Monthly Archives: February 2018

Technically Speaking: Tudor’s 10-Rules To Navigate Q4-2020

In this week’s Technically Speaking, I wanted to review Paul Tudor Jones’ 10-rules and how to navigate the market for the rest of 2020. Due to a small surgery, I am out of commission this week, so I had to write this article on Saturday. The data is as of Friday’s close, but given we are looking at weekly and monthly charts, it doesn’t change the analysis.

Recap

As noted in “The Sell-Off Is Overdone,” on a very short-term basis, the recent correction has played out much as we suggested in the middle of August.

Over the last couple of weeks, we have been discussing the ongoing market correction. As shown below, the sell-off has been orderly and not one of a “panic” induced decline.

The market did retrace from the top of the 2-standard deviation range to the bottom, which is part of a healthy correction process. As we noted last week, the correction also aligns with the historical weakness seen in September and October, particularly in years preceding an election.

Sell-Off Overdone Correction, The Sell-Off Is Overdone. The Correction May Not Be. 09-25-20

“While the sell-off in the market has gotten overdone short-term, we still suggest using rallies back to the 50-dma to rebalance portfolio risks. Look at the first chart above. The market is currently in a very defined downtrend. Friday’s march failed to break out of that resistance.

In the chart below, we see the market rallied back to the previous consolidation lows with the 20-dma approaching a cross of the 50-dma. Such would suggest more downward pressure on prices short-term. The 200-dma is roughly 7% lower from Friday’s close.

If the market can break above resistance on Monday, clear the 50- and 20-dma’s, then old highs should not be an issue.

Sell-Off Overdone Correction, The Sell-Off Is Overdone. The Correction May Not Be. 09-25-20

But what about for the rest of 2020. For that, we need to look at weekly and monthly charts for better understanding.

A Look At Weekly Data

It is essential to understand that time-frames are important in analysis. If you are a day-trader, you can skip to the bottom of the article. However, if you are a longer-term investor looking to grow capital and manage risk, weekly analysis becomes more beneficial.

The reason we look at weekly data is that it smooths out the day-to-day price volatility and tends to reveal overall market trends more clearly.

While the market is working off some of the more extreme overbought conditions, it remains 2-standard deviations above its 200-week (4-Year) moving average. Even a correction back to the 52-week (1-year) moving average still requires another 7% decline from current levels.

It is also important to note that relative strength has negatively diverged from the market, going back to the beginning of 2018.

The still overly extended market from long-term means with declining RSI suggests investors should remain cautious over the remainder of the year and manage portfolio risk accordingly.

Monthly Data Suggests Caution

When analyzing the monthly data, the bearish backdrop is more evident.

From an investment standpoint, look at the last two bull market advances compared to the current Central Bank fueled explosion. The recent extension failed at the top of the rising upper-trend line forming a “megaphone” pattern.

Secondly, the market is trading MORE THAN 2-standard deviations above the long-term (4-Year) mean, ideal for a more considerable corrective decline. As noted above, combine the extreme extension with a negatively diverging RSI, the risk of a more massive mean-reverting event becomes evident.

When both the MACD and deviation from the 4-year moving average have coincided with previous declines in relative strength, it signaled more important correction processes. However, those correction processes did not occur immediately. As markets do, they tend to “suck” the most investors into the peak just before it gives way.

Importantly, MONTHLY data is ONLY valid at the end of the month. Therefore, these indicators are VERY SLOW to turn. Using Daily and Weekly charts are better for managing your immediate portfolio risk. Monthly charts provide a better long-range prediction of market trends.

Winter Is Coming Value, Winter Is Coming. Is It Time For “Value” To Shine? 08-28-20

Investing For The Rest Of 2020

Given the technical backdrop above, it should be evident that “risk” likely outweighs “reward” for the rest of this year. There are more than enough potential catalysts to upend markets unexpectedly:

  1. A contested election
  2. Lack of fiscal support
  3. A reduction in Federal Reserve support
  4. A resurgence of the pandemic.
  5. Economic growth weakens
  6. Earnings fail to meet expectations

You get the idea.

However, currently, investors are merely chasing performance. However, why would you NOT expect this to be the case when financial advisers, the mainstream media, and WallStreet continually press the idea that investors “must beat” some random benchmark index from one year to the next.

