Monthly Archives: September 2017

In the past month, the U.S. stock market has chopped all over the place while getting nowhere in the end. Many traders have been whipsawed by market’s erratic recent action as they hope for another clear trend to form instead of back and forth reversals. Interestingly, during this time, the S&P 500 has been forming a wedge pattern that indicates that another significant trend is likely ahead once the market breaks out from this pattern (up or down). If the market breaks down from this pattern in a convincing manner, another phase of the sell-off that started in October is likely to occur. On the other hand, a convincing bullish breakout from this pattern would likely indicate that the market will attempt to re-test its September highs.

SP 500

The chart below shows the VIX Volatility Index, which appears to be forming a wedge pattern that may indicate that another big move is ahead. If the VIX breaks out of this pattern in a convincing manner, it would likely lead to even higher volatility and fear (which would correspond with another leg down in the stock market). On the other hand, if the VIX breaks down from this pattern, it could be the sign of a more extended market bounce or Santa Claus rally ahead.


For now, I am watching which way these patterns break out and if the breakouts confirm each other.


Clues from the Fed II, an RIA Pro article from November 28, 2018, provided important insight into one of Jerome Powell’s most important speeches as the Federal Reserve Chairman. We share the article to provide context to this article as well as to demonstrate the benefits of subscribing to RIA Pro.

Since the latter stages of Chairwoman Janet Yellen’s term and including the beginning of Powell’s term, the Fed has been on monetary policy autopilot. As a result of policy actions taken following the financial crisis, the fed funds rate was so far below the rate of inflation and economic growth that they felt comfortable raising rates on a steady basis without much regard for economic, inflationary and financial market dynamics. In Fed parlance, they were not “data dependent.”

Based on Powell’s most recent speech and policy trial balloons floated in the media, the fed funds rate is now much closer to the expected rate of economic growth, therefore it is much closer to what is known as the neutral fed funds rate. As a result, future Fed rate moves are expected to be increasingly influenced by incoming economic data. If true, this change in monetary policy posture is one to which the market is far less accustomed.

Powell’s Abrupt Change

On October 3, 2018, Jerome Powell stated the following: “We may go past neutral. But we’re a long way from neutral at this point, probably”

On November 28, 2018, he said: “Funds rate is just below the broad range of estimates of the level that would be neutral for the economy.”

In less than two months, the Fed Chairman’s perspective about the proximity of the fed funds rate to neutral shifted from a “long way” to “just below.” Clearly, something in Mr. Powell’s assessment shifted radically. We have some thoughts about what it might be, but we decided to canvas the opinions of others first.

We created a Twitter poll to gauge our follower’s thoughts on Powell’s pivot, which came despite very little evidence that economic conditions have meaningfully changed in the interim.

The poll results from over 1,400 respondents are telling. Accordingly, we provide a brief discussion of the respective implications for monetary policy and the stock market.

“Trump persuaded Powell”

President Donald Trump, a self-described “low-interest rate guy”, has been openly displeased with Jerome Powell and the Federal Reserve for raising rates. To wit:

  • CNBC 11/27/2018– Trump told the Post, “So far, I’m not even a little bit happy with my selection of Jay,” whom he appointed earlier this year. The president told the newspaper that he thinks the U.S. central bank is “way off-base with what they’re doing.” — “I’m doing deals and I’m not being accommodated by the Fed,” Trump told the Post. “They’re making a mistake because I have a gut and my gut tells me more sometimes than anybody else’s brain can ever tell me.”
  • WSJ 10/23/2018– “Every time we do something great, he raises the interest rates,” Mr. Trump said, adding that Mr. Powell “almost looks like he’s happy raising interest rates.” The president declined to elaborate, and a spokeswoman for the Fed declined to comment. — Asked an open-ended question about what he viewed as the biggest risks to the economy, Mr. Trump gave a single answer: the Fed.
  • NBC 10/16/2018– “I’m not happy with what he’s doing because it’s going too fast,” Trump said of Powell. “You look at the last inflation numbers, they’re very low.”
  • AP News 10/16/2018 – Stepping up his attacks on the Federal Reserve, President Donald Trump declared Tuesday that the Fed is “my biggest threat” because he thinks it’s raising interest rates too quickly.– Last week, in a series of comments, Trump called the Fed “out of control,”

The Fed is under increasing pressure from the White House to halt interest rate hikes. While we like to think Fed independence means something and the President’s pressure is therefore futile, there is a long history of Presidents taking explicit steps to influence the Fed and alter their actions.

29% of poll respondents believe that Trump’s comments made in the open, and those we are not privy to, are the cause for Powell’s change in tone. If this is the case, it likely means that Powell will shift towards a more dovish monetary policy going forward. This would entail fewer rate hikes and a reduced pace of Fed balance sheet normalization. Since the financial crisis, the precise combination of low interest rates and expanded balance sheet (QE) has proven extremely beneficial for stocks. Looking forward, excessive monetary policy amid a smoothly running economy is a recipe for inflation or other excesses which would not bode well for stocks.

We think this scenario is short-term bullish, but it could easily be diminished by higher interest rates or growing inflationary pressures.

Before moving on, it is important to note that Trump’s remarks above (and many other of his comments) are a first of their kind. This isn’t, because other Presidents haven’t said similar things but because Trump’s comments are in the public for all to see.

Economy Slowing Quickly

Votes that a quickly slowing economy produced Powell’s shift represented 42% of all responses. If correct, this is the worst case scenario for the stock market. Global economic growth is already decelerating as witnessed by the declining GDP growth posted by Germany, Canada, Italy, Japan and Switzerland in the most recent quarter. Further, China, the main engine for global economic growth since the financial crisis, is sputtering.

In addition to the global forces affecting the economy, the growth benefits seen over the last year from a massive surge in fiscal spending and corporate tax cuts are waning. Lastly, higher interest rates are indeed taking their toll on our debt-burdened economy.

It goes without saying that stocks tend to do very poorly during recessions, regardless of whether the Fed is dovish and lowering rates. During the past two recessions, the S&P 500 dropped over 50% despite aggressive interest rate cuts.

We think this scenario is decidedly bearish.

Stock market woke him up

The “Greenspan Put” is a phrase that was used to describe Fed Chairman Alan Greenspan’s preemptive policy moves to save the stock market when it was headed lower. While Greenspan’s name is on the term, it goes back even further. Following the crash of 1929, for instance, the Fed made enormous efforts to halt stock market declines to no avail. In recent years, the Greenspan Put has taken on more significance as Ben Bernanke and Janet Yellen followed in his footsteps and spoken repeatedly about a beneficial wealth effect caused by higher share prices.

In the past, Powell has expressed reservations about the policy measures taken by his predecessors and has openly worried about the risk of high stock valuations and other potential imbalances. He has generally demonstrated less concern for protecting the stock market. With the market falling and the proverbial rubber hitting the road, we are about to find out if a 10% decline from record highs is enough to scare Powell into a dovish stance. If so the Greenspan, Bernanke, Yellen, Powell put is alive and well.

As previously mentioned, there have been several occasions in years past when the market suffered steep declines despite the presence of the Fed Put.

We think this scenario is bullish on the margin, but it may not be enough to save the market.


As judged by the voting, the most likely explanation accounting for Powell’s sudden and aggressive change in tone involves some combination of all three factors. Like most central bankers, he probably believes that he can engineer a “soft landing.” In other words, he can allow the current global and domestic economic pressures to reduce economic growth without causing a recession.

While such a plan sounds ideal, the ability to execute a soft landing has eluded central bankers for decades. Some will say the Fed, by delaying plans for rate hikes and reducing their balance sheet, avoided a hard landing in 2015 and 2016. They may have, but since then global economic and political instabilities have risen markedly. This makes a repeat execution of a soft landing much more difficult. A second concern is that the Fed, with rates still historically very low, does not have enough fire power to engineer a soft landing.

We will continue to pay close attention to the Fed for their reaction to what increasingly looks like a changing economic environment. We also leave you with a reminder that, while the Fed is powerful in igniting or extinguishing economic activity, they are simply one of many factors and quite often throughout their 105-year history they have fallen well short of their goals.

The market is a highly complex global system influenced more by the unseen than by the obvious. Jay Powell, like most of his predecessors who thought they could control market outcomes, apparently suffers from this same critical handicap. Of all the moral hazards the Fed sponsors, their hubris is certainly the most destructive. The stability of the last ten years and the shared perception of Fed control will lead many to forget the sheer panic that occurred only a decade ago.

This past weekend in the NYTimes, Nobel-laureate economist Robert Shiller sounded the alarm on housing again. For those who don’t know, Shiller called the stock market bubble of the late 1990s and the housing bubble of the following decade. He is famous for his house price index and for his method of stock market appraisal called the “Shiller PE,” which judges price relative to past 10-year average real earnings, even if this latter metric comes from the great market analyst Benjamin Graham.

Shiller doesn’t use the word “bubble” in his article, but he argues that since around 2012 we have been experiencing one of the great housing booms in history. And this one is on the heels of the previous great boom and bust. (The third and more benign boom coincided with the great post-war Baby Boom).House prices are now 53% higher than they were in early 2012, meaning they have appreciated at least 7% annualized. Inflation, measured by CPI, since 2012? Less than 2%. That’s a big gain on CPI-adjusted grounds. The excellent graphic below from my colleague, Jesse Colombo, in a Forbes article, tells the price-CPI discrepancy story.

How is it that house prices can surge higher than inflation when median household income is mostly stagnant? Shiller places great importance on the psychological aspects of large price movements. He doesn’t think single economic factors typically tell the story — or the whole story. Therefore, he is skeptical that low interest rates are the primary cause of home price increases. There is some merit to blaming low rates, according to Shiller, and they have been present at the last two bubbles, but rates have actually been going up since 2012, while prices have continued to surge. As Shiller puts it, “The housing market does not react as directly as you might expect to interest rate movements. Over the nearly seven years of the current boom, from February 2012 to the present, all major domestic interest rates have increased, not decreased. So, while interest rates have been low, they have moved the wrong way, yet the boom has continued.”

Another possible explanation is economic growth. But house prices didn’t surge from 1950 through 2000 despite GDP roaring ahead sixfold during that time. And it’s not quite correct either to say prices are normalizing, because they are higher now than at the bubble peak.

Perhaps the home price increases are now a self-fulfilling prophesy, says Shiller. In other words, prices have been going up so people expect them to keep going up. Shiller quotes Keyenes saying, “people seem to have a “simple faith in the conventional basis of valuation.” If the conventional basis is now that home prices are going up 5 percent a year, then sellers, who would otherwise have no idea what to ask for their houses, will just put a price based on this convention. And likewise buyers will not feel they are paying too much if they accept the convention. In the United States, we may believe that the process is all part of the “American dream.”

The price surge can’t go on forever, but Shiller explains that nobody knows when it will stop. All we know now is that prices have surged  as they have only two other times in recorded history. Let buyers and sellers beware. And if you have questions on our views of stock and bond markets, please contact us here.

In this past weekend’s missive, “Stuck In The Middle (Range) With You,” I discussed the view from John Murphy via that the S&P 500 may have more downside to come. To wit:

The daily bars in the chart shows the S&P 500 retesting previous lows formed in late October and late November. And it’s trying to hold there. The shape of the pattern over the past two months, however, isn’t very encouraging. Not only is the SPX trading well below its 200-day average. The two red trendlines containing that recent sideways pattern have the look of a triangular formation (marked by two converging trendlines). Triangles are usually continuation patterns. If that interpretation is correct, technical odds favor recent lows being broken.

If that happens, that would set up a more significant test of the lows formed earlier in the year. Other analysts on this site (besides myself) have also been writing about that possibility. That would lead to a major test of the viability of the market’s long-term uptrend.”

Yesterday, the market opened flattish as concerns over the “Huawei Incident” continue to linger. Via Zerohedge:

“China warned both Canada and the US over Huawei CFO’s arrest, warning of ‘retaliation’ and ‘further action’, with the US countering with ‘hard deadlines’ and concerns of ‘predatory behavior.’)”

But it isn’t just China that is the issue.

“Here’s a non-exhaustive list of potential risk-off drivers hanging over Monday’s open (as succinctly summarized by Bloomberg’s Garfield Reynolds):

  • China summons U.S. Ambassador over the Huawei case
  • Trump Chief of Staff Kelly to leave, amid a welter of fresh Mueller developments
  • China reports weaker trade and inflation data
  • May pushes ahead on Brexit vote despite Cabinet, DUP opposition
  • Soggy U.S. payrolls, though not soggy enough to stop a December Fed hike
  • France protests intensify, raising concerns of economic damage”

The biggest concern currently, from a technical perspective, is the important support levels the markets are currently testing.

Most importantly, the most recent failure at key resistance levels has set the market up to complete the formation of a ‘head and shoulder’ process. This is a topping pattern that would suggest substantially lower asset prices going into 2019 ‘IF,’ and this is a key point, ‘IF’ it completes by breaking the lower ‘neckline.’” 

On Monday, the market did indeed break the “neckline” and successfully tested the 2018 lows. However, since the market rallied back, and closed, above that support level the “break” is not valid. This keeps the current consolidation range intact for now.

While the market was able to hold that level on Monday, the overall market action was very poor. More importantly, as shown in the series of charts below, the technical backdrop is not suggestive of a market which has completed its corrective process as of yet.

The daily Relative Strength Index (RSI) is NOT oversold as of yet despite the market testing recent lows.

Sentiment is not grossly “bearish” yet, either.

This is confirmed by our broad market fear/greed gauge which is the combined reading of AAII, INVI, MarketVane, NAAIM, and the volatility index. Which the greed levels have been reduced, we are not yet at levels which have historically represented more lasting market bottoms.

The broad market. as measured by the S&P 1500 (comprised of large-cap S&P 500, mid-cap S&P 400, and small-cap S&P 600) has currently registered a cross of the 50-dma below the 200-dma which suggests further downward pressure on prices. However, with the high-low percentages plumbing recent “wash out” levels, the potential for a “reflex rally” is highly likely over the next couple of weeks. This is supportive of a “Santa Rally” as we will discuss momentarily.

The advance-decline percentages and volumes are also turning lower which, with the market already at recent lows and on important support, suggests pressure remains to the downside as well.

An important change, and warning, for investors is that unlike the sell-off in February which tested the long-term moving average and traded ABOVE it, which confirms the bullish trend, the major markets are now all trading BELOW that long-term average which is bearish. 

Technically, the backdrop of the market is about as poor as it can get currently. The majority of the shorter-term signals are bearish and longer-term signals are turning lower as well.

It’s Now Or Never For Santa

However, as noted above, with the market oversold, and flirting with important support levels, it is now or never for the traditional “Santa Rally.” As Michael Lebowitz noted last week:

“For this analysis, we studied data from 1990 to current to see if December is a better period to hold stocks than other months. The answer was a resounding ‘YES.’ The 28 Decembers from 1990 to 2017, had an average monthly return of +1.70%. The other 11 months, 308 individual observations over the same time frame, posted an average return of +0.62%.

