanent, they will fail to change the economics of poverty after one-year.

A Temporary Solution

Given the massive support given to the poor over the last 60-years, it should be readily apparent that something is flawed in the thinking. To explain the issue, let’s use another “socialistic policy” being floated by more liberal thinkers – a “universal basic income” or “UBI.”

The idea is that if the Government supplies a basic “living income” to the poor, they will be better off as they won’t have to worry about meeting their “basic needs.” While noble in its intent, economically, it doesn’t change outcomes over the longer term.

Let’s run a hypothetical example using GDP from 2007 to the present. In 2008, in response to the “Financial Crisis,” Congress passes a bill, in theory, that provides $1000/month ($12,000 annually) to 190 million families in the U.S. 

The chart below shows the economy’s annual GDP growth trend assuming the entire UBI program shows up in economic growth. For those supporting programs like UBI, it certainly appears as if GDP elevates permanently to a higher level. 

When you look at the annual rate of change in economic growth, which is how we measure GDP for economic purposes, a different picture emerges. In 2008, when the $12,000 arrives at households, GDP spikes, printing a 17% growth rate versus the actual 1.81% rate.

However, beginning in 2009, the benefit disappears. The reason is that after UBI enters the system, the economy normalizes to a “new level” after the first year. Also, notice that GDP grows at a slightly slower rate as dollar changes to GDP at higher levels print a lower growth rate.

UBI’s Dark Side

Of course, the money to provide the $12,000 UBI benefit had to come from somewhere.

According to the Center On Budget & Policy Priorities, in 2020, roughly 75% of every tax dollar went to non-productive spending. 

“In the fiscal year 2019, the Federal Government spent $4.4 trillion, amounting to 21 percent of the nation’s gross domestic product (GDP). Of that $4.4 trillion, federal revenues financed only $3.5 trillion. The remaining $984 billion came from debt issuance. As the chart below shows, three major areas of spending make up most of the budget.”

Think about that for a minute. In 2019, 75% of all expenditures went to social welfare and interest on the debt. Those payments required $3.3 Trillion of the $3.5 Trillion (or 95%) of the total revenue collected.

Given the decline in economic activity during 2020, those numbers become markedly worse. For the first time in U.S. history, the Federal Government will have to issue debt to cover the mandatory spending. If we add a UBI payment, the deficit spending becomes markedly worse.

The chart below shows the impact of the additional debt on the Federal deficit.

While the “theoretical models” assume that UBI will create enough economic growth and prosperity to “offset” the increase in debt, 40-years of history suggest otherwise.

, #MacroView: Is The &#8220;Debt Chasm&#8221; Too Big For The Fed To Fill?

The Poor Will Remain Poor

Social programs don’t increase prosperity over time. Yes, sending checks to households will increase economic prosperity and cut poverty for 12-months. However, next year, when the checks end, the poverty levels will return to normal, and worse, due to increased inflation.

In a rush to help those in need, economic basics are nearly always forgotten. If I increase incomes by $1000/month, prices of goods and services will adjust to the increased demand. As noted above, the economy will quickly absorb the increased incomes returning the poor to the previous position.

The annual increases in the cost of living impact those in the bottom 20% and those in the bottom 60% of income earners. As I discussed in “The Feedback Loop:”

“‘The ability to ‘maintain a certain standard of living’ remains problematic for many forcing them further into debt.’ – WSJ”

I often show the “gap” between the “standard of living” and real disposable incomes. In 1990, incomes alone were no longer able to meet the standard of living. Therefore, consumers turned to debt to fill the “gap.” 

However, following the “financial crisis,” even the combined income and debt levels no longer filled the gap. Currently, there is almost a $4050 annual deficit facing the average American.

The problem with an economy built on “debt” is exceptionally problematic for the poor as they generally can’t obtain credit. Such cuts off a much-needed source of spending power in the economy.

“‘Consumers increasingly need it [debt].Companies increasingly can’t sell their goods without it. And the economy, which counts on consumer spending for more than two-thirds of GDP, would struggle without a plentiful supply of credit.’ – WSJ”

In the end, once the stimulus fades and the economy adjusts for inflation, Biden’s small moment of reduced poverty rates will revert with a vengeance.

, #MacroView: Is The &#8220;Debt Chasm&#8221; Too Big For The Fed To Fill?

Not A “New New Deal”

While the media is quick to fawn on Biden’s stimulus plan, claiming it to be the 2nd coming of FDR, it isn’t.

FDR’s “New Deal” did have many “social programs” embedded in it, including the beginning of the social welfare safety net. However, FDR backed those social programs with massive works projects from the Hoover Dam’s building to the Tennesse River Valley Authority. Not only did the spending on these projects create jobs, but they were also productive investments repaying the debt used to fund them.

More importantly, the focus of many of the programs was the creation of “jobs.” From the Works Progress Administration to the National Labor Relations Act, Roosevelt believed the best solution to help those in need was to get them back to work.

Furthermore, FDR focused on cleaning up the predatory nature of the financial system on Americans. The 1933 Banking Act, which reformed the banking system by separating banking and brokerage activities. He also established regulatory oversight on the banking system with the Securities Act of 1933.

While providing short-term relief, Biden’s plan does nothing to solve the long-term problems of those living at poverty levels. They need both incentives to “go to work” and access to training and education to obtain gainful employment.

Such is what FDR understood. As with all Government programs, some programs worked while others didn’t. Today, there is still debate about whether FDR’s programs cured or exacerbated the “Great Depression.”

However, what history does define well is that debt-funded programs to provide social assistance to the poor have failed.