Investing, ultimately, is about managing the risks, which will substantially reduce your ability to “stay in the game long enough” to “win.” However, the distinction between investing and speculating has disappeared. As Ben Graham noted, we should be concerned:

“The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all its dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.” – Ben GrahamThe Intelligent Investor:

Yes, the risks are high. However, as investors, we can not merely sit on the sidelines, which is why a set of “rules” to manage risk is so essential. Such is something we can learn from the legendary investor Paul Tudor Jones.

The Rules That Made Tudor Jones Successful

Rule #1: Cut Losers Short & Let Winners Run.

It takes tremendous humility to navigate markets successfully. There can be no such thing as hubris when investments do not go the way you want them. Investors plagued with big egos cannot admit mistakes, or they believe they’re the most significant stock pickers who ever lived. To survive markets, one must avoid overconfidence.

Rule #2: Investing Without Specific End Goals Is A Big Mistake.

Before investing, you should already know the answer to the following two questions:

  1. At what price will I sell or take profits if I’m correct?
  2. Where will I sell it if I am wrong?

Hope and greed are not investment processes.

Rule #3: Emotional & Cognitive Biases Are Not Part Of The Process.

If your investment  (and financial) decisions start with:

  • I feel that
  • My friend told me
  • I heard
  • I hope

You are setting yourself up for a bad experience.

Rule #4: Follow The Trend.

“80% of portfolio performance is determined by the underlying trend. “

Rule #5: Don’t Turn A Profit Into A Loss.

Investing is about creating returns over time. If you don’t harvest gains, and then allow them to turn into a loss, you have started a “financial rinse cycle.”

Most importantly, “getting back to even” is not an investment strategy.

Rule #6: Odds Of Success Improve Greatly When Technical Analysis Supports Fundamental Analysis

The market for a long-time can ignore fundamentalsAs John Maynard Keynes once said:

“The stock market can remain irrational longer than you can remain solvent. “

Applying a technical overly to determine the “when” to invest can significantly improve the return and control the capital risk of the “what” fundamental analysis uncovers.

Rule #7: Try To Avoid Adding To Losing Positions.

Paul Tudor Jones once said, “only losers add to losers.”

The dilemma with “averaging down” reduces the return on invested capital, trying to recover a loss than redeploying capital to more profitable investments. Cutting losers short allows for more significant growth over time. 

Rule #8: In Bull Markets You Should Be “Long.” In Bear Markets – “Neutral” Or “Short.”

To invest against the major “trend” of the market is generally a fruitless and frustrating effort. During secular bull markets – remain invested in risk assets like stocks or initiate an ongoing process of trimming winners.

During bear markets – investors can look to reduce risk asset holdings overall back to their target asset allocations and build cash. An attempt to buy dips believing you’ve discovered the bottom or “stocks can’t go any lower” generally doesn’t work out well.

Rule #9: Invest First with Risk in Mind, Not Returns.

Investors who focus on risk first are less likely to fall prey to greed. We tend to focus on the potential return of investment and treat the risk taken to achieve it as an afterthought.

The objective of responsible portfolio management is to grow money over the long-term to reach specific financial milestones and to consider the risk taken to achieve those goals. Managing to prevent significant drawdowns in portfolios means giving up SOME upside to prevent the capture of MOST of the downside. While portfolios may return to even after a catastrophic loss, the precious TIME lost while “getting back to even” can never be regained.

Rule #10: The Goal Of Portfolio Management Is A 70% Success Rate.

Think about it – Major League batters go to the “Hall Of Fame” with a 40% success rate at the plate.

Portfolio management is not about ALWAYS being right. It is about consistently getting “on base” that wins the long game. There isn’t a strategy, discipline, or style that will work 100% of the time.

Once you understand that, the other 9-rules above become much simpler to incorporate,

Conclusion

“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.” – Howard Marks

The biggest driver of long-term investment returns is the minimization of psychological investment mistakes.

As Howard Marks opined:

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

As an investor, it is merely your job to step away from your “emotions” for a moment. Look objectively at the market around you. Is it currently dominated by “greed” or “fear?” Your long-term returns will depend much not only on how you answer that question but how you manage the inherent risk.