The following graph shows the monthly returns as well as the maximum and minimum intra-month returns for each December since 1990. It is worth noting that more than a third of the data points have returns that are below the average for the non-December months (+0.62%). Further, if the outsized gains of 2008 and 1991 are excluded, the average for December is +1.05%. While still better than the other months, it is not nearly as impressive as the aggregate 1.70% gain.”

“Next, we analyzed the data to explore if there are periods within December where gains were clustered. The following two graphs show, in orange, aggregate cumulative returns by day count for the 28 Decembers we analyzed. In the first graph, returns are plotted alongside daily aggregated average returns by day. Illustrated in the second graph is the percentage of positive days versus negative days by day count along with returns.”

Here is the important point of that analysis:

IF “Santa” is going to visit “Broad & Wall” this year, it will most likely occur between the 10th through the 17th trading days of the month. Such would equate to Friday, December 14th through Wednesday, December 26th.

As I have discussed previously, with mutual funds finishing up their annual distributions, portfolio managers and hedge funds will likely look to “Stuff Their Stockings” of highly visible positions to have them reflected in year-end statements.

While the current oversold condition is supportive of a rally over the next couple of weeks, that does not mean this is a “stocking” you should shove everything into. Given the overall technical backdrop, any rally may be short-lived going into 2019 unless some of the pressure from weaker economic data, Brexit, Washington politics, “trade wars”, balance sheet reductions, and softer-earnings growth is relieved.

Therefore, here are the rules for the “Santa Rally.”

Rules For “Santa Rally”

If you are long equities in the current market, we continue to recommend following some basic rules of portfolio management.

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

Notice, nothing in there says “sell everything and go to cash.”

Remember, our job as investors is actually pretty simple – protect our investment capital from short-term destruction so we can play the long-term investment game. Here are our thoughts on this.

  • Capital preservation
  • A rate of return sufficient to keep pace with the rate of inflation.
  • Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)
  • Higher rates of return require an exponential increase in the underlying risk profile.  This tends to not work out well.
  • You can replace lost capital – but you can’t replace lost time.  Time is a precious commodity that you cannot afford to waste.
  • Portfolios are time-frame specific. If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

With forward returns likely to be lower and more volatile than what was witnessed over the last decade, the need for a more conservative approach is rising. Controlling risk, reducing emotional investment mistakes and limiting the destruction of investment capital will likely be the real formula for investment success in the decade ahead.

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

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

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

It’s okay to be wrong; it’s unforgivable to stay wrong.” Marty Zweig, (October 16, 1987 Wall Street Week – at six minute and 40 second mark!)

As observed on Wall Street Week 31 years ago by Lou Rukeyser, the Dow Jones Industrial Average “crashed” by more than 230 points in the week ending October 16, 1987 – knocking out all previous records. In the aforementioned video (above) Lou cited a tumbling in Treasury bonds, jitters in the Persian Gulf, an discouraging political situation, scary layoffs on Wall Street and, of course, the mindless computer based (“portfolio insurance”) selling. (Full disclosure I managed some of the family’s wealth while a General Partner at Glickenhaus and Co.)

Sound familiar? It is (as last week’s market dive was also conspicuous in it’s character)!

But the worst was yet to come on the following Monday (October 19, 1987) , when the DJIA dropped by 22% on the day.

As I have often noted history rhymes – though history doesn’t necessarily repeat itself. And (as Benjamin Disraeli reminded us), what we have learned about history is that we have not learned about history.

Beginning early this year I argued that the market was in the process of making an important top. I described a market top and bottom as resembling an ice cream cone – that tops are processes and bottoms are events.

With the benefit of hindsight it is clear that the market’s nine year uptrend and Bull Market have likely been broken.

The question is whether we are entering a full fledged Bear Market.

While I believe we may get some seasonal respite over the next two weeks, I would conclude (with the normal caveats) that we have not only broken the Bull Market uptrend but that the odds are rising that we may be approaching a Bear Market.

At 103 months, we are currently into the second longest Bull Market in modern investment history. (The 1990-2000 Bull Market lasted 110 months). On average, those seven Bull Markets have lasted 76 months. And, on average, the mean decline from the peak of the last six longest Bull Markets has been -51%.

Here are the top ten reasons why we may be entering a Bear Market:

1. Markets Generally Move in Anticipation of a Change in the Rate of Economic and Corporate Profit Growth – That Path and Trajectory Are Deteriorating: Since 1860 there has been at least one recession in each decade – representing 47 recessions since the Articles of Confederation was approved in 1781. We have not yet had a recession in the current decade but, my view is that this decade will not be spared and that we will likely be in a recession in the second half of next year. (See my 15 Surprises for 2019).

2. President Trump is Making Economic Uncertainty and Market Volatility Great Again (#MUVGA). Trump’s more frequent and incendiary twitter utterances and behavior reflects badly on him, his office and our country. His conduct and policy (often seemingly written ad hoc on the back of a napkin) are arguably beginning to adversely impact our markets as his Administration’s dysfunction and policy (conflated with politics), and have begun to reduce business and consumer confidence and is starting to negatively influence the real economy.

We are in a unprecedented politically toxic and divisive backdrop – which was underscored during Wednesday’s funeral for President George H.W. Bush. As my good pal Mike Lewitt (‘The Credit Strategist’) wrote over the weekend,

The saddest thing is not that Bush passed – it was his time – but that his generation is succeeded by a bunch of greedy, narcissistic empty suits.”

This is happening at a point in history where the world has grown more complex, interrelated, networked and flat. With these conditions in place, there are more dominoes today than yesterday and more yesterday than the day before. Again, from Mike,

“The next crisis is approaching and not only is it self-imposed but we are ill-equipped to manage it precisely bc there are few men like George H.W. Bush to lead us.”

a. The United States is leaning more and more “purple” – moving to the Left at a time that the Right is feeling terribly insecure after 10 years of The Screwflation of the Middle Class (something I initially discussed in an editorial I wrote for Barron’s in 2011). The schism between the “haves and have nots” has not been addressed by policy (and has been worsened by the trickling up from the tax bill, which was intended to trickle down and by such provisions as real estate tax and mortgage interest limitations which have served to dent the residential real estate market). Further neglecting or failing to narrow this split will likely have grave social, economic and market ramifications down the road (or sooner).

b. It is becoming increasingly clear that the 2016 election was materially a vote against Hilary Clinton. Trump’s road to nomination in 2020 is growing more precarious and the odds, after barely winning the first time, are not favorable that he wins reelection (given the Wisconsin voting results as well as the outcomes in Michigan and Pennsylvania). It is hard to see markets prospering with Washington D.C. in such a mess – preventing anything from getting done on deficits, debt, taxes, spending and infrastructure.

c. “The Orange Swan” has grown increasingly untethered in the face of divisive and extremely partisan midterm elections (that brought the House under Democratic control), the implicit threats of the Mueller investigation, the hostility of the Kavanaugh hearings, the controversy surrounding the Khashoggi killing, etc. The White House’s dysfunction and repeated personnel changes would be laughable if they weren’t so sad. Most recently, a hardline approach on trade (with China) seems to have tipped over the markets in recent days. Increasingly, short term solutions are being advanced in the face of long term problems. (A classic example is our burgeoning deficit, endorsed by both parties, that is unchecked and is running wild this year).

d. As we are move further from the midterm elections. my core expectation is that the President will likely be impeached by the House. Though there may be far less reasons for Senate Republicans to tie their political futures to such an individual – especially with a plethora of qualified Republican presidential hopefuls – the Senate vote on impeachment could be closer than many expect.

3. A Pivot in Monetary Policy: For years a zero interest rate policy in the U.S. has served to repair the domestic economy as it came out of the Great Recession in 2007-09. Unfortunately it has had second order consequences like pulling forward economic growth – already seen in Peak Housing and Peak Autos. Artificially low rates have served to protect many corporations who have been temporarily resuscitated. Some of those should not have been permitted to survive – and they won’t in the next recession. This served with liberal loan terms (“covenant lite”) could produce a surprisingly steep economic downturn compared to consensus expectations.

4. Economic Growth and Profit Estimates Are Substantially Too High: With U.S. Real GDP forecast to fall back into the +1% to +2% range in 2019’s first half and turning negative in the second half, the contraction in valuations (so apparent thus far in 2018) may continue in 2019. (See my 15 Surprises for 2019). Over there, matters are worse. England has never been more divided (Brexit), Italy (one of the largest economies in the EU) is on the economic deathbed, Deutsche Bank (DB) (and its monstrous derivative book, poor loan quality and systemic money laundering) is the most dangerous financial institution in the world and two of Europe’s most important leaders (Merkel and Macron) are so unpopular that both may be on the way out.

5. The Chinese Challenge to U.S. Hegemony Is a Battle For the Next Century – It Will Likely Be Long Lasting, Disruptive to Current Supply Chains and Costly to Profits: We have likely started a lengthy ‘Cold War in Trade’ with China – a time frame measured in years not (three) months.

6. The Apple Complex (its suppliers) Have Been Upended by a Maturing High-End Smart Phone and Weakening iPhone Market and The Social Media Space is Under Increased and Costly Regulatory Scrutiny: These factors have a broad impact on the market leading technology stocks and for the market as a whole. Moreover, over the last decade technological progress has outpaced regulatory supervision – but this is now being reversed as the social media companies now face the existential threat of rising regulations. The costly imposition of regulatory oversight is something I have been writing about for over a year.

7. An Avalanche of Debt: The private and public sector are levered more than any time in history as, rather than addressing the flaws in our system, we tried to solve the last debt crisis with trillions of dollars of more debt. It is the existence of this mountain of debt that has delivered a fragile economic recovery despite a 2 1/4% Federal Funds rate. Given this, a rate hike of only 25 basis points today has about the same impact of 75 basis points a decade ago. As such that accumulated debt loads are vulnerable to a weakening economy and/or rising interest rates (there have been eight rate hikes since the 2016 election.

8. The Market’s Structure Has Made Equities More Vulnerable Than At Any Time Since October, 1987 (see the Wall Street Week interview from October 16, 1987, above): Passive products and strategies (which are generally agnostic to fundamentals) are the dominant factors in market trading. Like “Portfolio Insurance” 31 years ago, they “buy high and sell low.”

9. With Short Term Interest Rates Now Meaningfully Above the Dividend Yield on the S&P 500 Index – There Is Now an Alternative to Stocks: The dividend yield on the S&P is about 1.8% compared to a one month Treasury note rate of 2.35%, a six month note yield of 2.54% and a one year note yield of 2.68%. Goodbye T.I.N.A. (‘there is no alternative’) to C.I.T.A. (‘cash is the alternative’). In terms of valuations, too many look at Non GAAP earnings (15-16x forward EPS) and ignore the record difference between Non GAAP and GAAP which would move the price earnings ratio to close to 20x. As well price to book, price to sales, market capitalization to GDP and Shiller cyclically adjusted P/E ratio speak (graphic) volumes about the degree of overvaluation today.

10. Technical Damage: Uptrends in place for nearly a decade have been reversed.

More Marty

On a more upbeat note, here is some more wisdom from the legendary Marty Zweig:

  • Patience is one of the most valuable attributes in investing.
  • Big money is made in the stock market by being on the right side of the major moves. The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not.
  • Success means making profits and avoiding losses.
  • Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major decision.
  • The trend is your friend.
  • The problem with most people who play the market is that they are not flexible.
  • Near the top of the market, investors are extraordinarily optimistic because they’ve seen mostly higher prices for a year or two. The sell-offs witnessed during that span were usually brief. Even when they were severe, the market bounced back quickly and always rose to loftier levels. At the top, optimism is king, speculation is running wild, stocks carry high price/earnings ratios and liquidity has evaporated. A small rise in interest rates can easily be the catalyst for triggering a bear market at that point.
  • I measure what’s going on and I adapt to it. I try to get my ego out of the way. The market is smarter than I am so I bend.
  • To me, the “tape” is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!
  • The idea is to buy when the probability is greatest that the market is going to advance.

Bottom Line

“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly.” – Woody Allen

Slowing economic growth, lower than expected profit growth, an untethered President, a dangerous change in market structure (impacting the trading transmission) and the other conditions listed in my Top 10 (above) provide robust headwinds to the U.S. stock market in 2019.

A hugely underappreciated fact is that because of the large accumulated debt loads in the private and public sectors over the last decade, a 25 basis point rate hike today is equivalent to almost a 75 basis point rate hike in 2008. So the eight hikes since the 2016 election is equivalent to almost 24 hikes of the past!

As is often the case in a maturing economic recovery and an extended Bull Market we are now finding out who is swimming naked. That tide is moving out further than at any time since the Generational Low in March, 2009.

Volatility, inversely related to liqudity, has entered a new regime – not seen since the early 2000s – providing a further challenge to investors’ confidence as they have grown unaccustomed to large daily market swings.

The Bull Market uptrend, in place for almost a decade, is now being threatened – investors are underpricing and under appreciating risk.

I am sticking to my baseline expectation that the market has been making an important top since late January, 2018, and that a Bear Market may be imminent.

Indeed, the four decade benign backdrop for financial assets may now be over.

I remain in the 2550-2775 S&P trading range camp over the next month (the Index closed at 2633 on Friday) – implying a slightly positive reward v. risk ratio skew:


There were some positive divergences (e.g., number of NYSE new highs v. new lows) on Friday as well as some other near term positives including the positive RSI and MACD divergences which resemble the 2015 and 2016 lows and show the potential for double bottoms.

While my view is that we might get some seasonal strength in the next few weeks, the upside will likely be limited and could set the stage in 2019 for a far more challenging year than in 2018.

Heed Marty Zweig’s pearls of wisdom (above).

I am.

All of sudden….volatility.

Well, that is what it seems like anyway after several years of a steady grind higher in the markets. However, despite the pickup in volatility, the breaks of previous bullish trends, and a reversal in Central Bank policy, it is still widely believed that bear markets have become a relic of the past.

Now, I am not talking about a 20% correction type bear market. I am talking about a devastating, blood-letting, retirement crushing, “I am never investing again,” type decline of 40%, 50%, or more.

I know. I know.

It’s the “doom-and-gloom” speech to try to scare investors into hiding in cash.

But that is NOT the point of this missive.

While we have been carrying a much higher weighting in cash over the last several months, we also still have a healthy dose of equity related investments.

Why? Because the longer-term trends still remain bullish as shown below. (Note: The market did break the bullish trend with a near 20% correction in 2016, but was bailed out by massive interventions from the ECB, BOE, and BOJ.)

Now, you will note that I keep saying a 20% “correction.” Of course, Wall Street classifies a bear market as a decline of 20% or more. However, as I noted recently:

“During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average. This is shown in the chart below which compares the market to the 75-week moving average. During ‘bullish trends’ the market tends to trade above the long-term moving average and below it during ‘bearish trends.’”