Next year, when the money is all spent, we will find poverty levels surged, economic growth weakened, and deficits exploded.

Such is the outcome of all socialistic programs in history.

Viking Analytics: Weekly Gamma Band Update 3/29/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The Gamma Band weekly model[1] ended the week with a 100% allocation to the S&P 500 (SPX) after dipping below Gamma Neutral and experiencing price volatility mid-week.   When the daily price closes below the Gamma Neutral or “Gamma Flip” level (currently near 3,910), the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below the lower gamma level (currently near 3,725), the model will reduce the SPX allocation to zero.

Investors who keep an eye on the Gamma Flip level are more aware of when market volatility is expected to increase.  The chart below shows how the length of daily candles tends to be longer when the market price is below or near the Gamma Flip level. 

The general idea behind the Gamma Band model is to keep high allocations to stocks when market risk is expected to be lower.  Investors who have been conditioned to “buy low and sell high,” it might seem counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

This is one of several signals that we publish daily in our SPX Report. Overall, we continue to rate the SPX options signals as “cautiously bullish.”  A free sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and price signals.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size daily based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics. He has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a B.S. in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space.  He is a former Managing Director at a multi-billion dollar hedge fund. Furthermore, he has deep experience with market data, software, and model building in financial markets. Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


Market Rallies On Powell’s “Easy Money” Promise


In this issue of “Market Rallies On Powell’s Easy Money Promise.”

  • Market Review And Update
  • Powell’s “Easy Money” Promise
  • Stock Buybacks Gone Wild
  • Portfolio Positioning
  • #MacroView: Could A Transaction Tax Be A Good Thing?
  • Sector & Market Analysis
  • 401k Plan Manager

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This Week 1-15-21, #WhatYouMissed On RIA This Week: 1-15-21

Catch Up On What You Missed Last Week


Market Review & Update

I could almost repeat last week’s market update.

“Over the past week, the market didn’t make a lot of headway, as price rises were limited while intraday dips got repeatedly bought. Such is what we would expect with the ‘money flow’ indicators we have discussed over the last several weeks back on “sell signals.” (Importantly, note that Friday’s early morning decline held the uptrend line from the October lows.)”

This week was much the same story, with stocks slopping around all week. However, on Friday, a late afternoon buying surge sent the market back to all-time highs. Again, as noted, stocks haven’t made a lot of headway since the February peak despite a lot of volatility. But Powell’s promise of continue “easy money” certainly didn’t hurt.

As discussed last week, the “sell signal” triggering on a short-term basis coincides with our concerns of quarter-end rebalancing for pension funds. We discuss the confluence of the long- and short-term indicators and the market’s potential outcome in Thursday’s “3-minutes” video.

I think we saw a good bit of that rebalancing this past week and are likely close to its conclusion. As noted, the positive weekly money flows keep downside risk somewhat mitigated for now. As seen over the last two weeks, dips continue to be bought despite overall price weakness. We also see relatively rapid rotations between the defensive and offensive market sectors. As stated previously, such suggests rallies may remain limited until the subsequent “buy signals” are triggered. 

I suspect we may have some additional quarter-end rebalancing risk early next week. However, buying on Thursday and Friday next week, as second-quarter positioning gets underway, would not be surprising.

As such, hold positions early next week and look for weaknesses to add to exposures as needed.

The Dollar’s Silent Action

Over the last couple of months, we repeatedly discussed the market’s ongoing rise, particularly the “value” rotation, depended on continuing dollar weakness.

The recent rotation to value has been primarily a function of a “weaker dollar,” which boosts commodities. As noted, if economic growth does strengthen, leading to higher rates will attract foreign inflows into the dollar for a higher yield. Such also undermines corporate profitability, given that roughly 40% of corporate profits are from abroad.

The dollar has been gaining strength this year on expectations of more robust economic growth. A break above the 200-dma could accelerate buying as shorts begin to cover their positions. 

The risk not factored into the current “value” trade is the inflation and interest rate increase due to the massive amounts of stimulus. However, that stimulus will quickly flow through the system, leaving consumers tapped by higher inflation and rates eroding disposable income.

In other words, the “value trade” could be just a fleeting as the “economic recovery” itself.

We are firm believers in “value investing.”  However, after years of artificial interventions, accounting gimmicks, share buybacks, and massive balance sheet leveraging, there is little “real” value in the markets currently.

Given that the markets have not been allowed to reset, speculators are now simply chasing the next “momentum” trade called “value.”

Powell’s “Easy Money” Promise

Last week, we discussed Powell’s latest change to monetary policy, or rather, lack thereof.

The U.S. economy is heading for its strongest growth in nearly 40 years, the Federal Reserve said on Wednesday, and central bank policymakers are pledging to keep their foot on the gas despite an expected surge of inflation.” – Reuters

In other words, despite the Fed’s mandate of maximum employment and price stability, the Fed is opting to let things run ‘hot’ for some time to ensure that growth is ‘sticky.'” That stance makes some sense, given the economy still requires massive liquidity support more than a decade after the financial crisis. As discussed previously in ‘Forever Stimulus:’ 

‘What this equates to is more than $12 of liquidity for each $1 of economic growth.'”

Fed Forever Stimulus, #MacroView: Is The Fed Stuck With &#8220;Forever Stimulus?&#8221;

The question that financial markets wanted answering was just how much of a decline in asset prices the Fed will tolerate before providing reassurance.