“The investor’s chief problem – and even his worst enemy – is likely to be himself.” – Benjamin Graham

Whether it is Paul Tudor Jones or any other great investor throughout history, they all had one core philosophy in common; the management of the inherent risk of investing.

“If you run out of chips, you are out of the game.”

TPA Analytics: Top 10 Buys & Sells As Of 09-28-20

Note from the RIAPro Team:

We are proud to offer TPA Analytics to you at a deeply discounted price. TPA has been serving institutional clients with their trading ideas and strategies. Now you can add the same long-short strategies and ideas to your portfolio as well.

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

As a subscriber, you will receive real-time alerts of trading activity by TPA and a minimum of 2-reports each week.

Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points.


These are high conviction stocks that TPA has recommended recently. They are technically positive for “buys,” or negative for “sells.” They are also trading at, or near, the recommended action price levels.

Viking Analytics: Weekly Gamma Band Update 9/28/2020

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

Gamma Band Update 09/28/20

  • The S&P 500 (SPX) continues to be at an important inflection point. Our Gamma Band model cut SPX exposure to 30% last Tuesday, September 22nd, and remained at the 30% level to close the week.
  • The SPX traded below the Gamma Neutral level all week, which points to higher volatility.
  • The slope of Gamma Neutral continues to be negative, which also lowers our model allocation.
  • The SPX closed near 3,300 on Friday and will need to overtake 3,350 on a closing basis for our model to begin raising its equity allocation.
  • If the SPX closes on a daily basis below the lower band (currently near 3,100), our indicator will cut SPX exposure to 0%.
  • Our binary Smart Money Indicator continues to have a full allocation, and we discuss this in greater detail below.
  • SPX skew, which measures the relative cost of puts to calls, presents a neutral environment at the moment.  
  • Our Thor Shield daily allocation model increased SPY allocation to 100% on Friday, and this full allocation will continue into Monday. ThorShield is a fast, daily signal based upon daily put and call volume.  Samples of all of our SPX and ThorShield daily reports can be downloaded from our website.

Smart Money Residual Index

This indicator compares “smart money” options buying to “hot money” options buying.  Generally, smart money will purchase options to ensure stable returns over the longer-term.  The smart money has in-depth knowledge and data in support of their options activity. In contrast, “Hot money” acts based on speculation, seeking a large payoff.

At the moment, hot money is more cautious than smart money, and the back-test supports a long position during this time.  When the Residual Sentiment Index in the second graph turns to red, then this model will cut all equity exposure to zero.  When the market is in the red regime below, the market has an overall negative return.

SPX Skew – the Price of Protection

In evaluating equity market risk, we also consider the cost of buying puts versus the cost of buying calls.  When puts command a larger-than-usual premium to calls, then the market will have higher volatility (in the red zone below), and this might be a signal to reduce equity exposure.  We consider skew to be neither bullish nor bearish at the moment.

Gamma Band Background

Market participants are increasingly aware of how the options markets can affect the equity markets in a way that can be viewed as the “tail wagging the dog.” 

We created a Gamma Band indicator to demonstrate the effectiveness of the Gamma Neutral level in reducing equity tail risk.  In our model, we compare the daily close of the SPX to the Gamma Neutral and Lower band levels to adjust our equity exposure allocation from 0% to 100%.  

We back-tested this strategy from 2007 to the present and discovered a 77% increase in risk-adjusted returns (shown below).  The Gamma Band model is a relatively slow but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish a faster, daily signal in a portfolio model which we call Thor’s Shield.  Thor Shield has a 20-year Sharpe of 1.5 and a rolling 1-year Sharpe of over 3.4.  Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

Authors

Viking Analytics is a quantitative research firm that creates tools to navigate complex markets.  If you would like to learn more, please visit our website, or download a complimentary report.