In other words, at least for me, it is the overall TREND of the market which determines a bull or bear market. Currently, that trend is still rising. But such will not always be the case, and we may be in the process of the “trend change” now.

The Collision Of Risks

Of course, after a decade of Central Bank interventions, it has become a commonly held belief the Fed will quickly jump in to forestall a market decline at every turn. While such may have indeed been the case previously, the problem for the Fed is their ability to “bail out” markets in the event of a “credit related” crisis. Take a look at the chart below.

In 2008, when the Fed launched into their “accommodative policy” emergency strategy to bail out the financial markets, the Fed’s balance sheet was only about $915 Billion. The Fed Funds rate was at 4.2%.

If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion dollar balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to “bail out” the markets today, is much more limited than it was in 2008.

But it isn’t just the issue of the Fed’s toolbox. It is the combination of other issues which have all coalesced which present the biggest risk to a substantial decline in the markets.


One of the most important issues overhanging the market is simply that of valuations. As Goldman Sachs pointed out recently, the market is pushing the 89% percentile or higher in 6 out of 7 valuation metrics.

So, just how big of a correction would be required to revert valuations back to long-term means? Michael Lebowitz recently did some analysis for RIA PRO:

“Since 1877 there are 1654 monthly measurements of Cyclically Adjusted Price -to- Earnings (CAPE 10). Of these 82, only about 5%, have been the same or greater than current CAPE levels (30.5). Other than a few instances over the last two years and two others which occurred in 1929, the rest occurred during the late 1990’s tech boom. The graph below charts the percentage of time the market has traded at various ranges of CAPE levels.”

Given that valuations are at 30.5x earnings, and that profit growth tracks closely with economic growth, a reversion in valuations would entail a decline in asset prices from current levels to somewhere between 1350 and 1650 on the S&P (See table below). From the recent market highs, such would entail a 54% to 44% decline respectively. To learn how to use the table below to create your own S&P 500 forecast give RIA Pro a 14-day free trial run.

This also corresponds with the currently elevated “Price to Revenue” levels which are currently higher than at any point in previous market history. Given that the longer-term norm for the S&P 500 price/sales ratio is roughly 1.0, a retreat back towards those levels, as was seen in 2000 and 2008, each required a price decline of 50% or more. 


One of the bigger concerns for the market going forward is the simple function of demographics. Famed demographer, Harry Dent, discussed the impact of the trends within the economy as the mass wave of “baby boomers” become net-distributors from the financial markets (most importantly draining underfunded pension funds) in the future. To wit:

At heart, I’m a cycle guy. Demographics just happens to be the most important cycle in this modern era since the middle class only formed recently — its only been since World War 2 that the everyday person mattered so much; because now they have $50,000-$60,000 in income and can buy homes over 30 years and borrow a lot of money. This was not the case before the Great Depression and World War 2.

And based on demographics, we predicted that the U.S. Baby Boom wouldn’t peak until 2007, and then our economy will weaken — as both did in 2008. We’ve lived off of QE ever since.”

The issue with the demographics is that they have only gotten markedly worse. Furthermore, the strain on pension funds has only mounted as required returns to sustain their viability have failed to appear. As I discussed previously:

“An April 2016 Moody’s analysis pegged the total 75-year unfunded liability for all state and local pension plans at $3.5 trillion. That’s the amount not covered by current fund assets, future expected contributions, and investment returns at assumed rates ranging from 3.7% to 4.1%. Another calculation from the American Enterprise Institute comes up with $5.2 trillion, presuming that long-term bond yields average 2.6%.

With employee contribution requirements extremely low, averaging about 15% of payroll, the need to stretch for higher rates of return have put pensions in a precarious position and increases the underfunded status of pensions.”

“With pension funds already wrestling with largely underfunded liabilities, the shifting demographics are further complicating funding problems.”

George Will summed it up best:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not ‘meddle’ with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.”


Of course, what fuels corrections is not just a change in investor sentiment, but an ignition of the leverage that exists through the extension of debt. Currently, leverage is near the highest levels on record which is the equivalent of a tank of gasoline waiting on a match. As I discussed last week:

“What is immediately recognizable is that reversions of negative ‘free cash’ balances have led to serious implications for the stock market. With negative free cash balances still at historically high levels, a full mean reverting event would coincide with a potentially disastrous decline in asset prices as investors are forced to liquidate holdings to meet ‘margin calls.’”

Of course, the key ingredient is ownership. High valuations, bullish sentiment, and leverage are completely meaningless if there is no ownership of the underlying equities. The two charts below show both household and corporate levels of equity ownership relative to previous points in history.

As can be clearly seen, leverage fuels both halves of the full market cycle. On the way up, increases in leverage provide the capital necessary for accelerated share buybacks and increased speculation in the markets. Leverage, like gasoline, is inert until a catalyst is applied. It is the unwinding of that leverage that accelerates the liquidation of assets in the markets causes prices to plunge faster and further than most can possibly imagine.

It has only happened twice already since the turn of the century, and both reversions of that leverage resulted in 50% declines. Yet, less than a decade from the last crash, with margin debt at near historic records, investors have once again fallen prey to excessive exuberance and the belief that somehow this time will most assuredly be different. 


Another key ingredient to rising asset prices is momentum. As prices rise, demand for rising assets also rises which creates a further demand on a limited supply of assets increasing prices of those assets at a faster pace. Rising momentum is supportive of higher asset prices in the short-term. However, the opposite is also true.

The chart below shows the real price of the S&P 500 index versus its long-term Bollinger-bands, valuations, relative-strength, and its deviation above the 3-year moving average. The red vertical lines show where the peaks in these measures were historically located.

The Fed’s Got It Under Control

This “Utopian” belief of infinite stability within the financial markets is due to ongoing Central Bank interventions and is a most dangerous concept.  This is particularly the case given the structural and economic shifts in the economy due to the rise in debt which has derailed the efficient allocation of capital. As shown below, the economy is currently mired at the lowest average annual growth rate since 1790. (Data courtesy of Measuring Worth)

As a portfolio strategist, what concerns me most is NOT what could cause the markets rise, as we are still somewhat invested, but what could lead to a sharp decline that would negatively impact investment capital.

[Important Note: It is worth remembering that winning the long-term investment game has more to do with avoidance of losses than the capturing of gains. It is a function of math.]

What causes the next correction is always unknown until after the fact. However, there are ample warnings that suggest the current cycle may be closer to its inevitable conclusion than many currently believe. There are many factors that can, and will, contribute to the eventual correction which will “feed” on the unwinding of excessive exuberance, valuations, leverage, and deviations from long-term averages.

The biggest risk to investors currently is the magnitude of the next retracement. As shown below the range of potential reversions runs from 36% to more than 54%.

That can’t happen you say?

It’s happened twice before in the last 20 years and with less debt, less leverage, and better funded pension plans.

More importantly, notice all three previous corrections, including the 2015-2016 correction which was stopped short by Central Banks, all started from deviations above the long-term exponential trend line. The current deviation above that long-term trend is the largest in history which suggests that a mean reversion will be large as well.

It is unlikely that a 50-61.8% correction would happen outside of the onset of a recession. But considering we are already pushing the longest economic growth cycle in modern American history, such a risk which should not be ignored.

There is one important truth that is indisputable, irrefutable, and absolutely undeniable: “mean reversions” are the only constant in the financial markets over time. The problem is that the next “mean reverting” event will remove most, if not all, of the gains investors have made over the last five years.

Still don’t think it can happen?

“Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months.” – Dr. Irving Fisher, Economist at Yale University 1929

When I wrote an article on REITs for the Wall Street Journal in early 2017, I used a research report from Research Affiliates in Newport Beach, CA to argue that the asset class was overpriced and poised to deliver 0%-2% or so real returns for the next decade.

My article sparked a lot of mail and controversy. One reader reply underneath my article on the WSJ website said “Among equity REITs traded on stock exchanges there has literally never been a 10-year period in the history of REIT investing when real total returns averaged 0% per year (or worse) as [John Coumarianos’s] approach predicts.”

Another letter, which the Journal published as a reply to my article, from Brad Case of the National Association of Real Estate Investment Trusts (NAREIT) strangely had the exact same language about REITs never producing such a poor 10-year return as the letter written by someone of another name under the column on the website. Case’s formal, published letter went on to say, “The current REIT stock price discount to net asset value suggests that returns over the next 10 years may exceed inflation by around 8.15 percentage points per year on average.”

The decade isn’t up, but now, two years in, let’s see how things are going for REITs. Also, what’s the forecast today? Have things improved? After we assess recent returns, let’s go through the forecast again to see if things look any better now.

Not A Great Two Years For REITs

In 2017, two major REIT index funds – the Vanguard REIT Index fund and the iShares Cohen & Steers REIT Index ETF — produced a nearly 5% return each.  Considering that the CPI (consumer price index) was up 2.1% in 2017, that’s about a 3% real or inflation-adjusted return.

In 2018, the iShares fund delivered a 5.29% return through October, while the Vanguard fund delivered a 2.03% return through October. So far inflation is running at an estimated 2.2% for the year, according to the Minneapolis Fed. That means REIT real returns for 2018 are in the 0%-3% range, depending on which index you use. For both 2017 and 2018, we are a far cry from Case’s 8.15% real return forecast.

Start With Dividend Yield

The analysis advocated by Research Affiliates was simple. First, start with “net operating income” (NOI) or rent minus basic expenses. NOI a good indication of the cash flow a property or a collection of properties are delivering. Investors take this number and divide by the price of a property to determine what they call a “capitalization rate.” In effect, that resembles an earnings yield (earnings divided by price) of a stock. Mutual fund investors can substitute dividend yield of a REIT-dedicated fund.

For my original article, the dividend yield of most REIT index funds and ETFs was around 4%. Now it’s closer to 3%. The iShares Cohen & Steers REIT ETF yields less than 3.2% right now, while the Vanguard REIT Index fund lists a current effective yield of 3.23% and a yield adjusted for return of capital and capital gain distributions over the past two years at 2.13%.


The second component of a return forecast is a property upkeep component. Real estate requires capital – not only for the initial purchase, but also for maintaining the property. Things are always breaking and obsolescence always threatens landlords who must update kitchens, bathrooms, and other aspects of their properties. It’s true that with some property types, tenants are responsible for some upkeep and improvement, but that isn’t always the case. Research Affiliates figures 2% of the cost of the property per year, is a decent round number to use in a return forecast. Unfortunately, that wipes out most of the 3% dividend yield investors are currently pocketing.

So far, we are running at a 0 or 1% real annualized return for the next decade.

Price Change

The last component of real estate valuation and return forecasting is the most speculative. Where will properties trade in a decade? Nobody knows for sure, but Research Affiliates estimated in early 2017 that commercial property was priced 20% above its long term trend. If prices remained at that level, investors would capture the 4% yield minus the 2% annual upkeep or 2% overall. If prices reverted to trend, investors would have to subtract enough from net operating income adjusted for upkeep to bring future returns down to 1.4%.

Currently on the Research Affiliates website, the firm forecasts REITs to deliver a 2% annualized real return for the next decade. That’s about where the forecast stood at the beginning of 2017. It’s worth noting that although that’s a low return, it’s actually a better forecast than the firm has for U.S. stocks, which it thinks won’t deliver any return over inflation for the next decade.

Gut Check

It’s often useful to take multiple stabs at valuation. So, in the spirit of providing a gut check, I supplemented this dividend-upkeep-price analysis with a simple Price/FFO (funds from operations) analysis. REITs have large, unrealistic depreciation charges, rendering net income a mostly useless metric. FFO, which adjusts net income for property sales and depreciation is a more accurate cash flow metric. FFO isn’t perfect either because it doesn’t account for different debt loads of different companies and because it doesn’t account for maintenance costs, but it’s a uniform metric that almost all REITs publish.

Of the top-20 holdings of the Vanguard Real Estate Index fund VGSIX, Weyerhaeuser and CBRE didn’t publish FFO metrics. The average of the other 18 companies was 20. That’s a pretty high multiple for REITs, which are slow growth stocks.

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Stuck In The Middle (Range) With You

On Tuesday, I asked the question as to whether the “bull is back” or “is it a bull trap?” This question was triggered by the outsized advance on Monday on hopes the “trade war” had been at least temporarily resolved at the G-20 summit:

“The good news is that on Monday the market cleared the 50- and 200-day moving averages. This was an important level of overhead resistance the market needed to clear to get back onto more bullish footing. However, in order for that break to be validated, it must hold through the end of the trading week.”

Unfortunately, the bulls quickly lost that foothold on Tuesday as the markets tumbled wiping out not only all of Trump’s “trade truce” gain, but “Powell’s Put” gain as well. Then on Thursday, news the CFO of Huawei had been arrested sent shock waves through the market which sent the Dow plunging nearly 800 points. The only saving grace was when a Fed official was trotted out to suggest the Fed was likely going to pause rate hikes. But, on Friday, weaker employment, confidence, and wage growth numbers sent the markets back to their lows once again.

Also, while it is has been widely suggested to dismiss the negative crossover of the 50- and 200-dma moving averages (red circle), what it represents is mounting downward pressure on stock prices currently.

However, for all of the volatility, the market has not made any real progress since October as the “bulls” and “bears” continue to fight it out in a broad trading range as shown below. While the lower support is currently holding at 2632ish, a failure of the that low will quickly lead to a retest of lows from March and April of this year.

So far, the consolidation of the market has continued to give supports to bulls case as sentiment has gotten very negative during this time. However, as I noted on Tuesday for our RIA PRO subscribers:

“Most importantly, the most recent failure at key resistance levels has set the market up to complete the formation of a ‘head and shoulder’ process. This is a topping pattern that would suggest substantially lower asset prices going into 2019IF,’ and this is a key point, ‘IF’ it completes by breaking the lower ‘neckline.’” 

Chart updated through Friday

John Murphy via confirmed the risk to prices as well on Friday:


The daily bars in the chart shows the S&P 500 retesting previous lows formed in late October and late November. And it’s trying to hold there. The shape of the pattern over the past two months, however, isn’t very encouraging. Not only is the SPX trading well below its 200-day average. The two red trendlines containing that recent sideways pattern have the look of a triangular formation (marked by two converging trendlines). Triangles are usually continuation patterns. If that interpretation is correct, technical odds favor recent lows being broken.

If that happens, that would set up a more significant test of the lows formed earlier in the year. Other analysts on this site (besides myself) have also been writing about that possibility. That would lead to a major test of the viability of the market’s long-term uptrend.”

Also, note that the lower MACD is close to registering a “sell signal” which would likely coincide with further weakness in asset prices.

Is there any hope a bigger decline can be averted? Absolutely.