It only took a 3% clip off of all-time highs before there was a scramble by Fed members to assuage market concerns. My colleague, Mish Shedlock, put together an excellent summary:

“Easy Money” Quotes

  • On Thursday, Fed Chair Jerome Powell said even with the economy rebounding faster than expected, any change in monetary policy would happen “very, very gradually over time and with great transparency. Only when the economy has all but fully recovered.”
  • Fed Vice Chair Richard Clarida said the central bank would stay in the game until the recovery is “well and truly complete.”
  • Fed Governor Lael Brainard promised “resolute patience.”
  • San Francisco Fed President Mary Daly said the central bank would show at least “a healthy dose” of patience. ”We are not going to take this punch bowl away.”
  • Richmond Fed President Thomas Barkin said that the United States might well see economic growth remain above trend for several years given the amount of pent-up demand. Nonetheless, “What matters is what outcomes we get. I will see where we go and am not trying to overthink the date (of any policy change). I am trying to think about the outcome.”

Not surprisingly, the Fed is very cautious about the financial markets due to its inherent impact on consumer confidence. However, at this juncture, with rates at zero, stimulus checks in the mail, and QE running $120 billion per month, verbal support is all they can do currently.

As Mish concludes:

“The Fed’s 2% inflation target is monetary insanity. Full speed ahead with the stimulus in search of inflation that would be visible to anyone who was not wearing groupthink blinders. Japan has tried what the Fed is doing now for over a decade, with no results.”

Japanification

He is correct. The Fed’s “inflation policy” will likely backfire on them badly. As discussed previously in “Japanification:”

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

Fed Zombies Japanification, The Fed, Zombies, &#038; The Pathway To Japanification

As my colleague Doug Kass noted, Japan is a template of the fragility of global economic growth. 

The bigger picture takeaway the fact that financial engineering does not help an economy, it probably hurts it. If it helped, after mega-doses of the stuff in every imaginable form, the Japanese economy would be humming. But the Japanese economy is doing the opposite. Japan tried to substitute monetary policy for sound fiscal and economic policy. And the result is terrible.”

I agree with Doug, as does the data, that while financial engineering props up asset prices, it does nothing for an economy over the medium to longer-term. It actually has negative consequences.

Santa Claus Broad Wall, Technically Speaking: Will &#8220;Santa Claus&#8221; Visit &#8220;Broad &#038; Wall&#8221;

Stock Buybacks Gone Wild

Two weeks ago, I addressed the “Money On The Sidelines” myth stating:

“No, this is not the ‘cash on the sidelines’ argument which I debunked previously. Following the pandemic, corporations drew down credit lines and hoarded cash due to economic uncertainty. Now, with expectations of recovery, corporations are once again beginning to deploy that cash.”

Bulls Rush Stimulus 03-12-21, Bulls &#8220;Rush In&#8221; With More Stimulus On The Way 03-12-21

As I stated then, while the mainstream media hope is all this cash will be flowing back into the economy, the reality is that it will primarily go to stock buybacks. Again, while not necessarily bad, it is the “least best” use of the company’s cash. Instead of expanding production, increasing sales, acquiring competitors, or making capital investments, the money gets used for a one-time boost to earnings on a per-share basis.

This past week, share buybacks hit a new record. 

Not surprisingly, the most prominent players in buybacks are the ones that need to subsidize their earnings the most to beat estimates; technology and financials.

Net Purchases

While share buybacks primarily are for the benefit of corporate insiders “cashing out,” it does have the effect of supporting asset prices as well. As I discussed in 2019, when stocks were hitting records amid record share repurchases:

“What is clear, is that the misuse, and abuse, of share buybacks to manipulate earnings and reward insiders has become problematic. As John Authers recently pointed out:

‘For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.’

In other words, between the Federal Reserve injecting a massive amount of liquidity into the financial markets, and corporations buying back their own shares, there have been effectively no other real buyers in the market.”

, Peak Buybacks? Has Corporate Indulgence Hit Its Limits

I bring this up for two reasons:

  1. The buybacks ARE SUPPORTIVE of asset prices in the short-term; and,
  2. We just had to “bailout” these companies because they couldn’t weather an economic downturn as they have spent years piling into debt and buying back shares.

While Janet Yellen is okay with the buybacks, as she thinks the banks are healthier now, why doesn’t anyone ask the question:

“If banks are so healthy, why do they need a constant monetary stimulus to remain in business and a bailout every time the economy declines?”

It doesn’t sound very healthy to me.

Portfolio Update

As noted above, with the “money flow” indicators now negative on both a daily and weekly basis, we are currently holding much higher levels of cash. Last week, we also added a bit of “duration” to our bond portfolio by stepping into TLT to add a hedge against a potential pickup in volatility short-term. 

With the market now about 1/3rd of the way through the correction cycle, there is limited downside risk currently as we remain in the year’s seasonally strong period. However, such doesn’t mean we can’t have a lot of volatility in the meantime.

We remain wary of the rise in yields, and ultimately the dollar, which remains the key to the current market cycle. As discussed last week, the “value trade,” which had become excessively overbought, corrected in earnest this past week. While we may see some “bottom-fishing” in the short-term, there is still substantially more room for a correction given the extension from long-term means. 

Our more significant concern over the next quarter is the extremely high net positioning of institutions in the markets. Historically, when “everyone is in the pool,” outcomes have not been all that pleasant. While we continue to remain allocated toward equity risk currently, we do it with a constant eye on the risk. We suspect that we could see a fairly substantial correction during the summer. 

But that is a story we will discuss when we get there. 

Continue to manage risk until we start to see “buy signals” across our indicators once again.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

   


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 87.10 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 76.3 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • Table shows the price deviation above and below the weekly moving averages.


Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

   

Low P/B, High-Value Score, High Dividend Screen

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

Repeating from last week, the market “indigestion” continues. However, the difference is our indicators have flipped to “sell signals.” As such, we have seen more downward pressure on prices, and the rotation between sectors and markets has been vicious. Such does not make our job very easy.

The good news is that markets continue to hold critical support, and investors keep stepping in to buy beaten-down stocks. We have raised cash across portfolios and will use the opportunity over the next two weeks to add to positions that have pulled back and held support successfully. 

Our longer-term indicators are still negative, which continue to apply downside pressure and limit upside. We should be getting to a point in the next two weeks where we will see those indicators begin to reverse back to a “buy signal.” That reversal will carry markets into early summer, where we think a more significant correction awaits as earnings and economic growth hit their peaks for this cycle. 

As noted below, with yields having reached our target “buy” zone, we did add some additional exposures back to portfolios to further hedge equity risk. We used some of our cash holdings to pick up bond exposures which should help offset equity volatility in the near term. 

As always, we continue watching our indicators closely. However, support at the 50-dma continues to hold, which negates some downside risk in the short-term.

Portfolio Changes

During the past week, we made minor changes to portfolios. We post all trades in real-time at RIAPRO.NET.

** Equity / ETF Portfolio – Trade Update ***

“While our S&P indicator is still in sell mode, energy and financials, are starting to turn up. They went into sell mode well before the broader market so are coming out sooner. As such, we added back to energy and financials.” – 03/26/21

Equity Model:

  • Added .5% to KMI, XOM, and FANG
  • Added .5% to GS and JPM

ETF Model

  • Added 1% to XLE and XLF

“With our models pointing to potential short-term turbulence in the equity markets and potential upside in bond prices (as discussed in Three Minutes on Markets), we increased our bond portfolio duration and equity hedge by swapping IEF for TLT. We also put extra cash to work by adding to our short-term bond position (SHY). We will redeploy SHY into stocks and or bonds when needed.” – 03/24/21

Equity and Sector Model:

  • Sold 6% IEF and Bought 6% TLT
  • Added 7% SHY

“With our daily “money flow” indicators very close to turning negative, with money flows negative as well, we are reducing equity risk across all models slightly.” – 03/23/21

Equity Model:

  • Selling 100% of MRO to reduce our overweight energy holdings. 
  • Selling 100% of ZM, reducing our exposure to communications and a sector laggard.
  • Initiating a 1% position in PG to add to our Consumer Staples (defensive) holdings.

ETF Model:

  • Reduce XLE to 2% of the portfolio

As always, our short-term concern remains the protection of your portfolio. We have now shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

Technical Value Scorecard Report For The Week of 3-26-21

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis (versus the assets benchmark) and on an absolute stand-alone basis. You can find more detail on the model and the specific tickers below the charts.

Commentary 3-26-21

  • When looking at the relative sector graphs you will notice the sectors on the left side continue to move up. In general, these sectors, such as Staples and Utilities, are lower beta, more conservative stocks, that tend to perform poorly in an inflationary/higher rates environment. Staples beat the S&P by 1.47% last week, while Utilities beat it by 1.65%. If you go back and look at the same graph from a month ago, you will notice the dots were positioned in order from the lower left of the graph to the upper right corner. Today, the graph has a slight bias lower starting from the upper left.
  • Note also the sigma (orange dots) are higher than the scores (blue dots) for Utilities and Staples. The sigma normalizes the score versus recent history, so moves away from recent trends result in higher sigmas than scores. The opposite is true for those sectors that just started lagging.
  • At the same time, the inflationary sectors like Energy and Financials are slowly fading back to fair value. XLE, after having been the best performing sector for a few months running, lost 7% versus the S&P in the last two weeks. The million-dollar question is whether or not the reflationary trade is over, or just taking a much-needed consolidation before another leg higher? Watching interest rates and break-even inflation expectations will help answer our question.
  • In the Absolute graphs, the sector tilt from the upper left to the lower right is a little more obvious. Staples and Realestate have the highest absolute sigmas. Energy is now only slightly above fair value after been highly overbought for months.
  • Most of the factor/indexes continue to hover around fair value, with small/mid-caps well lower than prior weeks. Emerging markets are the most oversold, in part due to the stronger dollar. The S&P graph, lower right, shows its score continues to hover in slightly overbought territory.
  • As shown in the third table below, Staples are now over 2 standard deviations above its 50 dma. The only other sector trading more than 2 standard deviations above or below a moving average is Realestate above its 200 dma.
  • The market has normalized on the recent consolidation. Given how overbought some sectors and factors/indexes were a few weeks ago, this is technically a healthy development.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum/minimum score, as well as on a normalized basis (sigma) for the last 200 trading days. Assets with scores over or under +/-60% and sigmas over or under +/-2 are likely to either consolidate or change trend. When both the score and sigma are above or below those key levels simultaneously, the signal is stronger.

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma represent a ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner the most bearish.

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Could A “Transaction Tax” Be A Good Thing?

Could a “transaction tax” be a good thing?

I recently discussed why “Free, Isn’t Really Free” regarding the retail investor. While “free trades” have certainly reduced the transaction costs, the selling of data to the highest bidder has likely cost investors more than they saved. To wit:

As is clear from the billions paid for order flow and the billions made from executing those orders, there is no such thing as ‘free trading.’ Thus, the claim of ‘commission free trading’ is often no more than a rhetorical ruse to attract new investors and distract from the billions of dollars in PFOF and other hidden costs that ultimately come out of retail investors’ pockets. It’s pretty clear that these intermediaries are often merely transferring the investors’ visible upfront commissions into invisible after-the-fact de facto commissions.”