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

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


Major Market Buy-Sell Review: 09-28-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 09-28-20

There are three primary components to each Major Market Buy/Sell chart in this RIAPro review:

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

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

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

Major Market Buy/Sell Review 09-28-20

S&P 500 Index

  • As noted last week: “The market is now oversold short-term, so look for a tradable rally next week.”
  • It was a bouncy week, but the markets did manage to rally on Thursday and Friday.
  • The break of the 50-dma sets the market up for resistance at that level and the 20-dma is now headed to cross lower. It will be very important the market rallies and closes above the 50-dma next week. 
  • We continue to suggest using rallies to reduce risk and take profits for now.
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow is now oversold, so a tradeable rally is likely. 
  • Like the S&P it will struggle with the 50-dma, so this is still a market to sell into for now until resistance is taken out. 
  • Use rallies to sell into for now and reduce risk. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • As we wrote last week: “The QQQ’s are now decently oversold. Look for a rally next week to get back above the 50-dma. If not, the decline will test the 200-dma.” 
  • The Nasdaq failed to get above the 50-dma, if it fails at that level, we are likely going to see additional weakness.
  • As stated last week: “There is a tradable opportunity for major tech stocks next week. Keep stops very close.” – That advice remains going into next this week. 
  • Short-Term Positioning: Bearish.
    • Last Week: No changes this week.
    • This Week: Taking profits.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps failed the 50-dma this past week, and have taken out the 200-dma. 
  • The bullish news is the 50-dma did cross above the 200-dma but did little to provide support. 
  • Risk is to the downside currently. 
  • Stops were violated, close-out positions on a rally next week. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. However, MDY held up better than SLY last week. 
  • MDY is testing its 200-dma and holding for now. That must continue next week, otherwise, we will see further weakness.
  • We continue to avoid mid-caps for the time being until relative performance improves.
  • The $330 stop-loss remains intact, but just barely. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss is set at $330
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets had performed better on a relative basis during the correction, but failed this past week. 
  • EEM is oversold. But we warned that a dollar rally would impact this sector. That happened and it did. 
  • The dollar decline was responsible for EEM’s performance, it is now payback with the dollar rally. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved to $42 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • The dollar rally is impacting international markets the same as emerging. 
  • Maintain stops and pay attention to the dollar for now. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • We noted previously that “Oil is currently 3-standard deviations oversold so a bounce is likely next week. However, a continued dollar rally could halt that.”
  • The rally in oil occurred but did little to help the energy sector. Energy stocks remain under tremendous pressure currently.
  • Oil is currently testing resistance at the 200-dma. It needs to clear that if energy is going to get a lift. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long in our current position in IAU, but as we discussed in our portfolio updates this week, we reduced those positions further due to the rally in the dollar. 
  • Gold took out support at the 50-dma. We are looking to increase our exposure when gold gets extremely oversold or the dollar rally appears to be over. 
  • Stops are set at $175 and that level is barely holding currently. 
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions.
    • Stop-loss moved up to $175
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds continued to hold up last week and is continuing its consolidation process. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold position.
    • This Week: We sold 50% of AGG, added a position in IEF, and added to MBB.
    • Stop-loss moved up to $157.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • As we have discussed over the last two months: “Given a large number of analysts with “bearish” forecasts on the dollar, the probability of a dollar rally has risen.”
  • We also suggested that Traders can add positions to hedge portfolios, but there is not likely a colossal move available currently given the current market dynamics. 
  • That rally has started. However, the dollar is overbought short-term. Use weakness to add to positions that holds the 50-dma. 
  • Stop-loss adjusted to $92.

“Enormous Uncertainty” Despite Fed Fueled Market Surge.

“Enormous Uncerntainty.” That is how SimplyWise stated the situation in their latest “retirement confidence survey.” Such is despite a surging stock market from the March lows, trillions in liquidity support from the Fed, and a rebound in economic activity.

So, what’s the problem? Here is SimplyWise:

The current public heath, economic, and political reality in the United States has created enormous uncertainty for many Americans. A majority of citizens lack the savings to last them even three months. That savings gap is even more drastic when it comes to retirement. Indeed, the pandemic has wrought havoc on the retirement plans of many, driving some into early retirement and forcing others to postpone long-anticipated retirement plans. A majority of people today are more concerned than ever about retirement. According to the September 2020 SimplyWise Retirement Confidence Index, 58% of Americans are more concerned about retirement today compared to a year ago.” – SimplyWise September Index

Major Highlights

  • Given the current economic climate, only 19% of Americans plan to invest more in the stock market. However, only 34% of households with an income of more than $100k plan to invest more in stocks. 
  • 40% of respondents are planning to save more.
  • 51% of Americans think the stock market will decline by 20% over the next 6-months. Only 5% believe it’s improbable.
  • 36% believe the economy will worsen in the next 6-months, and 28% think it will get better.
  • 63% of Americans are confident in the future of Social Security if Biden is elected versus only 44% if Trump is elected.
  • 86% of Americans are concerned that the current payroll tax will hurt Social Security in the long term.  (90% of Dems and 83% of Republicans). 