The recent market turmoil, which threatens both consumer confidence and the household wealth effect, has shaken the Fed from their “hawkish” position. In the next few days, the market will be analyzing Jerome Powell’s latest message as the Fed hikes rates 0.25% in December. If the language of the announcement becomes substantially more “dovish,” and signals no more hikes into 2019, the markets will initially rally sharply on the news. However, given that a Fed pause at 2.5% would signal much slower economic growth, it will likely only be a temporary boost until weaker earnings are realized from slower economic growth.

The other potential opportunity is for the current Administration to drop the “trade war” rhetoric. Given that Trump created the “trade problem” to begin with, even small gestures of trade improvement between the U.S. and China would be counted as a “Trumpian victory.” However, a reversal or reduction of the tariffs would be a boost to corporate earnings and provide a boost of confidence to corporations.

Again, as with the Fed funds rates, the reduction of tariffs would most likely only provide a short-term boost to asset prices. Eventually, the focus of the markets will turn back to earnings and economic growth which are going to slow as previous boosts from natural disasters and tax cuts fade. 

However, that is in the future.

For now, we have to deal with what “IS,” and the weakness of the market is very concerning.

After having reduced equity risk a couple of weeks ago, we are looking for opportunities as they present themselves. However, for the most part, our bond positions have continued to carry the bulk of the load as of late as rates continue to drop.

As I noted on Friday, don’t dismiss the yield curve too quickly. But like our technical indicators below, we are looking for confirmation of several curves to go negative simultaneously which has historically provided the clearest signal of a recessionary onset.

Daily View

Last week I stated:

“The rally over the past few days has virtually exhausted a bulk of the ‘oversold’ condition which previously existed. While such doesn’t mean the market can’t move higher, it simply suggests that most of the ‘fuel’ available for a rally has been utilized. With the markets still on a “sell signal” currently, and below major points of resistance, remaining a bit cautious until the underlying technical backdrop improves seems prudent.”

That turned out to be very good advice as the market retested lows once again. With the market back to “oversold” conditions (what a difference a week can make) all the market needs is any bit of “good news” to bounce. However, as noted above, with the markets sitting on major support, a rally this coming week is critical. We suggest using the rally to sell into currently to rebalance risk in portfolios.

Action: After reducing exposure in portfolios previously, and portfolios much heavier in cash currently, we are giving the market time to figure out what it wants to do. Given the consolidation range over the last couple of months, it is too risky to be either overly short or aggressively long currently. Cash is the best hedge currently. 

Weekly View

On a weekly basis, the story remains much the same. With a sell signal registered for only the 7th time in the past two decades, we will just allow the markets to figure out what they want to do before getting more aggressive. The recent violations of long-term moving averages suggest a change in market conditions that should not be dismissed. However, should the market improve, and ultimately reverse the relative “sell signals,” we will gladly increase exposure back to target weights.

Action: Hold higher levels of cash and rebalance risk as necessary on this rally.

Monthly View

Like the daily and weekly analysis above, the market has confirmed a “sell signal” on a monthly basis as well. The good news here is that the long-term moving average, which is a critical level of bullish trend support, has NOT been violated as of yet. This suggests the longer-term bullish trend remains intact and we should not get overly conservative just yet.

Nonetheless, the deterioration in the markets is extremely concerning, and while the official “bull market” is not dead as of yet, there are more than enough warnings which suggest erring to the side of caution, for now, is warranted.

Action: Use any rally to reduce risk and rebalance portfolios accordingly. 

As always, we will keep you apprised of what we are thinking.

You can also follow our actual portfolio models and positioning at RIA PRO.

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

S&P 500 Tear Sheet

Performance Analysis

ETF Model Relative Performance Analysis

Sector & Market Analysis:


Discretionary and Technology The brief rally back above declining 50- and 200-dma averages failed last week confirming the continuing downtrend in these two sectors in particular. After having sold our positions previously, we will continue to sit on our hands until the current correction is complete. While not grossly oversold yet, I would suspect we could see a sellable short-term bounce next week.

Industrials, Materials, Energy, Financials, Communications – we are currently out of all of these sectors as the technical backdrop is much more bearish. With all of these sectors below their respective 50- and 200-dma’s, the downside pressure remains on for these sectors for now. The ongoing “trade war” and flattening yield curve is weighing on the outlook for these sectors. If you choose to be long these sectors it is advisable to reduce weightings markedly on rallies. As I have stated repeatedly over the last several months:

“Industrials, Materials, and Energy are representative of the broader economic activity in the U.S. and currently suggests we are seeing weakness on the horizon.”

Real Estate, Staples, Healthcare, and Utilities continue to be bright spots as “defensive” sectors. A warning, these are NOT safe sectors, they are defensive plays in a bull market. In a bear market, they will decline with the rest of the market, maybe just not as much. However, the dividend chase over the last several years has pushed valuations to extremes. We continue to remain long staples and healthcare specifically but the sell-off last week pushed both below their 50-dma. .Trends are still positive which may provide an opportunity to add to these sectors so we will re-evaluate again next week.

Small-Cap and Mid Cap – both of these markets are currently on macro-sell signals and the recent rally in both markets failed to get above technical resistance. As I noted last week:

“More importantly, the previous oversold condition is now gone and suggests lower prices are coming. Like Industrials and Materials above, Small and Mid-cap stocks are very economically sensitive and suggests a much weaker backdrop going into 2019. We remain out of these markets for now.”

Both of these markets are once again oversold. Small-caps broke their recent lows last week and Mid-caps are not far behind. As noted, we are out of these markets currently.

Emerging and International Markets – As noted last week:

“Emerging markets broke above its downward trending 50-dma last week and showed some signs of life. We have seen this before which ultimately led to lower lows.”

As suspected, emerging markets failed to hold above the 50-dma last week and is threatening to break the recent series of higher bottoms. A move lower next week is possible.

International markets still look terrible and no improvement is being made there just yet. With major sell signals in place currently, there is still no compelling reason to add either of these markets to portfolios at this time. 

Dividends, Market, and Equal Weight – Not surprisingly, given the rotation to “defensive” positioning in the market, dividend-based S&P Index is outperforming other weighting structures. All three sold off last week as downward pressure was broad-based across all sectors. The overall market dynamic remains negative for now and important supports are being tested.

Gold – As we noted last week, while Gold remains in a downtrend, the good news is the price continues to hug along the 50-dma which has turned up. This market volatility this past week, gave gold the boost it needs to make a run for the declining 200-dma. With Gold very overbought short-term look for a pullback next week to the $115-116 area to add trading positions to portfolios with a tight stop at $112.

Bonds – continued to perform better last week and after a successful retest of the 50-dma have turned higher and broke above the 200-dma. Currently, bonds are very overbought which likely suggests a pullback is coming which would coincide with a rally in the stock market. However, such a pullback will likely provide a good buying opportunity as evidence of broader economic weakness continues to mount. We remain long our core bond holdings for capital preservation purposes and will look for a trading opportunity which does not violate the 200-dma.

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

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

Portfolio/Client Update:

As noted last week, the market action remains troubling, to say the least. The bullish trend longer-term remains intact, but more bearish dynamics continue to mount. We continue to sit on our hands with current positions and overweights in both cash and fixed income.

With the longer-term bullish trend intact, and multiple supports at current levels, it is not yet viable to short the broader market. That time will come, but shorting has capital risk just like being long. Given the recent uncertainty of the market, the best “hedge” remains cash for now.

While we expect a rally next week from short-term oversold conditions, we will remain on hold with any actions.

  • New clients: We will continue to hold existing positions and sell “out of model” holdings on rallies.
  • Equity Model: We will continue to hold current positions which are mostly 1/2 weights. Stops have been dramatically tightened up. 
  • Equity/ETF blended – Same as with the equity model. 
  • ETF Model: We will hold current holdings for now.

Again, we are moving cautiously. There is mounting evidence of short to intermediate-term risk of which we are very aware. However, with the market moving into the seasonally strong period of the year, we realize that short-term performance is just as important as the long-term. It is always a challenge to marry both.

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


The Real 401k Plan Manager – A Conservative Strategy For Long-Term Investors

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


Sit Tight, The Bear Is Still Prowling

Two week’s ago, I said it was critically important for the market to rally if the bulls were going to regain control of the market. The bulls tried and rallied the market back above the 50- and 200-dma. But that was all they could do and last week, the markets fell apart retesting recent lows.

Once again, it is critically important for the “bulls” to try and rally the market next week. As I noted last week:

“It is important to recognize that markets are generally optimistically biased and looks for ‘reasons’ to rally regardless of whether there is real ‘merit’ to it.”

With the Fed on deck on the 18th and 19th, look for more “trial balloons” next week about potential policy of stopping rate hikes. Also, it would not surprise me to start to hear more commentary from Washington about backing off some of the “trade rhetoric” with China.

Any of this would like push markets higher from deeply oversold conditions.

Given the markets remain extremely range bound, we are maintaining our current weightings in our 401k plans for now until we get confirmation about what the markets want to do next. However, with confirmed “sell signals” in place, defense remains our primary strategy for 401k-plans currently.

Continue to use rallies to reduce risk towards a target level with which you are comfortable. Remember, this model is not ABSOLUTE – it is just a guide to follow. 

  • If you are overweight equities – reduce international, emerging market, mid, and small-capitalization funds on any rally next week. Reduce overall portfolio weights to 75% of your selected allocation target.
  • If you are underweight equities – reduce international, emerging market, mid, and small-capitalization funds on any rally next week but hold everything else for now.
  • If you are at target equity allocations hold for now.

Unfortunately, 401k plans don’t offer a lot of flexibility and have trading restrictions in many cases. Therefore, we have to minimize our movement and try and make sure we are catching major turning points. Over the next couple of weeks, we will know for certain as to whether more changes need to be done to allocations as we head into the end of the year.

If you need help after reading the alert; don’t hesitate to contact me.

Current 401-k Allocation Model

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

401k Choice Matching List

The list below shows sample 401k plan funds for each major category. In reality, the majority of funds all track their indices fairly closely. Therefore, if you don’t see your exact fund listed, look for a fund that is similar in nature.


The price depreciation of risky assets in the financial markets continued through most of November but took a breather late in the month. The rebound in the final week provided for month-end to month-end optics that were otherwise better than what one might expect had they been watching markets transpire day-to-day.

Performance across the fixed-income sector was reflective of the recent challenges that extended into November. The list of issues included the sell-off of General Electric stock and bonds, Brexit uncertainty and the devastation and financial uncertainty associated with the California wildfires. The market reaction to these events has been justifiably imposing and leaves investors to consider the anxiety-inducing potential for contagion risk.

Money flowed into the safety of Treasuries, mortgages and municipal securities (Munis) and out of corporate bonds and emerging market bonds. As for year-to-date performance, only munis and high-yield corporate bonds are positive at this point, and in both cases, just barely.  All other sectors are negative.

ETFs performed similarly but the Muni bond ETF, unlike the index, is now negative on a year-to-date basis. Somewhat surprisingly and concerning, the emerging market ETF (EMB) is down almost twice the index (-7.24% vs. -3.79%) on a year-to-date basis.

Corporate credit spreads widened meaningfully in November largely offsetting the decline in Treasury yields. Investors appear to be contemplating an imminent slowdown in corporate earnings growth and the associated rating implications. This will be an important story to follow given the large percentage of companies that are BBB, and near junk status. The decline in crude oil prices, down -33% from the early October high, among other languishing commodities raises further concerns about a broader global growth slowdown.

Looking in detail at high yield sector spreads, the best junk rating (BB) widened only modestly (+85 bps) off recent tight levels while the worst rating (CCC) widened substantially (+255 bps).

Considering the drop in the price of crude oil in recent months, an evaluation of the relationship between high yield spreads and oil prices is informative and troubling. As shown in the chart below, crude oil prices below $50 over the past four years are associated with significantly wider high yield spreads.

Finally, there has been a lot of recent discussion about various yield curves beginning to invert. In U.S. Treasuries, the 2y-3y part of the curve is now imperceptibly positive (less than 1 basis point), and the 2y-5y curve is slightly negative. Treasury yields and various curves are highlighted below.

In recent history, an inverted yield curve has implied the eventuality of a recession. Based on the financial media and research from Wall Street, the current yield curve trends are becoming worrisome for investors. While there are good reasons for an economy so dependent on activities associated with borrowing and lending to succumb to an inverted curve, the anxiety being projected is probably more troubling at this stage than the early phase of this event. It is important to watch but should not be a major concern just yet.

Given the volatility in stocks and other risky assets in the early days of December, it remains unclear whether investors should count on the traditional healthy seasonal performance to which they have become accustomed. Uncertainties about the economic and geopolitical outlook loom large, urging a cautious approach and defensive posture in the fixed-income sector. Safer sectors, such as Treasuries, MBS and munis might continue to benefit if recent market turmoil continues.

Data source: Barclays

So, have you heard the one about the “flattening yield curve?”

It almost sounds like the start of a bad joke because there have been so many discussions during this past year on it. However, it has been largely dismissed under the “this time is different” scenario as trailing economic data has remained strong and the recent stock market struggles are believed to only be temporary.

As I discussed yesterday, however, it is quite likely the message being sent by the bond market should not be dismissed. Bonds are important for their predictive qualities which is why analysts pay an enormous amount of attention to U.S. government bonds, specifically to the difference in their interest rates. This data has a high historical correlation to where the economy, stock, and bond markets are generally headed in the longer-term. This is because volatile oil prices, trade tensions, political uncertainty, the strength of the dollar, credit risk, earnings strength, etc., all of which gets reflected in the bond market and, ultimately, the yield curve.

But which yield curve really matters?

It depends on whom you ask?

“The rate on the 2-year has already jumped above the shorter-term 5-year note, a move that suggests the ‘economy is poised to weaken,’ DoubleLine Capital’s Jeffrey Gundlach told Reuters in an interview on Tuesday. Gundlach, a noted bond investor, has been warning investors to be cautious.” – CNBC

“Michael Darda, the chief economist at MKM Partners, says people may be too focused on the wrong data. ‘Recession forecasting is fraught with difficulty, so it’s important that we don’t make it more difficult than it has to be by focusing on the wrong indicators, or, at a minimum, less reliable one. It is the difference between the 10-year and the 1-year that everyone should worry about.” – CNBC

“While inversions have been reliable recession indicators in the past, the most important relationship — between the 3-month and 10-year government notes — is not inverted and thus hasn’t triggered the likelihood of a contraction ahead.” – CNBC

Wait, so which is it?

My answer is a bit different. When I am looking at technical indicators for the market it is not just “one” signal I am looking at, but several. The reason is that sometimes a single indicator can provide a “false” signal.

For example, the 200-dma has had several violations which did NOT lead to bigger declines. Therefore, there have been numerous articles questioning the efficacy of that moving average as an indicator. However, if you combine the 200-dma with a couple of other indicators to “confirm” the signal being sent, then some of the false readings can be removed.

This same premise applies to the yield curve.