However, there is another problem with “free trading” that will likely reduce your investing outcomes over time.

It’s A You Problem

Over the years, I’ve heard from several clients who have had trouble disciplining themselves from trading too frequently. That was in a low-cost world.

Now that trades are no-cost, it’s going to get a lot worse.

It’s difficult enough to match, much less beat, stock indexes without the drag of frequent trading. Frequent traders, from my experience, rarely do well in the stock market.

A Kiplinger article noted the same.

In one study, Odean found that trading costs did indeed weigh on the performance of investors who traded more frequently. Such is a problem that no-commission accounts will render obsolete.

But no-commission trades won’t do anything about the results garnered from another study. Odean found that, ‘on average, the stocks these investors bought went on to underperform the stocks they sold.’

Speculative trading (trades that didn’t seem driven by, say, tax purposes or rebalancing concerns) was even worse. Across all trades, stocks that investors bought underperformed those they sold by three percentage points. However, that disparity widened to five percentage points when considering only speculative trades.

The zero-commission trade is bound to amplify the low-cost proposition of exchange-traded funds. By accelerating the huge migration of investor dollars away from actively managed mutual funds. Now, if investors simply stuck to buying broad-based index ETFs and holding them, that actually would be a good thing.

But what’s far more likely is that a big swath of these investors will trade more. They will try to pick ETFs and stocks that will beat the market over short time periods. After all, the trade is free – why not make it?”

Psychological Drag

So free trading may save you money on trading costs, but if it causes you to trade rashly,  your returns may suffer. For most investors, investment returns are a much bigger deal than trading costs. Therefore, being able to trade for free can be counter-productive if it tempts you to become a day trader and tank your investment performance.

Such was the conclusion of Daniel Wiener, editor of The Independent Adviser.

“Free trading doesn’t help investors. It only encourages bad behavior. As someone who’s been managing client assets for more than 25 years, we talk about ‘time in the market, not market timing’ because long-term investing works.”

The annual Dalbar Investor Survey shows the same. Equity investors consistently do worse than the index.

Such is due primarily to the psychological pitfalls that occur from “herding” to “confirmation bias.” 

“When discussing investor behavior it is helpful to first understand the specific thoughts and actions that lead to poor decision-making. Investor behavior is not simply buying and selling at the wrong time, it is the psychological traps, triggers and misconceptions that cause investors to act irrationally. That irrationality leads to buying and selling at the wrong time, which leads to underperformance.” – Dalbar

Another study by Barber, Lee, Liu, and Odean shows much the same:

“On average, individual investors lose money from trading. Barber and Odean (2000) document that the majority of losses incurred can be traced to trading costs. However, trading costs are not the whole story. On average, individual investors have perverse security selection abilities. They buy stocks that earn subpar returns and sell stocks that earn strong returns (Odean (1999)). In aggregate, the losses of individuals are material” – Barber, Lee, Liu, and Odean

Shrinking Holding Periods

Repeated studies show that long-term holding periods lead to better outcomes. Short-term trading, driven by overconfidence, generally leads to worse.

“The length of time that investors hold shares has been shrinking for decades but the trend accelerated this year. There are different ways of slicing it. However, Reuters calculations of NYSE exchange data show the average holding period for U.S. shares was 5-1/2 months in June. This was a decline from 8-1/2 months at end-2019.

The previous record low of six months was hit just after the 2008 crisis. In 1999, for example, 14 months was the average.”Reuters

Why are holdings times shrinking?

“From 0% interest rates, pandemic-induced volatility to sports gamblers that are bored to death at home due to lack of sports betting. Then there are the millennials living in their parents’ basements with nothing else to do. Also, the day-traders by the millions playing the market using the Robinhood app. And the unemployed trying to multiply their $600+ weekly unemployment checks and also have fun doing it. Don’t forget those same people also throwing the $1,200 stimulus checks into the market to make some money to pay bills, etc. Not to mention algorithm-based machine trading by big institutions, locked-down realtors unable to flip houses finding their luck in the stock market, etc.” – David Hunkar via TFS

While the reasons for the continuing decline in holding periods are many, commission-free trading is exacerbating that trend by removing the “brake pedal” from the speeding car.

Whatever the cause, ultimately, investors’ inability to hold stocks for the long-term is damaging for the market and investors. Simply churning stocks all day long or even holding them for only a few months will not lead to a growing and robust equity market.

Right Solution For The Wrong Reason

One of the proposals by Democratic candidates, and hinted at by the current Biden Administration, is a “Financial Transaction Tax (FTT).”

An FTT is a proposal to place a “tax” on buying and selling a stock, bond, or other financial contracts like options and derivatives. Taxing stock trading is not new. America already has an FTT, albeit extremely small: currently set at roughly 2 cents per $1,000 traded

According to the Brookings Institute, there are many problems with an FTT, harming savers and investors, reducing economic growth, and failing to raise the promised revenue by driving activities to lower-taxed areas overseas.

An FTT is a wrong proposal to solve the Government’s persistent overspending problem. However, it could reapply a “brake pedal” to slow over-trading by individuals. It also could discourage hedge funds from more predatory practices. Such could improve holding periods and longer-term returns.

The Wall Street Journal reported that online brokerages see record spikes in new accounts and trading activity in recent months. The authors argue this trend is due in part to the industrywide move to zero-commission trading. Platforms like E*Trade and Robinhood exacerbate this trend by providing individual investors to trade with few restrictions.