There are several critical issues in the index which encapsulate the ongoing financial distress that existing before the pandemic, but have since markedly worsened.

Financial Insecurity

Here are some additional key findings as they relate to the financial insecurity of Americans today.

  • 15% of people who lost their job due to COVID-19 are now planning to retire earlier than anticipated. Just 10% in their 50s and 60s are now planning to retire earlier than expected.
  • 58% of people in their 50s are not confident they’ll maintain their same quality of life in retirement.
  • 30% of people in their 50s saved $0 for retirement in the last year—and 43% of them couldn’t last more than a month on their savings.
  • 27% of Americans are now considering tapping their 401(k)—a pandemic high.
  • 45% of Hispanics, 39% of Black, and 34% of White Americans couldn’t last a month on their savings.
  • 63% of Americans feel confident in the future of Social Security if Biden is elected. Only 44% feel optimistic with the re-election of President Trump.

These statistics, while stunning, importantly, NOT a result of the COVID-19 pandemic. The financial insecurity of Americans is an issue that has continued to grow over the last two decades. Such is an issue we discussed in “Boomers Are Facing A Financial Crisis.”

“The lack of savings, of course, is directly related to the rising cost of living versus the lack of wage growth over the last 35-years which led to a massive surge in debt to maintain the standard of living.”

Rising Concerns Across The Spectrum

Such an inability to fill the gap between the incomes and the “cost of living,” which is evident given the surge in debt, continues to give rise to financial and lifestyle concerns. As noted:

“For those not yet claiming Social Security benefits, financial concerns are among the highest anxieties around retirement. Fifty-seven percent worry about Social Security drying up, and 52% worry they will outlive their savings. For Americans who are currently on Social Security, 54% now worry about their benefits drying up—a significant increase from the 29% reported in July. Also, 47% are concerned about their ability to pay for medical bills in retirement. Another 47% are concerned about their ability to pay daily living expenses when they retire.” – SimplyWise

The reported problem was worst for those closest to retirement. Such is not surprising given the ongoing $70 Trillion unfunded liabilities for social welfare programs, which exacerbate each year.

The collapse in economic growth has resulted in a collapse in Federal Tax revenue needed to pay for the massive social welfare schemes in the U.S.

Retirement, Retirement Confidence Declined Despite A Surging Market

It now requires over 100% of Federal tax receipts to meet the mandatory spending of social welfare and interest on the debt. In other words, we are now going into debt more to provide social assistance.

How Bad Is It?

It isn’t projected to get better.

“Steadily worsening annual balances and cumulative values toward the end of the 75-year period provide an indication of the additional change that will be needed by that time in order to maintain solvency beyond 75 years. Consideration of summary measures alone for a 75‑year period can lead to incorrect perceptions and to policy prescriptions that do not achieve sustainable solvency.” – SSI 2020 Report

Under current law, the projected cost of Social Security increases faster than projected income through 2040 primarily because the ratio of workers paying taxes to beneficiaries receiving benefits will decline as the baby-boom generation ages and is replaced at working ages with subsequent lower birth-rate generations. While the effects of the aging baby boom and subsequent lower birth rates will have largely stabilized after 2040, annual cost will continue to grow faster than income, but to a lesser degree, reflecting continuing increases in life expectancy. Based on the Trustees’ intermediate assumptions, Social Security’s cost exceeds total income beginning in 2021, and throughout the remainder of the 75‑year projection period.” – SSA

Getting Worse

That report, dire in its warning already, was issued before the “Pandemic” and “economic shutdown.”

Meanwhile, demographics are blowing up the basic premise of the funding of Social Security. There were 2.8 workers for every Social Security recipient in 2017. That’s down from 3.3 in 2007, and that’s way down from the 5.1 workers per beneficiary in 1960.