While the 3-5 yield spread is currently in negative territory, it has not been confirmed by other yield spreads across the spectrum. As shown in the chart below, the best signals of a recessionary onset have occurred when a bulk of the yield spreads have gone negative simultaneously. However, even then, it was several months before the economy actually slipped into recession.

However, as I addressed previously, as with all measures, technical or otherwise, it is the trend of the data which is more important to your outlook than the actual number itself.

It is correct that the longer-dated yield curve has not turned negative as of yet.  However, the market is already beginning to adjust to the reality the economy is beginning to weaken, earnings are at risk, valuations are elevated, and the support from Central Banks has now reversed.

So, which one am I watching?

All of them. 

Just something to think about as you catch up on your weekend reading list.

Economy & Fed


Most Read On RIA


Research / Interesting Reads

“Successful investing is anticipating the anticipation of others. – John Maynard Keynes

Questions, comments, suggestions – please email me.

Quite often, our articles follow a similar format. We start with a “hook” to grab your interest and then offer a summary of what’s to come. Next comes the meat of the article, with data, graphs and a discussion that supports our view on the subject matter. Our closing summary typically encapsulates the main takeaways along with investment implications if applicable. A quote or two along the way never hurts.

In this article, we take a different tack. We present and analyze the factors that drove the bull market to record highs over the last nine years. It is these same factors that will also determine where the market will head in the coming years. However, instead of stating our opinions and giving a market forecast, we leave that to you. This approach will not only allow you to estimate the future price of the S&P 500, but importantly prove valuable in helping you understand the forces that drive market prices.

Foundations of the Bull

Valuing a stock or an index may seem complex, but there are only two factors that account for the price and its performance – estimates of a corporation’s future cash flows and the factor, or multiple, investors are willing to pay for those cash flows. While this does not occur neatly in a program or spreadsheet as the description might imply, the performance of every stock and index can be decomposed into those simple pieces.

With that in mind, we turn to the current U.S. equity bull market which started in the shadow of the financial crisis of 2008/09. The 315% rally, which might celebrate its tenth anniversary in March of 2019, is the longest uninterrupted equity expansion in modern U.S. history. Given the extended duration of this rally, it is more important than ever to look forward and not assume yesterday gains will continue tomorrow.

The following two sections look at corporate cash flows and valuation multiple trends on the S&P 500. This historical attribution analysis offers context and perspective about how those trends may or may not change going forward and ultimately what that means for the price of the index.

Cash Flows

Corporate cash flows that accrue to investors should be dissected into two components, revenues (sales) and profit margins.

Not surprisingly, corporate revenues are highly correlated with economic growth. Since 2010, aggregate revenues of the S&P 500 grew by 35.7%, while GDP grew by a similar 38.6%. The graph below shows the tight correlation. Historical observations going back decades further support this data.

Data Courtesy Bloomberg

Given the recent and longer-term correlation, it is sensible to assume that expectations for future economic growth, or GDP, are a solid proxy for future revenue growth.

The following graph of the long-term trend of GDP provides guidance for future revenue expectations. As we have written all too often, demographics, the increasing debt burden, and declining productivity growth will continue to impose a heavy and growing toll on economic growth. That does not mean there will not be periods of stronger than average growth, but we believe the 30-year trend lower is intact.

Data Courtesy Bloomberg

Revenue is only half of the cash flow story. Net earnings, which is what investors are ultimately paying for, account for all of the expenses required to produce revenue. Net earnings as a percent of revenues, better known as profit margin, is the common metric used to express this.

Aggregate profit margins historically vacillate above and below the historical average, but they have always been mean reverting.  To wit, here is the wisdom of an investing legend:

The following graphs provide historical context on profit margins over the last two and seven decades respectively.

Data Courtesy Bloomberg and St. Louis Federal Reserve

In both graphs, the profit margin post-financial crisis is at or near all-time highs and has failed to regress to the mean despite the wisdom of Jeremy Grantham.

While not an extensive list, consider the following chief factors responsible for elevated profit margins:

  • Lowest interest rates in recorded history
  • Minimal wage growth
  • Low input costs
  • Unchanged shipping, trucking, and freight costs

Review the following table of major corporate expenses to understand current margins and formulate expectations for future ones. The table compares some key proxies for expenses over the last year versus the prior three years.

Data Courtesy Bloomberg

Two aspects of corporate expenses omitted from the table are taxes and tariffs. Recent tax reform boosted margins and helped more than offset the negative effects of the rise in costs shown above. The consequences of the on-going “trade war” are yet to be seen, but they are likely negative.

Valuation Multiple

Since 1877 there are 1654 monthly measurements of Cyclically Adjusted Price -to- Earnings (CAPE 10). Of these 82, only about 5%, have been the same or greater than current CAPE levels (30.5). Other than a few instances over the last two years and two others which occurred in 1929, the rest occurred during the late 1990’s tech boom. The graph below charts the percentage of time the market has traded at various ranges of CAPE levels.

Data Courtesy Shiller

Valuations are a function of investor sentiment. When sentiment is exuberant, as it has been recently, investors are willing to pay more for a series of cash flows in expectations that revenue and earnings will rise at a heady rate in the future. Conversely, when investors are concerned about future earnings and economic growth, valuations tend to decline.

Looking back, there are many factors that drove investors to pay a higher multiple for cash flows over the last ten years. Consider a few:

Historically Low-interest rates

  • Lower discounting rates made the value of future earnings higher.
  • Resulted in a push towards higher returning, riskier, longer duration securities like equities and long maturity bonds.

Heavy Monetary Stimulus

  • Record low-interest rates and burgeoning central bank holdings of financial assets here and abroad.

Corporate Share Repurchases

  • Since 2013, S&P 500 companies have annually bought back 3% of their outstanding shares in aggregate.

Margin debt

  • Since 2012, net credit balances have been larger than those seen before the market drawdowns of 2000 and 2008.
  • Currently, balances are 3x larger than any peak seen in at least the last 36 years.

The proliferation of passive investment strategies which tend to ignore valuations

The expansion of corporate leverage to record highs nominally and as a percent of GDP

To that list we submit one important factor – inflation. The following graph demonstrates that valuations have only been well above the norm during periods when annual inflation is running between one and four percent. Outside of the “sweet spot,” CAPE valuations tend to peak about 25-30% lower than current levels.

Data Courtesy Shiller

How The Market Got Here

With an understanding of the factors that account for price performance since 2010, we now turn to the graphs below which decompose the gains of the last eight years into the components: revenue growth, profit margin expansion, and valuation expansion.

As shown, durable organic growth only accounted for 26.96% of the gains in the S&P 500 index since 2010. In other words, without multiple and margin expansion, the S&P 500 would stand at 1587, a far cry from the current 2790.

DIY- Forecasting the S&P 500

Now we let you forecast where the S&P 500 might be headed over the next five years based on your expectations for revenue, profit margins, and valuations. To formulate a personalized forecast, you will need to complete a two-step process. First, answer the three questions below. Next, feed your answers into one of three tables provided below. The result will be your forecast.  To help with answering questions two and three below, we provide current levels along with minimum, average, and maximum historical levels. We also urge you to go back and consider the graphs and factors that drove recent trends.

  1. How much will GDP, and therefore corporate revenues grow over the next five years?
  2. Will margins stay at current levels, expand further or contract back to or below historical norms?
  3. Will valuations stay at current levels, expand further or contract back to or below historical norms?

Once the questions are answered, the data can be used to generate a forecast. The example below offers a guide to the process. In the example shown, the question responses are that GDP growth will average 1% a year for the next five years, and that profit margins and valuations will stay the same for five years. The resulting output of 2838, as highlighted, is the expected value of the S&P 500 in five years.

Choosing among the three tables below is based on your forecast for future economic growth: low 1%, average 3% or high 5%. Once you select the appropriate table, find your expected profit margin for five years from now on the horizontal axis at the top and your estimate for CAPE valuations on the vertical axis on the left. The estimate for the future level of the S&P 500 lies at the intersection of the two forecasts.


The framework described above can be used for something as simple as finding one answer as we did in the example, but it also allows an investor to conduct scenario analysis to arrive at a range of possibilities. By assigning various probabilities to one, two or all variables, one can calculate a weighted average outcome. For example, hold CAPE and Profit Margin constant and assign a 30% probability to 1% GDP growth, 60% probability to 3% growth and 10% probability to 5% growth. Repeating that process produces a range of answers which could effectively be used to gauge risk versus return.

Although relatively simple in its construction, the ability to customize your forecast and apply multiple scenarios is a powerful risk management tool.


Last week, I discussed the recent message from Fed Chairman Jerome Powell which sent the markets surging higher.

“During his speech, Powell took to a different tone than seen previously and specifically when he stated that current rates are ‘just below’ the range of estimates for a ‘neutral rate.’ This is a sharply different tone than seen previously when he suggested that a “neutral rate” was still a long way off.

Importantly, while the market surged higher after the comments on the suggestion the Fed was close to ‘being done’ hiking rates, it also suggests the outlook for inflation and economic growth has fallen. With the Fed Funds rate running at near 2%, if the Fed now believes such is close to a ‘neutral rate,’ it would suggest that expectations of economic growth will slow in the quarters ahead from nearly 6.0% in Q2 of 2018 to roughly 2.5% in 2019.”

Since then, the bond market has picked up on that realization as the yield has flattened considerably over the last few days as the 10-year interest rate broke back below the 3% mark. The chart below shows the difference between the 2-year and the 10-year interest rate.

Now, there are many who continue to suggest “this time is different” and an inverted yield curve is not signaling a recession, and Jerome Powell’s recent comments are “in line” with a “Goldilocks economy.”


But historically speaking, while an inversion of the yield curve may not “immediately” coincide with a recessionary onset, given its relationship to economic activity it is likely a “foolish bet” to suggest it won’t. A quick trip though the Fed’s rate hiking history and “soft landing” scenarios give you some clue as to their success.

While the Fed has been acting on previously strong inflationary data due to surging oil prices, the real long-term drivers of inflation pressures weren’t present. I have commented on this previously, but Kevin Giddis from Raymond James had a good note on this:

“We have always known that the bond market wasn’t as worried about inflation as the Fed, but it really needed the Fed to come out and indicate a ‘shift’ in that way of thought to seal the deal.”

This is exactly correct, and despite the many arguments to the contrary we have repeatedly stated the rise in interest rates was a temporary phenomenon as “rates impact real economic activity.” The “real economy,” due to a surge in debt-financed activity, was not nearly strong enough to withstand substantially higher rates. Of course, such has become readily apparent in the recent housing and auto sales data.

Flat As A Pancake

All of sudden, the bond market has woken up to reality after a year-long slumber. The current spread between the 2-year note and the 10-year note is as tight as it has been in many years and has rarely occurred when the economic fundamentals were as strong as many believe.

The reality, of course, is much of the current strength in economic activity is not from organic inputs in a consumer-driven economy, but rather from one-off impacts of several natural disasters, a surge in consumer debt, and a massive surge in deficit spending. To wit:

“The problem is the massive surge in unbridled deficit spending only provides a temporary illusion of economic growth. Over the long-term, debt leads to economic suppression. Currently, the deficit is rapidly approaching $1 Trillion, and will exceed that level in 2019, which will require further increases in the national debt.”

“There is a limited ability to issue debt to pay for excess spending. The problem with running a $1 Trillion deficit during an economic expansion is that it reduces the effectiveness of that tool during the next recession.”

Our assessment of Powell’s change in tone comes from the message the bond market is sending about the risk to the economy. Since economic data is revised in arrears, the onset of a recession will likely surprise most economists when they learn about it “after the fact.”  Let’s go back to Kevin:

“Here is what we know right now:

1) The U.S. economy seems to be slowing, falling under the weight of higher borrowing costs. What’s hard to predict is whether this is a trend change or a temporary pause.

2) The Fed appeared to blink last week, but we won’t know for sure until December 19th when they release their Rate Decision and ‘tell’ the market what the forward-looking path looks like to them.

3) Inflation is well-contained. For all of you who left town riding on the ‘inflation train,’ welcome back.

4) Global economies are weakening and could get weaker.

5) Friday’s release of the Employment Report should give the market guidance on wages, but not much else.

Kevin is correct, take a look at inflation breakeven rates.

It is quite likely these are not temporary stumbles, but rather a more important change in the previous trends. More importantly, the “global weakness” has continued to accelerate and given that roughly 40% of corporate profits are driven by exports, this does not bode well for extremely lofty earnings forecasts going into 2019.

What Powell Really Said

Caroline Baum had an interesting comment on MarketWatch on Tuesday morning:

“I read with interest the articles last week about the Federal Reserve’s new “unpredictable” and “flexible” approach to monetary policy. No longer can financial markets rely on the gradual, premeditated and practically pre-announced adjustments to the benchmark overnight interest rate, according to these analyses. From now on, the Fed will be ‘data dependent.’”

The whole article is worth a read, but the point being made is that the Fed has always been “data dependent” even if their ability to read and interpret the data has been somewhat flawed. The table below is the average range of their predictions for GDP they publish each quarter versus what really happened.

As Caroline noted, the September projections pegged the “neutral rate” range at 2.5-3.5% with a median estimate of 3%. If Powell is indeed suggesting that the neutral rate has fallen to the low-end of that range, he is likely only confirming what the “yield curve” has been telling us for months. As I quoted previously:

“The yield curve itself does not present a threat to the U.S. economy, but it does reflect a change in bond investor expectations about Federal Reserve actions and about the durability of our current economic expansion.”

Importantly, yield curves, like valuations, are “terrible” with respect to the “timing” of the economic slowdown and/or the impact to the financial markets. So, the longer the economy and markets continue to grow without an event, or sign of weakness, investors begin to dismiss the indicator under the premise “this time is different.” 

The spread between the 10-year and 2-year Treasury rates, historically a good predictor of economic recessions, is also suggesting that Powell may have “woken up to smell the coffee.” While the curve is not inverted as of yet, the trend of the spread is clearly warning the economy is much weaker much of the mainstream economists suggests. (The boosts to economic growth are now all beginning to fade and the 2nd-derivative of growth will begin to become more problematic starting in Q4.)

Mr. Powell most likely also realizes that continuing to tighten monetary policy will simply accelerate the time frame to the onset of the next recession. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.

The only question is the timing.

There are currently too many indicators already suggesting higher rates are impacting interest rate sensitive, and economically important, areas of the economy. The only issue is when investors recognize the obvious and sell in the anticipation of a market decline.

As I discussed previously, the stock market is a strong leading indicator of economic turns and the turmoil this year may be signaling just that.

Believing that professional investors will simply ignore the weight of evidence to contrary in the “hopes” this “might” be different this time is not a good bet as “risk-based” investors will likely act sooner, rather than later. Of course, the contraction in liquidity causes the decline in asset prices which will contribute to the economic contraction as consumer confidence is shattered. Importantly, since recessions are only identified in hindsight when current data is negatively revised in the future, it won’t become “obvious” the yield curve was sending the correct message until far too late to be useful.