“Many are young and first-time traders confronting the first economic downturn of their professional lives. Yet with free trading at their fingertips and massive online communities with which to discuss trading ideas, many figure they have little to lose.

Research shows that individual investors tend to underperform the broader market, in part because of frequent trading. That hasn’t stopped scores of traders from taking the plunge.” – WSJ

Slowing It Down

As discussed previously, the selling of customer data provides high-frequency trading firms the ability to front-run retail investors.

“If people can find trading patterns and use that to make money, then fair play to them, but they should not be able to do that by selling information that does not belong to them. If they do not sell the information to anyone else, that reduces the scope for front running.” – Financial Times

The removal of payment for order flow, and a return to a transaction fee, remains the most sensible option. But, an FTT could accomplish the same.

“Proponents and opponents alike agree that an FTT would reduce high-frequency trading, or HFT. The profit margins on these individual trades are typically small—for example, profit margins could be as little as a few cents in a heavily traded stock. An FTT would make these trades unprofitable and drastically reduce, or even eliminate, HFT activity.” – Tax Foundation

While an FTT may indeed impact retail investors, resulting in reduced trading volume, it may also help squash the predatory effects of hedge funds and HFT’s.

“Some HFT-oriented trading firms have allegedly engaged in heavily scrutinized (and in some cases illegal) practices, publicized in Michael Lewis’ 2014 book Flash Boys: A Wall Street Revolt. These practices include frontrunning (detecting a large buy/sell order and moving in front of it in anticipation of the resulting price movement) and slow-market arbitrage (simultaneously buying and selling securities on separate exchanges to exploit small, transient price discrepancies).”

The removal of payment for order flow, and a return to a transaction fee, remains the most sensible option. But even an FTT might be worth considering if it reduces professional firms’ ability to take advantage of retail traders.

Free And Fair

As a fiscal conservative, I’m not too fond of taxes of any sort. I am a firm believer in “free markets.”  However, for “free markets” to work effectively, they must also be “fair markets.”

Our current capital market system may be “free,” but it is not “fair” in many ways. Regulators should take steps to ban payment for order-flow, restrict high-frequency trading, and create markets that protect retail investors from predatory practices.

Such would mean that firms providing transaction services would have to go back to charging a commission for their services. But such would potentially have the knock-off effect of “slowing things down” and providing better investors’ outcomes.

However, the reality is that since Wall Street owns regulators, those money-making schemes already in place are likely to remain.

Therefore, while not a proponent, I can make the case an FTT would raise financial transaction costs, resulting in fewer of them. How this affects the overall economy depends on whether the reduced trading is beneficial. If it is, will the reduction will be significant enough to have an impact that goes beyond the investors and traders involved.

While the emergence of zero-commission trading is generally a win for investors, there’s one potential downside — the temptation to over-trade. In other words, it could be more tempting to move in and out of stock positions more frequently because it doesn’t cost anything to do it.

Don’t make this mistake. Although there are certainly some good reasons to sell stocks, the lack of trading commissions isn’t one of them.

But what we do need are “free” and “fair” capital markets.

#WhatYouMissed On RIA This Week: 3-26-21

What You Missed On RIA This Week Ending 3-26-21

It’s been a long week. You probably didn’t have time to read all the headlines that scrolled past you on RIA. Don’t worry, we’ve got you covered. If you haven’t already, opt-in to get our newsletter and technical updates.

Here is this week’s rundown of what you missed.


RIA Advisors Can Now Manage Your 401k Plan

Too many choices? Unsure of what funds to select? Need a strategy to protect your retirement plan from a market downturn? 

RIA Advisors now has the capability to manage your 401k plan for you. It’s quick, simple, and transparent. In just a few minutes we can get you in the “right lane” for retirement.


What You Missed This Week In Blogs

Each week, RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus is the risks that may negatively impact our client’s capital. These are the risks we are focusing on now.



What You Missed In Our Newsletter

Every week, our newsletter delves into the topics, events, and strategies we are using. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how we plan to trade it.



What You Missed: RIA Pro On Investing

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now for 30-days free) If you are a DIY investor, this is the site for you. RIA PRO has all the tools, data, and analysis you need to build, monitor, and manage your own money.



The Best Of “The Real Investment Show”

What? You didn’t tune in last week. That’s okay. Here are the best moments from the “Real Investment Show.” Each week, we cover the topics that mean the most to you from investing to markets to your money.

Best Clips Of The Week Ending 3-26-21


What You Missed: Video Of The Week



Our Best Tweets For The Week: 3-26-21

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

See you next week!

Seth Levine: Trading Time As A Fractal Experience

Trading Time As A Fractal Experience

I’m currently reading Benoit Mandelbrot’s brilliant book The Misbehavior of Markets: A Fractal View of Financial Turbulence (TMM). In it, Mandelbrot makes a case for discarding the bell curve when modeling financial markets, the bedrock of modern financial theory. Instead, he recommends using fractal geometry as a far more accurate lens through which to view markets. However, it’s not just security prices that seem to behave in fractal patterns. Time does too. This observation really resonates with me. I’m simply not experiencing the current, turbulent market moves as furious. Rather, it all seems to be happening in slow motion—in fractal trading time.

Fractals Not Bells

Modern financial theory rests upon the premise that security prices move in accordance with the bell curve (i.e. a normal or Gaussian distribution). This assumption underpins nearly every accepted investment doctrine: from portfolio construction (Modern Portfolio Theory) to option pricing (Black-Scholes). Its truth has been drilled into our heads by university professors, professional credentialing organizations, financial advisors, consultants, and policymakers.