Furthermore, the two programs function mostly as a giant conveyor belt to transfer wealth from the young and relatively poor to the old and relatively wealthy. Such allows the average person (who now lives to be 78) more than a decade of taxpayer-funded retirement.

In April, welfare spiked to the highest percentage of disposable personal incomes in history as the Government responded with massive taxpayer funds subsidies. While those numbers have declined in recent months, as the fiscal support runs dry, welfare still comprises 1/3rd of total disposable personal incomes.

“During the ‘Great Depression,’ the economically devastated masses would form ‘breadlines.’ Today, those ‘breadlines’ form at the mailbox.”

Unfortunately, recycled tax dollars used for consumptive purposes has virtually no impact on increasing economic activity. However, given the rather dire statistics, you can understand why for Americans in their 50s, 65% are now worried that Social Security will dry up by the time they retire. Moreover, 50% of them are concerned about paying for daily living expenses in retirement.

The D.A.D. Plan

The lack of financial security, and concerns over the solvency and stability of social welfare, has led to an increasing number of Americans to adopt the D.A.D. retirement plan. (Die. At. Desk.)

“The September Index found that more Americans than ever are planning to work into retirement. Today, 73% of workers plan to work after they claim Social Security retirement benefits. That is up from 67% this May and 72% in July. Delaying retirement may be attributed to the fact that only 63% of workers surveyed are making what they made prior to COVID-19.” – SimplyWise

We have discussed the lack of financial savings many times previously. Not surprisingly, SimplyWise noted the same in their survey.

“The September Index found that 30% of Americans saved nothing for retirement in the last year. In fact, the majority (56%) saved under $1,000 in the last year. The results were similar to those of May and July, when one in three Americans saved $0 for retirement.”

The statistics are even worse for older Americans.

“Of Americans in their 50s, 30% saved $0 for retirement in the last year. And 43% of people in their 50s couldn’t last more than a month off their savings.

These statistics are not new. However, there are far-reaching consequences on both the fiscal solvency of social welfare and long-run economic growth.

The Savings Dilemma

These are pretty depressing statistics when you think about it. However, for the bottom-80% of income earners whose income growth has been stagnant over the last two decades, the roadblocks to being “financially secure” for retirement shouldn’t be surprising.

In a survey from Kiplinger and Personal Capital, Americans said the biggest roadblocks to saving for retirement were:

  • The high cost of health insurance. “From 1999 to 2017, the cost of family health insurance coverage has more than doubled the amount of take-home pay it consumes.”
  • Disappointing investment performance.Just under 30% of all respondents (29.4%) said that disappointing investment performance had stopped them from saving as much as they would have liked to for retirement.” 
  • The amount of consumer debt they carried. “21.3% of Americans said that debt, not including student loans, kept them from saving for retirement combined with the increased costs of living.”

A Market For The Wealthy

The financial “insecurity” of most Americans has been the result of decades of financial mismanagement. Stagnant wage growth, combined with a consistent relaxation of lending standards, led to three generations of Americans living beyond their means.

The problem with “living for today,’ is that it leaves you with a financially depleted tomorrow. However, the financial media is full of “pundits” and “gurus,” suggesting that if you aggressively invest in the financial markets, all your problems will disappear.

However, the problem with the thesis is it hasn’t worked out that way. Repeated crashes in the stock market have destroyed both investor wealth and confidence. As SimplyWise noted, only a small fraction of respondents were planning to invest more in the financial markets due to changes in income levels.

No Trickle Down

While the Fed keeps inflating stock markets, the “trickle-down” effect has yet to occur. Even as noted in the SimplyWise survey, “disappointing investment returns” have stunted retirees saving plans. 

However, after 4-decades of transferring wealth from the middle-class to the rich, it is the top-10% of income earners who own 88% of stock markets. Therefore, it should not be surprising that most individuals planning to invest more are in the top income brackets.

For the rest, two major bear markets, lack of wage growth, and surging costs of living have eroded any ability to build savings for retirement. Such is why most retirees will depend on social welfare for 50%, or more, of their retirement income. 