While it is unwise to use the “yield curve” as a “market timing” tool, it is just as unwise to completely dismiss the message it is currently sending.

In 1897, Virginia O’Hanlon asked her father if Santa Claus was real. He said she should ask The Sun, a prominent New York City newspaper of the day. Back then there was no fake news apparently, so if the Sun put it in print that there was a Santa Claus, there must be a Santa Claus.

Francis Church, an editor for The Sun, penned the response which contained the now famous phrase “Yes, Virginia, there is a Santa Claus.

As the holiday season rolls around, many investors have a similar question; will there be a Santa Claus rally? In this article, we examine historical data to see whether Saint Nick will provide holiday cheer to investors or the Grinch will foil their wishes.

The Santa Claus Rally

The Santa Claus Rally, also known as the December effect, is a term for the occurrence of more frequent than average stock market gains as the year winds down. For longer-term investors, this article serves as a whimsical note on what might or might not occur this December. Traders willing to measure trades in hours and days, not months or years, might find useful data in this article to make a few extra bucks. Regardless of your classification, we use the traditional disclaimer that past performance is not indicative of future results.

For this analysis, we studied data from 1990 to current to see if December is a better period to hold stocks than other months. The answer was a resounding “YES.” The 28 Decembers from 1990 to 2017, had an average monthly return of +1.70%. The other 11 months, 308 individual observations over the same time frame, posted an average return of +0.62%.

The following graph shows the monthly returns as well as the maximum and minimum intra-month returns for each December since 1990. It is worth noting that more than a third of the data points have returns that are below the average for the non-December months (+0.62%). Further, if the outsized gains of 2008 and 1991 are excluded, the average for December is +1.05%. While still better than the other months, it is not nearly as impressive as the aggregate 1.70% gain.

Data Courtesy Bloomberg

Next, we analyzed the data to explore if there are periods within December where gains were clustered. The following two graphs show, in orange, aggregate cumulative returns by day count for the 28 Decembers we analyzed. In the first graph, returns are plotted alongside daily aggregated average returns by day. Illustrated in the second graph is the percentage of positive days versus negative days by day count along with returns.

Data Courtesy Bloomberg

Visually one notices the “sweet spot” in the two graphs occurs between the 10th and 17th trading days. The 17th trading day, in most cases, falls within a day or two of Christmas. The table below parses data for the aggregated Decembers into three time frames; early, mid and late December to highlight the “sweet spot.”


This year, the 10th through 17th trading days are December 14th through the 26th. If 2018 plays out like the average of the past 28 years, there might be some extra goodies under the tree for those playing the Santa Rally. We caution, as shown earlier, that there have been Christmases where investors relying on the rally woke up to find coal in their portfolio stockings.

(This article originally appeared in Citywire.)

Back in September, I examined the records of the managers that Morningstar nominated as candidates for ‘domestic equity Manager of the Decade’ in 2009. The results were not hugely encouraging. After making that illustrious shortlist, not one manager went on to beat their best-fit index. The Yacktman fund came closest, gliding so smoothly to its 11.43% annualized return from 2010 through August 2018 that it nearly produced the same Sharpe ratio as the S&P 500 index (1.14 versus 1.15 over the past decade). However, it still trailed the index’s return by more than 2.5 percentage points annualized.

Now, though, it’s time to focus on the nominees for the fixed income ‘Manager of the Decade’ award. The results are decidedly better. In 2009, Morningstar shortlisted Dan FussJeffrey GundlachBill Gross, Christine Thompson of Fidelity’s municipal bond funds, and the team on the Dodge & Cox Income fund. The award ultimately went to Gross, but it turns out that he is the only one to have subsequently posted a poor set of results.

It is unclear why Morningstar’s fixed income nominees have fared better than its equity picks. Perhaps, given the relative illiquidity of the bond market, it’s simply easier for fixed income managers to beat their indices than it is for their equity counterparts. Or maybe manager selectors and consultants have an easier job when it comes to identifying talented bond managers. Whatever the explanation, the fund analysts at Morningstar (including me, at the time) certainly seem to have been more successful in having their bond ‘Manager of the Decade’ nominees go on to post good returns in the future.

Masters of their domains

First up is Christine Thompson, who headed Fidelity’s municipal bond operation at the time of the nominations. She is no longer listed as a manager of Fidelity’s funds, but it was obvious that Fidelity’s municipal bond operation had depth and that this was a team nomination. For the period from 2010 through the end of September 2018, the Fidelity Municipal Income fund has posted a 43.7% cumulative return, while the Bloomberg Barclays Municipal Bond index has delivered 39.9% (see Figure 1). Over the past decade, the fund’s 1.09 Sharpe ratio has trailed that of the index (1.13), meaning that it has incurred more volatility to achieve its outperformance. Even so, it would be difficult to say that the fund has carried an unjustifiably high level of volatility.

Next, we have the ‘bond kings,’ Bill Gross and Jeffrey Gundlach, and the Dodge & Cox Income fund. All three deserve to be judged against the Bloomberg Barclays US Aggregate Bond index. There are two caveats with our data here. Gundlach left the TCW Total Return fund in December 2009 and began managing the DoubleLine Total Return fund the following April. Here, I have taken the TCW fund’s 2010 data through April and then hooked it up to DoubleLine’s data starting on May 1 that year. Similarly, for Bill Gross, I took the Pimco Total Return fund’s data from 2010 through October 2014 and then picked up with Gross’s new charge, the Janus Global Unconstrained fund, in November 2014. Gross began his tenure at Janus on October 6, 2014.

No Undue Risk

Realistically, Gundlach has dominated the period since the ‘Manager of the Decade’ nominations. According to the spliced data, he posted a 58.9% cumulative return from 2010 through the end of September 2018. His combination of safe Ginnie Mae bonds and beaten-up, high-yielding Alt-A private label mortgage-backed bonds has worked splendidly.

The team of managers that runs the Dodge & Cox Income fund has acquitted itself well too, delivering a cumulative return of 39.6% versus the index’s 30.7%. Gross, by contrast, has returned just 29.4% over that period (see Figure 2).

And lest anyone suppose that it was reckless portfolio positioning that accidentally produced Gundlach’s heady post-crisis returns, let the record show that he hunkered down with higher quality securities exactly when he should have done in 2008. That year, he piloted the TCW Total Return fund to a top-decile performance in the Morningstar intermediate-term bond fund category, with a 1.09% return.

Finally, the Loomis Sayles Bond fund, led by Dan Fuss, has outpaced the index with a cumulative return of 65.1% versus the Agg’s 30.7% (see Figure 3). However, investors should take this with a pinch of salt. The fund routinely invests in junk bonds and emerging market debt, along with a slug in safer sovereign debt. That makes it more volatile. Indeed, its Sharpe ratio over the past decade through September 2018 is 0.84. Compared with the Agg’s 1.04 Sharpe ratio over the same period, the Loomis Sayles Bond fund arguably hasn’t achieved as attractive a volatility-adjusted return.

Overall, the Morningstar ‘Manager of the Decade’ nominees in fixed income have produced solid results since 2009. Consultants often think small-cap stocks and international markets afford greater opportunities for active management to shine. Perhaps the ability fixed income provides has been under-appreciated.

The stock market’s roller coaster ride this year is beginning to cause a certain amount of apprehension among investors. What has prompted the recent weakness? Is the recent decline just another bump in the road or the beginning of a prolonged downturn? Should adjustments be made to the portfolio?  

Most financial analysis focuses on factors such as cash flows, growth expectations, and balance sheet strength, and rightly so. The relevance of these factors to asset prices is strongly supported by both theoretical and empirical evidence. Yet one of the most basic tenets of economics is that price is a function of supply and demand. While investors tend to hear a lot less about the supply and demand for stocks themselves, this relationship can also have a meaningful influence on prices.

In order to fully understand the supply/demand dynamics for stocks, it is important first to remember the difference between primary and secondary markets. In primary markets, a good is manufactured or provided and a price is established by the provider. Those providers make their best estimates as to what the prices should be. In secondary markets, a pre-existing good is traded. Price is determined by the interaction of buyers and sellers as the point at which supply equals demand.

A common misconception is that stocks are priced like primary goods (which is only true of initial public offerings). There is a price for the product, you decide to buy or sell it, and that’s that. You either have the stock or you don’t. Such thinking is often enabled, if not encouraged, by the financial media. For example, the Financial Times reported [here] (in regards to bonds, though it is just as relevant for stocks),

“Investors have pulled almost $6bn out of corporate bond funds in the past week, in the latest sign of nervousness about companies’ debt pile in an environment of rising US interest rates and falling oil prices.”

Financial securities like stocks and bonds, however, are normally priced in secondary markets. This means that when a stock is bought or sold, it is really exchanged between the buyer and seller. The price is established by determining the price that clears the market, i.e., balances the demand from buyers with the supply from sellers. As John Hussman instructs [here], 

“[O]nce a security is issued, whether it’s a government bond or a dollar of base money [or a share of stock], that security must be held by someone, at every point in time, until that security is retired.”

Therefore, while the statement about bond funds is true, it is also true that “investors have added $6bn into corporate bonds in the past week”. Why? Because when owners of mutual bond funds sell shares, the mutual fund company generally needs to sell bond holdings, and when they do, some other investors need to buy those bonds. As a result, the story reveals very little about whether corporate bonds should be bought, held, or sold. It only reveals the behavior of investors in corporate bond mutual funds, which is only one subset of the universe of all of investors.

What the story does reveal, at least indirectly, is that different investors have different goals, different investment horizons, and different levels of risk tolerance. These can all change over time and affect demand.

The demand for existing homes provides a useful example. Such demand is not level through the year; a disproportionate number of prospective home buyers appear in the spring and summer months. As a result of this imbalance, home sellers tend to get better prices for their homes during these times. The same types of supply/demand imbalances occur with stocks as well, so it can be useful to analyze the composition of various types of investors in order to gauge the impact on prices.

Demographics is one of the most common ways to do this because it is not only an important determinant of demand for stocks but also a reliable one. Demographics affect demand because the value proposition of stocks, which are more growth-oriented than bonds, is stronger for working age people than it is for retired people.

As noted [here],

“Large populations of retirees (65+) seem to erode the performance of financial markets as well as economic growth.” The rationale is also fairly straightforward: “Middle-aged adults are the engine for capital market returns; they are in their prime for income, savings, and investments. And senior citizens contribute to neither GDP growth nor stock and bond market returns; they disinvest to buy goods and services that they no longer produce.”

As Rob Arnott and Anne Casscells describe [here],

“The simple mechanisms of supply and demand should lower the return on assets: A larger group of retirees than ever before will be selling to a proportionately smaller working population than ever before. So, what the retirees wish to sell will already be priced lower, in real terms, but the time they wish to sell it.

These implications for capital market returns and prospective inflation (stated here in their strongest terms) stem from the most basic law of economics: Supply and demand must match. Prices are set to equate supply and demand; no policy choices can alter this relationship. Retirees demand goods and services; workers supply them.

Arnott and Casscells conclude, “The potential implications of our results are sobering,” and indeed that may be an understatement. For starters, “The selling pressure, however, is not likely to affect all assets uniformly. Retirees favor some assets more than others. They tend to rely less on growth assets, such as stocks, and favor fixed income assets.” As a result, the diminishing demand for stocks should start to affect the prices paid.

In addition, the effect on GDP growth and market prices is likely to be significant. As reported [here],

“…demographic factors alone can account for a 1 1/4-percentage point decline in the natural rate of real interest and real gross domestic product growth since 1980”.

John Authers from the FT concludes [here],

“This is a huge claim, as it implies that demographics — rather than fiscal or monetary policy, technology or other changes in productivity — are responsible for virtually all of the decline in economic growth over the past 35 years.”

In other words, the impact of demographics is large and there is very little that public policy can do about it.

Finally, the demographic impact should already be taking effect now. Arnott and Casscells note,

“The ratio of retirees to workers begins to rise in roughly 2008-2010 and starts to soar around 2015.”

Given that markets tend to anticipate the future and that demographic trends are extremely reliable, “overt selling pressure on risky assets” should already be in process.

In an important sense then, the more interesting question is not, “Why has the market been down over the last few weeks?” but rather, “Why hasn’t the market been selling off over the last several years in anticipation of demographically-driven lower demand for stock ownership?”

An unrelated story provides some interesting insight. I have been going through and reviewing some research files recently and came across the headline in the Financial Times [here], “Facebook backtracks on privacy.” The article started, “Facebook has been forced to retreat on some changes to its privacy settings after the move created an outcry from data protection campaigners and left users confused and irate.” None of it struck me as especially interesting except for one thing. The story was published on December 12, 2009, almost nine years ago.

This struck me as interesting because nothing in the content of the article came across as dated. Given the commonality in privacy issues with those raised by the Cambridge Analytica incident, the article could just have easily been written one year ago as nine years ago. The details were different, but in both cases the company displayed broad disregard for customer privacy. So why did it take eight years for the story to finally gain traction?

The answer to both questions, I believe, lies in one of the more interesting and unique aspects of this latest bull market run: The substantially increased share purchase activity by entities such as central banks and corporations. For example, I wrote [here] that

“Billions and billions of dollars’ worth of stock purchases by central banks have severely distorted those [market] signals.”

More recently, I noted [here],

“Since share purchase activity is dominated by price insensitive share repurchases, stock prices reveal little information content about underlying economics. This helps explain why neither inflation fears nor trade wars nor emerging market chaos nor increasing rates have been able to rein in stock prices to any great degree.”

This applies to Facebook stock just as much as to the market as a whole.

As a result, aging demographics is to stock demand as a slow leak is to air in a tire. Just a little bit seeps out each day such that you don’t really notice it. If you regularly put more air in the tire, it can last quite a while. Over time you have to refill the tire with increasing frequency, though, until even with that effort, the tire cannot retain enough air to be safe.

This suggests that despite regular and significant “refills” of demand by central banks and corporations, it is only a matter of time before the “leak” of aging demographics will finally cause demand for stocks to fall short. As I noted before,

While high valuations may appear, superficially, to validate underlying economic strength, they are really just temporarily masking the darker reality of ‘the relentless demographic tide of Baby Boomers rebalancing their portfolios away from equities and into bonds’.”

Further, almost as if to add insult to injury, there is yet another trend that investors should keep their eyes on. Taxes are always an important investment consideration and the recent tax legislation may further hasten the retreat from stocks. As the FT notes [here],

“Mr [Cory] Booker’s initiative [to create Opportunity Zones] was a little-noticed element of President Donald Trump’s 2017 tax bill. In simplest terms, it allows investors to reduce their capital gains by investing in deprived areas.” Specifically, “The authors of the plan settled on a simple incentive: allow investors to defer capital gains — from the sale of property, stocks, a business, anything — as long as they reinvest the profits in one of 8,700 Opportunity Zones around the country.”