While commonplace, most practitioners will readily admit that such models are approximations at best; not accurate representations of actual security price behaviors. Most notably, the “tails” are fatter than assumed. Large price moves—both gains and losses—occur far more frequently than they would if normally distributed. However, despite this conflict, few discard the familiar theories. More commonly, a “fudge factor” is applied to adjust for discrepancies. It’s an art form, not really science.

In TMM, Mandelbrot dispatches with such approaches altogether. Instead, he builds new models based on fractal geometry. To be sure, it’s less exotic than it first sounds. Fractal distributions are everywhere: from gravity to foraging patterns of various species, to frequencies of family names, to the shape of broccoli. However, Mandelbrot’s application to investing is certainly novel.

Examine price records more closely, and you typically find a different kind of distribution than the bell curve: The tails do not become imperceptible but follow a “power law” [i.e. fractal distribution]. These are common in nature.

Benoit Mandelbrot, The Misbehavior of Markets: A Fractal View of Financial Turbulence

Trading Time as Fractal

However, according to Mandelbrot, it’s not just security prices that behave in fractal patterns. Time does too. It moves in so-called “trading time.” Activity is not evenly distributed throughout time. Rather, it is episodic and periodically clusters with times of “high drama” and “low drama.”

On occasion, trading is fast. Scores of news items are flitting across the electronic “crawl” on the bottom of the screen. Colleagues are waving and shouting all around. Phones are ringing. Customers are zapping electronic orders. The volume of trades is climbing, and prices are flying by. On such days are fortunes won or lost. Time flies (emphasis added). Then there are the slow times. No news, only tired reports from the in-house financial analysts to chew over. The customers seem to be on holiday. Trading is thin. Prices are quiet. No big money to be made here; might as well go for a long lunch. Time hangs heavy (emphasis added).

Benoit Mandelbrot, The Misbehavior of Markets: A Fractal View of Financial Turbulence

This is consistent with my professional experience. There are times when I’m so busy I don’t eat lunch for days; and others when I could nap all afternoon and not miss a trade. However, I never viewed my activity as a distribution of time as Mandelbrot does. It’s an intriguing application of fractals, to say the least.

… price-changes in a financial market can cluster into zones of high drama and slow evolution.

Benoit Mandelbrot, The Misbehavior of Markets: A Fractal View of Financial Turbulence

Today’s Fast and Slow Markets

There is a lot going on in markets these days. They appear turbulent: The S&P 500, rates, high yield bonds, gold, bitcoin, you name it. Markets are no longer on auto drive. They seem to be moving fast.

Many markets seem to be moving, and fast! Shown above are prices for the S&P 500 (SPX), U.S. treasury bonds (TLT), gold (GLD), US high yield bonds (HYG), emerging markets stocks (EEM), and bitcoin (BTCUSD).

Yet to me, these gyrations feel like they’re happening in slow motion, not a highly active period. Maybe it’s because I’m myopically absorbed in my own investment work, a case of déjà vu, mere market fatigue, or that I’ve been working from a remote location for a month (for a change in scenery). Whatever the cause, these markets don’t seem as turbulent as they appear. Thus, I can’t help but wonder if Mandelbrot’s trading time is at play.

The Integrating Investor’s temporary headquarters last month.

However, the data support my suspicions. As shown in the charts below, historical volatilities of the markets presented don’t suggest this to be a zone of “high drama”, such as last spring. Rather, it seems like we’re in another period of “slow evolution” (and that the mountain air has not corrupted my senses).

While the recent price moves seem turbulent, historical volatilities for these same markets do not screen as notably high.

Advancing Beyond the Bell Curve

Today’s financial theories rest upon the assumption that investment markets behave according to normal distributions. They generally treat conflicting data, such as the presence of “fat tails”, as inconveniences and basically ignore them. However, these occurrences are immensely important to investment returns. Thus, I readily write off much of conventional theory as useful approximations at best and misleading nonsense at worst.

Mandelbrot’s application of fractal geometry to financial markets is fascinating. While beyond my current expertise, it holds promise for advancing investing knowledge beyond the bell curve.

“Trading time” as a non-linear, fractal distribution is another interesting observation of this framework. My experience of today’s turbulent markets as slow-moving is a consistent anecdote. Thus, even our understanding of time may require updating. The implications are potentially huge. Today’s fast-moving markets may not be so high-drama after all. Maybe, they’re just a slow evolution of price—another calm before a forthcoming cluster of market volatility.

David Robertson: Buffett’s Boring Stories Of Glory Days.

Warren Buffett’s view of the glory days as part of the much-awaited letter to shareholders. It provided a typical mix of transparent reporting of business results, dollops of investment wisdom, and occasional witticisms. As usual, it also offered a hearty tribute to entrepreneurialism in the US.

Many of the stories are inspirational reminders of the success that can accrue to hard-working souls in the land of opportunity. However, it is increasingly difficult to square the letter’s optimistic tone with the harsher reality many people face today. Buffett’s letter also smacks of Bruce Springsteen’s less favorable characterization of “trying to recapture a little of the … glory days”.

To be sure, investors read Buffett’s letters because they are informative and insightful for all kinds of investors. Unlike many corporate communications, Buffett does not provide any short-term financial guidance. Instead, he offers general updates to the businesses and includes competitive positioning, strategic advantage, and economic opportunity. As such, the letters are real-time case studies in business analysis by one of the industry’s best.