The mirage of consumer wealth has not been a function of a broad-based increase in Americans’ net worth. Instead, it has been a division in the country between the Top 20% who have the wealth and the Bottom 80% dependent on increasing debt levels to sustain their current standard of living.

With the vast amount of individuals already vastly under-saved and dependent on social welfare, the current economic devastation will reveal the full extent of the “retirement crisis.” 

Of course, this is also why the calls for more socialistic policies continue to rise.

The Sell-Off Is Overdone. The Correction May Not Be.


In this issue of “The Sell-Off Is Overdone. The Correction May Not Be.”

  • An Orderly Sell-Off
  • Is The Fed Done?
  • The Correction May Not Be Over
  • Portfolio Positioning Update
  • MacroView: A Permanent Shift To Valuations
  • Sector & Market Analysis
  • 401k Plan Manager

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


The Pre-Election Retirement Guide

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP, for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are wanting.

  • When: Saturday, October 3rd, 2020
  • Time: 9-11 am
  • Where: An exclusive GoTo Webinar Event (Register Now)

Catch Up On What You Missed Last Week


An Orderly Sell-Off

Over the last couple of weeks, we have been discussing the ongoing market correction. As shown below, the sell-off has been orderly and not one of a “panic” induced decline.

The market did retrace from the top of the 2-standard deviation range to the bottom, which is part of a healthy correction process. As we noted last week, the correction also aligns with the historical weakness seen in September and October, particularly in years preceding an election.

Importantly, given there was no sharp rise in volatility, such also confirms this was a more orderly and healthy market retracement.

While the sell-off in the market has gotten overdone short-term, we still suggest using rallies back to the 50-dma to rebalance portfolio risks. Look at the first chart above. The market is currently in a very defined downtrend. Friday’s march failed to break out of that resistance.

In the chart below, we see the market rallied back to the previous consolidation lows with the 20-dma approaching a cross of the 50-dma. Such would suggest more downward pressure on prices short-term. The 200-dma is roughly 7% lower from Friday’s close. 

If the market can break above resistance on Monday, clear the 50- and 20-dma’s, then old highs should not be an issue.

But that will take a fair bit of work at a time where market risks have increased.

Is The Fed Done?

“Federal Reserve Board Chairman Jerome Powell warned Wednesday that a lack of further fiscal support from Congress and President Trump could “scar and damage” a U.S. economy restrained by the coronavirus pandemic.” – The Hill

Such is an interesting position from the head of the Central Bank who has flooded the system with liquidity. The chart below is a bit dated but shows the rather tepid uptake of emergency measures.

The reason the usage of the programs is so low is two-fold.

  1. The functioning credit markets function on sentiment. There is always plenty of liquidity in the credit markets. What was needed was the “confidence” the markets would work properly. Once the Fed cured the “sentiment” problem, there was mostly no need for liquidity from the Fed. Companies were able to go to market, issue securities, or borrow money as needed. 
  2. Companies didn’t want to take on additional debt. While the design of the programs was to support businesses in keeping employees paid, if there is “no” or “greatly reduced” customers due to lockdowns, taking on debt to keep employees makes little sense.

The second point is more important. While the Federal Reserve can calm and support public markets, they have little impact on the non-public markets. The real crisis is in small and medium-sized businesses that do not have access to public markets, either equity or debt, to raise needed capital.

The large pool of non-public businesses are facing large amounts of devastation currently, and the “death rate” of small businesses is rising to nearly 50%. Given that small businesses make up roughly half of the employment in the U.S., this is no trivial matter.

The Fiscal Kink

The Federal Reserve is trying to plug a hole that fiscal policy was widely expected to fill by now. However, the Fed’s ability to expand on current programs is limited to the Treasury Department’s issuance of additional debt. Without another “fiscal relief” bill, there isn’t enough debt issuance to support another round of interventions by the Fed. 

Currently, the Federal Reserve is continuing to run “Quantitative Easing” at $120 billion per month, but much of that is just replacing bills that are maturing. As shown below, the Fed’s balance sheet has been stagnating since June as the uptake from its various programs has waned.

Subsequently, excess bank reserves, which have supported the market recovery from the March lows, have also peaked.