In terms of the impact of the plan, the FT reports that views are mixed:

“Proponents argue that Opportunity Zones may one day come to be seen as the boldest economic development plan for poor areas in a generation. But they could also end up presenting the most generous tax deal to the rich in decades.”

Reports suggest a wide variety of stock owners could be affected. James Nelson, of real estate broker Avison Young, predicts, “Opportunity Zones would become the method of choice for high net-worth individuals and family offices to make ‘intergenerational’ transfers of wealth.” Daniel Barile, managing director at SkyBridge Capital, says his firm is “targeting the ‘mass affluent’ sitting on inflated stock portfolios after a long bull market and facing big capital gains taxes if they sell.”

Regardless, the prospect of relief from capital gains taxes and its commensurate effect on demand for stocks seems to be the most predictable aspect of the legislation. By one account, many executives “were already salivating at what could be the biggest tax break of their lifetimes.” The Economist noted [here], “Boosters point to the trillions of dollars of unrealised capital gains ready to be unlocked,” in a story entitled, “Boondocks and boondoggles”. As a result, anyone holding stocks that have appreciated considerably, whether they are interested in Opportunity Zones or not, needs to be aware that the plan is likely to further reduce demand for stocks. In other words, the leak in the tire just got bigger.

For investors who are making tactical decisions about whether to increase, maintain, or reduce exposure to stocks, then, it is important to consider the supply and demand of stocks. One aspect of such consideration is to realize that when you go to buy or sell stock, you are engaging with others who are doing the same. Stocks do not provide the same value proposition as bonds for retirees and as the proportion of retirees to workers continues to increase, demand for stocks will diminish. As prices increasingly get set by price sensitive buyers, it is quite likely they will need to be considerably lower in order to meet the increasing supply provided by retirees selling stocks.

In addition, the recent regime change in the market may well be, at least partly, an indication of the ongoing structural shift in demand. A piece by the FT [here] notes,

“Taking advantage of weakness in US stocks, known as buying the dip, has stopped working for investors this year for the first time since 2002, in the latest sign that the bull run in under threat. We are de-risking, moving from buying the dips to selling the highs.” – Georg Schuh, chief investment officer for Emea at Deutsche Wealth Management describing an important change in their strategy 

Investors should also be attuned to the reality that regardless of evidence for structural shifts in demand for stocks, there will always be pundits making the case for remaining invested. For example, Citigroup’s chief global equity strategist, Robert Buckland, wrote in the FT [here],

“It still seems too early to call time on this ageing bull market”, and specifies, “So our advice is to buy this dip.” Not for nothing, this advice comes from the same company that told us back in 2007, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Finally, there are also good reasons why more strategic holders of stocks may want to reassess their holdings. Many investors are told that stocks provide the best returns for long term investors, a thesis popularized by Jeremy Siegel with his book, Stocks for the Long Run, and one that has become almost a religious belief for many investors and advisors. As Grant’s Interest Rate Observer (November 16, 2018) points out, however, a closer analysis of historical returns depicts the case for stocks as considerably more uncertain and less attractive than widely believed.

Enlisting the help of Edward McQuarrie, professor emeritus at the Leavy School of Business, Santa Clara University, Grants tells us, “Almost all the real price appreciation of the S&P 500 since the late 1920s occurred in the past 30 years, after the boom of the 1980s was well under way.” For one, this implies that stocks can provide unexceptional returns for long enough periods of time to affect even long-term investors. In addition, since the 30-year period of strong real returns coincides almost perfectly with Baby Boomer peak savings years, one could argue that strong real stock returns depend primarily on favorable demographics. Insofar as this is the case, many investors may want to reconsider the role of stocks in their portfolios.

So, for investors who may be unsettled by recent market gyrations, and even those who aren’t, evaluating the merits of stocks through the lens of supply and demand can provide useful insights. Many investors are focused on avoiding big “pot holes” such as an economic downturn, trade wars, and the like, which could cause stocks to go down quickly. The greater danger, however, may be the less visible “slow leak” of declining demand due to aging demographics which is just as effective at ruining a nice trip.

The Roman philosopher Seneca wasn’t talking about the stock market when he wrote that “Time discovers truth,” but he could have been. In the long run a stock price will reflect a company’s (true) intrinsic value. In the short run the pricing is basically random. Here are two real-life examples.

Let’s say you had the smarts to buy Microsoft in November 1992. It would have been a brilliant decision in the long run — the software giant’s stock has gone up many-fold since. But nine months later, in August 1993, that call did not look so brilliant: Microsoft shares had declined 25% in less than a year. In fact, it would have taken you 18 months, until May 1994, for this purchase to break even. Eighteen months of dumbness?

In the early 1990s, the PC industry was still in its infancy. Microsoft’s DOS and Windows operating systems were de facto standards. Outside of Apple Macs and a tiny fraction of computers, every computer came preinstalled with DOS and Windows. Microsoft had a pristine balance sheet and a brilliant co-founder and CEO in Bill Gates who would turn mountains upside-down to make sure the company succeeded. The above sentence is infested with hindsight — after all, that was almost 30 years ago. But Microsoft clearly had an incredible moat, which became wider with every new PC sold and every new software program written to run on Windows.

Here is another example: GoPro is a maker of video cameras used by surfers, skiers, and other extreme sports enthusiasts. If you had bought the stock soon after it went public, in 2014, you would have paid $40 a share for a $5.5 billion–market-cap company earning about $100 million a year — a price-earnings ratio of about 55. Your impatience would, however, have been rewarded: The stock more than doubled in just a few short months, hitting $90.

Would it have been a good decision to buy GoPro? The company makes a great product — I own one. But GoPro has no protective “moat” around its business. None. Most components that go into its cameras are commodities. There are no barriers to entry into the specialized video camera segment. Most important, there are no switching costs for consumers. Investors who bought GoPro after its IPO paid a huge premium for the promise of much higher earnings from a company that might or might not be around five years later.

What is even more interesting is that some of those buyers were then selling to even bigger fools who bought at double the price a few months later. GoPro was a momentum stock that was riding a wave about to break. Fast-forward a few years and GoPro sales have been on decline; nowadays its stock trades below $6.

These two examples bring us to the nontrivial topics of complex systems and nonlinearity. My favorite thinker, Nassim Taleb, wrote the following in his book “Antifragile: Things That Gain from Disorder”:

“Complex systems are full of interdependencies — hard to detect — and nonlinear responses. Nonlinear means that when you double the dose of, say, a medication, or when you double the number of employees in a factory, you don’t get twice the initial effect, but rather a lot more or a lot less.”

The stock market is a complex system where in the short term there are few if any interdependencies between decisions and outcomes. In the short run, stock prices are driven by thousands of random variables. Stock market participants have different risk tolerances and emotional aptitudes, and diverse time horizons ranging from milliseconds (for high-speed traders) to years (for long-term investors).

In other words, predicting where a stock price will be in a day, a month or even a year is not much different from prognosticating whether the ball on a roulette wheel will land on red or black. In the longer run, good decisions should pay off because fundamentals will shine through — as was the case with buying Microsoft in 1992 and not buying GoPro in 2014. But in the short run there is no correlation between good decisions and results.

Whenever you look at your portfolio, think of Microsoft and GoPro. The performance of your stocks in the short run tells you absolutely nothing about what you own or about the quality of your decisions. You may own a portfolio of Microsofts, and its value is going down because at this juncture the market doesn’t care about Microsofts. Or maybe you stuffed your retirement fund with overpriced fads that may not be around a year from now. But in the longer run, remember what Seneca knew:

“Time discovers truth.”

“Present time is very brief, so brief indeed, that to some there seems to be none; for it is always in motion, it ever flows and hurries on; it ceases to be before it has come, and can no more brook delay than the firmament or the stars, whose ever unresting movement never lets them abide in the same track.” – Seneca, On The Shortness of Life.

What observations can be made from a personal photo snapped 10 years ago?

Did you wince at your hairstyle or clothes? Maybe you carried less pounds, not so much gray on top. I’m certain you muttered – “I wish I knew then what I do now!”

A photograph is a frozen moment; a special selection from life’s rapidly spinning reel. As years pass, the film of a life reaches hyper-speed. Along the way, financial status such as life, is constant ebb and flow.  As we age, our experiences aid us to meet financial goals or veer us into a ditch. Life is characterized by ever-changing probabilities that push us forward or pull us back – Health issues, bear markets, Great Recessions (how many of those do you need to change your life forever?), divorce, career change, children returning to the nest, college costs, and so many other circumstances I fail to identify here can diminish or accelerate the ability to meet financial milestones.

A financial plan is a comprehensive snapshot; consider it a personal financial documentary of who you are in the present, how past actions and circumstances shaped your current household balance sheet, and a revealer of financial strengths and possible future vulnerabilities.

A comprehensive financial plan is art as well as quantitative analysis. Between the numbers lies a picture of your relationship with saving, debt, investing, risk mitigation and charitable or estate intentions.

So, what can a plan reveal about you?

You possess a healthy worry about your finances.

Like a low hum in the back of the mind, a small dose of worry in the form of money awareness, resonates overwhelmingly throughout successful plan outcomes. A dose of worry is healthy since it fosters discipline and minimizes complacency when it comes to making financial progress and working through money mishaps. Over the last 29 years, those individuals who share with me how much they worry about money and feel they can’t save enough ironically save more than enough. A healthy concern over money leads to satisfying financial plan results. Advisers who suggest not to worry compel me to worry!

You seek validation.

Habits reveal themselves in plans. If you intuitively think you have strong financial discipline, you probably do. A plan should validate positive fiscal activity; think of it as a formal pat on the back. It’s rewarding how a plan can project the power of good habits into the future. It’s a positive pattern I call financial “vibrocity.” Consistent good habits like living smaller, debt avoidance/minimization, saving/investing at least 20% of gross income and enough insurance coverage, ripple through all areas of a plan and enhances the speed of reaching goals and minimizes the impact of financial vulnerabilities such as job loss, lack of career mobility, loss of income due to disability or the growing costs of long-term care. A new retiree recently described to me how this validation has helped to make the transition retirement less stressful. It warmed me to hear those words.

You are motivated by financial reality.

A plan doesn’t lie. Numbers crystalize the story of where a household stands today and the probabilities of meeting future financial goals. It’s a complete financial chemistry employed to enhance good behaviors and detect possible headwinds. For example, I undertake a comprehensive blood chemistry at the minimum every year, as blood reveals tremendous information about the current state of health. A financial plan is the ultimate purveyor of truth and those who decide to complete the exercise may be apprehensive, but they’re anxious to embrace potential financial vulnerabilities and do what they can to mitigate them.

Seneca said – “the growth of anything is a long process, but its undoing can be rapid, even instant.” Those who embrace the process of planning internalize these words. A financial mishap or life event can destroy a lifetime of savings. While a plan can’t predict future surprises, it certainly can aid in awareness of possible pitfalls and help establish an action plan to deal with them.

You’re a long-term thinker.

A plan is a freeze frame taken at a point in an ever-changing financial life. A static blueprint can provide a path to meet future needs, wants and wishes. Unfortunately, paths tend to get blocked or accelerated by unforeseen life events. Those who complete a plan understand when life is altered, so does a plan require an update.

People who embrace planning believe in taking a long-term view of their lives. They tend to build a resistance to adverse conditions and embrace estate planning to protect their assets for future generations; they’re better equipped to deal with their own mortality and perceive insurance and vehicles that minimize the impact of disability or long-term care as positive protections. Awareness of adverse situations, those who go through a planning exercise also wind up making wiser choices within employer benefits plans.

Recently, The CFP Board expanded their fiduciary duty. The organization that governs Certified Financial Planners has added several and welcomed requirements to the Code and Standards. A CFP® professional must place the interests of clients above the interests of the professional and the professional’s firm which is going to be an incredible challenge for big-box financial retailers who primarily hire CFPs to sell products. I encourage those seeking to complete a comprehensive plan only look to a registered investment advisory such as Clarity for guidance.

A CFP must fulfill a “Duty of Care” which isn’t taken lightly by the 4-CFP® professionals (me included) at Clarity Financial. Cumulatively we have over 80 years of industry experience and each have a decade or more of maintaining the CFP® designation.

A financial plan says a lot about who you are from a financial perspective.

Unlike the photograph from a decade ago that made you wince in embarrassment, a solid plan and steps to improve should endure and make you smile, especially when financial life benchmarks are met.

In this past weekend’s missive, “Did The Powell Put Change Anything?,” I discussed the surge in the market following Jerome Powell’s change of stance on Fed policy and the potential for a Trump to acquiesce to China in order to boost the stock market.

“While Goldman is leaning more towards an “escalation,” President Trump has staked his entire Presidential career to the stock market as a measure of his success and failure.

If President Trump was heading into the meeting this weekend with the market at record highs, I think a “hard-line” stance on China would indeed be the outcome. However, after a bruising couple of months, it is quite possible China will see an opportunity to take advantage of a beleaguered Trump to keep negotiations moving forward.

This is also particularly the case since the House was lost to the Democrats in the mid-term. This is an issue not lost on China’s leadership either. With the President in a much weaker position, and his second tax cut now “DOA,” there is little likelihood of any major policy victories over the next two years. Therefore, the risk to the Trump Administration is continuing to fight a ‘trade war’ he can’t win anyway at the risk of crippling the economy and losing the next election.”

Not surprisingly, that is exactly what happened.

With smiles and much back-patting to go around, the G-20 meeting ended with a “roar of applause but the accomplishment of nothing.”

Nonetheless, as I also pointed out, the market did reach extremely oversold levels during the October/November correction which provided the necessary “fuel” for a short-term rally. All the market needed was a “reason” and Trump’s weakened stance with China over trade provided just that.

The Bullish View

The good news is that on Monday the market cleared the 50- and 200-day moving averages. This was an important level of overhead resistance the market needed to clear to get back onto more bullish footing. However, in order for that break to be validated, it must hold through the end of the trading week.

Also, on a very short-term basis, the market has triggered a short-term “buy signal.” From a trading perspective, this does provide support for a rally in the short-term. As Richard Mojena noted in his commentary this past weekend:

“The nearly 5% gain this past week was an impressive surge off the primary downtrend’s lows from just the previous week, with some key resistance trend lines taken out. The model’s technical indicators leapt in response, notably tripping two key indicators (index vs month-end trend and statistically significant weekly percent increase) from sells to buys. Monetary and sentiment indicators improved some as well.

This buy signal came just after the confirmation of a new primary downtrend at 9 weeks with a decline of -10%. Just one week ago the S&P 500 at -10.2% from its September high visited correction territory and at +0.1% was barely above water year-to-date, breathing only from its dividends. The index itself (without dividends) was off -1.5% YTD. And now the SPX is up 5% year-to-date. What a difference a week makes. The model now believes with 80% probability that a new primary uptrend is underway, although its realization may very well be rocky.”