Another hallmark of Buffett letters is salesmanship. While he rarely misses an opportunity to talk up his businesses’ quality, he is also a diehard fan of the US’s economic landscape. As he describes:

“Since our country’s birth, individuals with an idea, ambition and often just a pittance of capital have succeeded beyond their dreams by creating something new or by improving the customer’s experience with something old.”

Success Stories

Boasting that “Success stories abound throughout America,” Buffett regales readers of several such examples. The stories of See’s Candy, GEICO, National Indemnity, Nebraska Furniture Mart, Clayton Homes, and Pilot Travel Center are all inspirational and plenty enough to get the juices flowing of any would-be entrepreneur.

As wondrous as the stories are, though, there is a character about them that seems not wholly of this world. For one, the stories are old. The companies were founded, respectively, in 1921, 1936, 1940, 1936, 1956, and 1958. In other words, the most recent started over fifty years ago. As a result, the anecdotes come across more as snippets of nostalgia, like sepia-toned photos at a grandparent’s house, than unusually insightful windows into today’s landscape for new business creation.

Similarly, Buffett’s stories don’t feature any technology. Only two of his origin stories predate transformational developments in transistors and semiconductors in the middle of the twentieth century. Given that all five of the largest S&P 500 are tech companies, this is a significant omission. It also makes Buffett’s sample set glaringly unrepresentative of today’s economy since the global economy and the US have become more dependent on knowledge and information.

The set is also unrepresentative in that it fails to capture any meaningful innovation. As the economy has evolved over the years, services have become much more important than goods. Simultaneously, knowledge and information have become more important than tangible things like commodities and manufactured items. As a result, today’s would-be entrepreneurs’ more interesting universe involves innovation and being at the cutting edge of change, not at the commoditized and outdated end.

Opportunities

While there have been plenty of entrepreneurial opportunities in business technology, communications, biotech, alternative energy, and many other areas, there are also new perils. Industry concentration has continued apace, which pits newcomers against increasingly powerful incumbents.

“The protective behavior of such companies, [in the form of acquiring competitors or driving them out of business] has become so transparent as to be labeled the ‘kill zone,'” – The Economist

The net result is an opportunity set for entrepreneurs that is much smaller than it otherwise would be.

As the Economist also reported:

“America’s tech giants have gobbled up competitors and spent lavishly on political donations and lobbying. There is no guarantee that superstars, having achieved dominance, will defend it through innovation and investment rather than anti-competitive behaviour. And even if large platform firms are perfectly efficient, economically speaking, Americans might worry about their influence over communities, social norms and politics.”

Population Problem

Another factor that clouds the skies for would-be entrepreneurs is low population growth. As Jeremy Grantham articulated in the Financial Times:

“We are in a global baby bust of unprecedented proportions … The worldwide fertility rate has already dropped more than 50 percent in the past 50 years, from 5.1 births per woman in 1964 to 2.4 in 2018, according to the World Bank. In 2020, the 20 percent shortfall below replacement rate in US fertility, together with low net immigration, produced the lowest population growth on record of 0.35 percent, below even the flu pandemic of 1918.”

One of the more powerful tailwinds for growth over the years has been healthy population growth. But now, growth is hovering just above zero. Further, as Grantham explains, “Lower population growth directly causes slower economic growth.” As a result, new businesses will not benefit from sustained organic growth to create demand (short-term debt-funded stimulus aside). Instead, growth will have to come by taking a share from incumbents.

The Pandemic

Also, many of the challenges for startups got exacerbated by the pandemic. Restrictions on travel and personal contact created massive headwinds for new businesses trying to get off the ground. Safety protocols increased costs for young companies with low margins. Erratic and inconsistent public policy has been difficult for small businesses to navigate. Further, it often favored large public companies or older companies with established business relationships when help did come.

Finally, a sustained period of economic instability has constrained the population of aspiring entrepreneurs. As Jean M. Twenge describes in her book, iGen, the generation of people born between 1992 and 2012 (aka Gen Z) is well aware of the limited potential for economic success. According to Twenge, iGen is very practical, especially relative to millennials, and is willing to take a job they don’t like to secure a regular paycheck. Economic security ranks as a high priority for them, and as a result, they have much lower expectations for work than those of millennials.

A Different Century

All of this paints a very different picture of entrepreneurial opportunity in the US than the one Buffett describes. To a significant extent, this is a shame because Buffett does provide valuable insights. Indeed, an idea, some hard work, and a little capital can go a long, long way with a determined individual. It is also true that such ideas don’t always have to be complicated; they can include a new creation, but they can also involve simply improving the customer’s experience with something old. These lessons are timeless.

However, the stories Buffett selects also reflect a time, an age, and an economy, which are highly different from today. Partly this speaks to a country that has grown older, as has much of the rest of the world. But it also speaks to public policy that has repeatedly and persistently borrowed from the future. From unaffordable pension plans to excessive debt levels to often erratic and capricious policymaking to regulatory capture by corporations, public policy has slowly but inexorably unleveled the playing field for entrepreneurs.

Conclusion

To a significant extent, one can forgive Buffett for gravitating to business examples from many years ago. We all tend to place disproportionate weight on experiences from more formative years. At 90 years old, those were quite some time ago for Buffett.

To another extent, however, Buffett can be criticized for his selection of entrepreneurial highlights. By drawing exclusively on companies that were founded many decades in the past, he glosses over the many business landscape changes since. In doing so, he does today’s aspiring entrepreneurs something of a disservice by being less than entirely forthright about the contemporary risk/reward calculus for starting a new business. Further, if the message is not relevant, not only will his valuable insights be missed, but they may even come across as just boring stories of glory days.