If he is correct, then our longer-term indicators should turn positive the weeks ahead as well. As noted at RIA PRO we did add some equity exposure to portfolios on Friday, but are still holding a higher level of cash than normal. As shown below, the 61.8% Fibonacci retracement level, and the 2016 bullish trend line, have remained formidable adversaries to the previous rally attempts. However, if the lower “sell signal” is reversed, such would likely coincide with a breakout above resistance and confirm a new uptrend is underway.

“IMPORTANT: It is the success or failure of this rally attempt will dictate what happens next.

  1. If the market remains above the 50-dma AND breaks above resistance at 2820, then another attempt at all time highs is likely. (Probability Guess =40%)
  2. However, if this rally fails such will result in a continuation of the correction back to recent lows. (Probability Guess = 60%)”

The Bearish View

So, why did I give Option #2 a greater weighting?

This is because, despite the recent oversold surge from lows, the primary backdrop of the markets has not changed markedly.

  • The “trade truce” was nothing more than that. China is not going to back off its position on “Technology Transfers” as that is the key to their long-term economic future. This means that either Trump caves into China or we will be back to a full on “trade war” in 2019.
  • The Federal Reserve is still reducing their balance sheet by $50 billion per month which has removed a primary buyer of U.S. Treasuries at a time when the Government has gone on an unfettered spending spree.
  • With the Democrats in control of the House, there will likely be “no” constructive legislative action to note in the next year. However, there is almost an absolute guarantee of more anti-Trump actions being lofted from the “Pelosi House.”
  • Valuation remains extremely elevated despite the recent correction. 
  • Most importantly, year-over-year earnings growth rates are set to deteriorate markedly in 2019 as both the effect of the 2018-tax cuts vanishes and end-of-year estimates still remain way too high.
  • The deterioration in credit is accelerating
  • Economic growth has likely peaked. 

As noted by Carl Swenlin of Decision Point this past weekend:

“SPY’s departure from the secular bull market rising trend line reached about +39% this year, as opposed to a departure of only +26% in 2015. That kind of excess begs for a correction. The monthly PMO has topped and crossed down through the signal line. This typically forecasts a lengthy period of decline.”

As he concludes:

“The S&P 500 hasn’t had a ‘Death Cross’ yet (50EMA passes down through the 200EMA), but 51% of S&P 500 components have. I continue to believe that we are in a bear market; however, recent price action has certainly been encouraging for the bulls. The promise of the positive divergences on the chart just above has been partially fulfilled, but the short-term indicators are becoming overbought, and time could be running out on the rally. It will take an advance of just +6.5% for the market to make new, all-time highs, but, if I am right about the bear, it’s not going to happen.”

Balancing Act

Weighing both the short-term bullish view and the longer-term bearish outlook is difficult. Despite the rally on Monday, the market still remains mired on a primary “sell signal,” has violated it’s long-term bullish trend and faces a substantial amount of headwinds heading into 2019.

The risk current remains to the downside, and we must wait until the end of the week to see if the “bulls” can take back the reins of the market.

There is little doubt the “bullish bias” persists currently, and the volatility this past year has made managing money more difficult than usual.

But that is the nature of markets and how “topping processes” work.

Given we are in the “seasonally strong” period of the year, it would not surprise me to see the markets try and muster a rally into January. But there are certainly some challenges to face over the next week or so as mutual funds are now firmly into their annual distribution period and Jerome Powell may reassert his “hawkishness” again next week which could spoil the party.

A look at the weekly internals of the market shows some notable deterioration in the advancing-declining issues. With a weekly “monthly” sell-signal in place, caution remains a primary consideration. Importantly, given these are monthly signals, it does NOT MEAN stocks can’t rally in the short-term. It simply suggests there is selling pressure on stocks and the path of least resistance currently is lower.

Again, while a short-term bounce in likely given the recent sell-off, it will require a move to new highs to reverse the currently more “bearish” dynamics at work in the market. 

While anything is certainly “possible”, we have to manage money on “probabilities.”

And right now, the probabilities remain to the negative.

Conclusion & Suggestions

Given the weekly “sell” signals currently in place, the recommendation to rebalance portfolio risks remains. Here are the guidelines I recommended previously:

Step 1) Clean Up Your Portfolio

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

Step 2) Compare Your Portfolio Allocation To Your Model Allocation.

  1. Determine areas requiring new or increased exposure.
  2. Determine how many shares need to be purchased to fill allocation requirements.
  3. Determine cash requirements to make purchases.
  4. Re-examine portfolio to rebalance and raise sufficient cash for requirements.
  5. Determine entry price levels for each new position.
  6. Determine “stop loss” levels for each position.
  7. Determine “sell/profit taking” levels for each position.

Step 3) Have positions ready to execute accordingly given the proper market set up.

As noted previously in 10-Investment Wisdoms:

“The absolute best buying opportunities come when asset holders are forced to sell.” – Howard Marks

We haven’t gotten to that point just yet.

I went on a long distance drive for Thanksgiving – Houston to Southern California and back. I don’t recommend doing that unless you have two full weeks. It’s 1500 miles each way, which means you should allocate six days to driving.

I didn’t allocate my time well, because I had around 10 days, not two full weeks. That meant I spent more time driving than visiting. But on the drive I managed to catch up on some podcasts, and one that stands out is Meb Faber’s interview of Howard Marks. Marks is a legendary investor and has a new book out called Mastering the Market Cycle. A few things stand out about the interview. Cycles are related to risk-taking and behavior, and they are often debt-driven. A rising stock  market often occurs simultaneously when lending standards relax. That’s why junk bonds and real estate often move in tandem with the stock market in what have come to feel like “risk-on, risk-off” trends.

Can anyone master these trends? First, don’t expect to time things exactly right. Marks raised an $11 billion fund in 2007-2009 that capitalized on bonds and other instruments of near-bankrupt companies. He’s frank with Faber that he didn’t know what was happening with CDOs or mortgage-backed securities; he didn’t have the precise insight that Michael Burry or Steve Eisman did, for example, in shorting mortgage-backed CDOs. But he saw deals being done everyday that didn’t make sense to him and reflected an increasing indifference to risk. In late 2008, he started putting money to work, buying distressed debt without knowing where the bottom was. Investors trying to time market cycles should understand that capturing tops and bottoms isn’t the goal. Buying on the way down and selling on the way up are difficult enough – and they will allow you to reap plenty of reward.

Another lesson for individual investors is that they should lessen their moves. Stop trying to be all in or all out of the market. Stop trying to be precise about timing; seeking precision can get you into trouble. As things get more expensive, your bias should be toward selling; as they get cheaper, your bias should be toward buying. It’s all about putting probabilities on your side, not timing full entries and full exits precisely. This part of the interview reminds me of Ben Graham’s discussion of the “enterprising investor” in his classic book The Intelligent Investor.

The enterprising investor doesn’t maintain a balanced or 60% stock / 40% bond mix at all times. Instead, he calibrates upward or downward between 75% stocks and 25% stocks. In other words, Graham counsels the most adept and studious investors never to be all in or all out, and Marks basically does the same thing. One has to be humble in trying to manage Mr. Market, Graham’s fictional, manic-depressive fellow one should think about when assessing markets.

A corollary to these lessons is that cycles can last longer than you think, and Marks is honest again that his caution in recent years has cost him. That’s not a reason to dismiss his wisdom; it’s just an acknowledgment that you shouldn’t seek precision. The current rally in stocks, corporate bonds, and real estate has gone on for almost a decade now. It feels long in the tooth, but that doesn’t mean it can’t go on longer. I’ve noted that the Shiller PE (stock prices relative to past 10-yr average earnings), for example, is in the low 30s, levels seen only in the run-ups to 1929 and 2000. But in 2000, the metric hit 44. There’s no law saying it can’t do that again — or even go higher this time. Marks mentions that it feels like the 8th inning now. But he also notes that final innings can last a long time, and games can go into extra innings. Again, a lot of patience is required whether you keep a steady allocation or whether you manipulate your allocation according to your understanding of cycles.

Marks says investors should set target allocations. But then they can deviate from them – as long as they know what they’re deviating from. So a classic balanced (60% stocks, 40% bonds) investor can go down to 50% or 40% stocks at this point, for example. Last, nobody should try timing cycles without being a keen student of market history. Too many investors try to time markets without having seen even one full market cycle. They don’t understand that things play out a little differently each time, and that they need to have patience. Timing market cycles isn’t easy even for Marks, and he’s had a 50-year career at this point. Everyone will have to calibrate to their own taste and temperament, but everyone should resist the temptation to make extreme moves. My own opinion is that smaller investors should also do this under the guidance of a professional. Don’t misallocate your assets the way I misallocated my time for this Thanksgiving trip. And call us if you have questions about how we allocate portfolios.

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

The Cartography Corner

A Review of November

Apple Inc.

We will begin with a review of Apple Inc. (AAPL) during November 2018. In our November 2018 edition of The Cartography Corner, we wrote the following, with emphasis given to shaded excerpts:

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

  • M4             251.64
  • M1             237.27
  • PMH          233.47
  • MTrend     220.33  
  • Close         218.86           
  • M3             211.98
  • PML           206.09           
  • M2             196.88          
  • M5             182.51

Active traders can use 220.33 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 211.98 as the downside pivot, whereby they maintain a short or flat position below it.

Figure 1 below displays the daily price action for November 2018 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  During the first trading day of November, the price ascended to, and closed above, our isolated upside pivot at MTrend: 220.33.  The buy signal for active traders was given.  However, Apple released quarterly earnings after the market closed on that day.  Market participants were disappointed with the earnings release and immediately started to sell Apple in the after-market hours.  The price never recovered.

The following two trading sessions were spent with the price blowing through our first-two support levels at M3: 211.98 and PML: 206.09, with the decline stopping just in front of our third support level at M2: 196.88.  The sell signal for active traders was given.  The following three trading sessions were spent with price ascending to, but not reaching, our isolated downside pivot at M3: 211.98, now acting as resistance.

The following eleven trading sessions saw Apple’s price decline hard into, and through, our monthly downside exhaustion level at M5: 182.51.  The final four trading sessions were spent with the price ascending back to, but not surpassing, our downside exhaustion level.

Active traders following our work completed two trades during the month.  Using closing prices, they bought $222.20 which was stopped out at $207.48.  They sold-short $207.48 which was covered at $176.98.  The net of the two trades was a gain of 8.08%.      

Figure 1:

E-Mini S&P 500 Futures

We continue with a review of E-Mini S&P 500 Futures (ESZ8) during November 2018. In our November 2018 edition of The Cartography Corner, we wrote the following, with emphasis given to shaded excerpts:

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

  • M4             3024.50
  • PMH          2944.75
  • M1             2942.50
  • MTrend     2844.47  
  • Close          2711.00        
  • PML           2603.00
  • M3             2503.00        
  • M2             2341.00        
  • M5             2259.00

Active traders can use 2844.47 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 2603.00 as the downside pivot, whereby they maintain a flat or short position below it.

Given the large distance between monthly levels, unless October’s low is breached, we suggest using the weekly levels each week to guide us through the month of November.

Figure 2 below displays the daily price action for November 2018 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines. October opened with the price rallying 105.50 points (closing basis) during the first five trading sessions.  We believe the surge is a classic bear-market rally.

And then the rug was pulled out from under market participants.  The following eleven trading sessions were spent with the price declining 187.00 points (closing basis) from the high close of November 7th.

The last week of November was a repeat of the first week; the price rallied 128.75 points (closing basis) from the low close of November 23rdAnother bear-market rally?

Active traders, with a monthly time-period focus, completed no trades during November.  The price-action was contained within our isolated upside and downside pivots.  Our weekly analysis accurately identified the major pivots during the month.


Figure 2:

December 2018 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESZ8).  The same analysis can be completed for any time-period or in aggregate.


  • Monthly Trend        2799.11       
  • Current Settle         2758.25
  • Quarterly Trend      2742.72       
  • Daily Trend             2737.94       
  • Weekly Trend          2707.50

As can be seen in the quarterly chart above, E-Mini S&P 500 Futures have been trading higher in price since the fourth quarter of 2015 and have been “Trend Up” for twelve straight quarters.  However, the market price spent the majority of October and November below Quarterly Trend.  Patience is required as this is a quarterly time-frame. If the price closes below the Quarterly Trend of 2742.72 the impressive twelve-quarter trend will have broken.

Stepping down one level in time-period, the monthly chart shows that E-Mini S&P 500 Futures are now in “Consolidation”, having ended the most recent five-month uptrend.  With a December settlement below Monthly Trend, they will be “Trend Down” in the monthly time-period.   Stepping down to the weekly time-period, the chart shows that E-Mini S&P Futures are in “Consolidation”.  The previous six weeks have been spent with the price trading either side of a roughly 200-point range.

Technical analysis of E-Mini S&P 500 Futures suggests that the market is aggressively trying to turn lower for a sustained downtrend. As is typical, the shorter time periods signal a trend change first.  Conviction is gained as the longer monthly and quarterly periods confirm the change.


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

  • M4             3033.00
  • PMH          2818.00
  • M3             2805.50
  • MTrend     2799.11
  • Close          2758.25        
  • M1             2691.25
  • M2             2649.00        
  • PML           2626.00         
  • M5             2307.25

Active traders can use 2818.00 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 2691.25 as the downside pivot, whereby they maintain a flat or short position below it.

Given the still-relatively-large distance between monthly levels, we suggest using the weekly levels each week to guide us through the month of December

We want to stress the point that if the S&P futures close the month of December below 2742.72, the market is providing a strong signal that the nine-year-old bull market may likely be in jeopardy.


Orange Juice

For the month of December, we focus on Orange Juice Futures.  We provide a monthly time-period analysis of Orange Juice Futures (OJF9).  The same analysis can be completed for any time-period or in aggregate.


  • Quarterly Trend     151.39          
  • Monthly Trend       143.98
  • Current Settle        143.95          
  • Daily Trend            142.05          
  • Weekly Trend         139.54

As can be seen in the quarterly chart above, Orange Juice is in “Consolidation”, after having been “Trend Down” for five quartersStepping down one level in time-period, the monthly chart shows that Orange Juice has been “Trend Down” for four months, effectively having the pulp beat out of it for a roughly 23% decline.  Stepping down to the weekly time-period, the chart shows that Orange Juice is in “Consolidation”, after having been “Trend Down” for ten weeks.  Technical analysis of Orange Juice suggests to us that perhaps the intermediate trend is in the early stage of a reversal to higher prices.


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

  • M4             154.20
  • M3             150.30
  • PMH          144.90
  • MTrend     143.98
  • Close         143.95           
  • M1             140.35
  • PML           131.80           
  • M2             128.00          
  • M5             114.15

Active traders can use 144.90 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 140.35 as the downside pivot, whereby they maintain a short or flat position below it.


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 to 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.