A Louder Message

While the Federal Reserve could undoubtedly begin to more bonds in the open market, they realize they run the risk of disrupting the credit market by becoming too big of a buyer. The Fed has previously warned they did not want to disrupt markets in this manner.

As noted by Zerohedge on Friday:

“Two weeks ago, when the Fed published its latest monthly breakdown of purchases Secondary Market Corporate Credit Facility which shockingly showed that in the entire month of August, the Fed had not purchased a single corporate bond ETF and had barely purchased any corporate bonds in the open market, we asked if Powell was ‘sending the market as message.’

In the subsequent two weeks, which saw a sharp drop in risk assets and the Nasdaq sliding into a 10% correction, coupled with a modest rout across the corporate bond sector, many had expected the Fed to revert to its role as custodian of market stability and ramp up its purchases of corporate bonds, if for no other reason then to assure investors that Uncle Jerome was still watching over everyone.

So in what may come as a big surprise to all those praying for the Fed to bail them out, or to at least telegraph that he is keeping an eye on the current tech-led market mess, Powell did no such thing and in fact the Fed’s latest weekly H.4.1 report showed that the corporate credit facilities held $12.911bn of corporate bonds and ETFs as of Tuesday, up a tiny $44 million from $12.867BN the prior week.”

As noted, without more “fiscal” support, their “monetary” capabilities become much more limited.

Fiscal Support Not Likely 

Despite the Federal Reserve imploring Washington for more “fiscal” support during the last couple of speeches, it is unlikely to happen. As we discussed in Tuesday’s reportNo Help Is Coming:”

“Why is this important to the market? Because Congress is facing three different events that have removed the focus from additional financial support for the economy.

  1. With the election fast approaching, Congress does not want to pass a fiscal support bill to help the other Presidential candidate. Such is why there are dueling bills between the House and Senate currently.  
  2. September ends the 2020 fiscal year of Congress. Such requires either a “budget,” or another C.R. (Continuing Resolution) to fund the government and avoid another shut-down.
  3. Lastly, the death of RBG will have the entire Democratic Party, which controls the House, focused on how to stop President Trump from nominating a replacement before the election. All Trump needs is a simple majority in the Senate to confirm a justice that he can likely get.”

Without more fiscal support, the entire premise of the “economic reflation” trade may be over. Economic data is already starting to disappoint as stimulus runs dry, and earnings estimates have begun to fall again, as I addressed last week.

“Such also correlates with weaker economic data showing up. Weaker economic data translates into reduced earnings outlooks for companies. During the last 30-days, 2021 estimates for the S&P 500 have declined by an additional $5/share. Furthermore, those estimates are down nearly $30 from the original forecast in January 2020. Yet, markets remain only slightly off all-time highs.”

Market Realized No Help, Technically Speaking: Market Realized No Help Is Coming

For these reasons, while the markets may indeed see a short-term bounce, the longer-term correction may not be over.

The Correction May Not Be Done

Given the challenges facing the markets over the intermediate-term from a “contested election,” a lack of financial support, a pandemic resurgence, and economic disruption, the risk of a deeper correction remain.

If we look at the weekly chart below, we find that when the market has historically broken below its short-term weekly moving average, it has, with some consistently, tested the longer-term average. Currently, that is almost 7% lower than where we closed on Friday.

Given we are still in a recessionary environment, that earnings remain weak, and the market remains rather extended from its long-term means, a deeper correction in the months ahead is certainly not out of the question.

Investors will likely benefit from maintaining caution in portfolios and continuing to use rallies to rebalance risks accordingly.

Portfolio Positioning Update

Over the last few weeks, we have repeatedly discussed the idea of reducing risk, hedging, and rebalancing portfolios. Part of this was undoubtedly due to the overly exuberant rise from the March lows and the potential for an unexpected election outcome.

This past week, we continued to look for a “tradeable bottom,” but did not see a reasonable risk/reward set up just yet. 

Given the extent of the correction over the last three weeks, and the increase in negative sentiment, we will likely add trading positions to portfolios on Monday. We will primarily focus on the Technology, Communications, Discretionary, and Staples sectors.

Such aligns with our short-term “risk-reward” ranges, which are provided weekly to our RIAPRO Subscribers (Click Here For 30-day Free Trial)

We are currently going to avoid international, emerging markets, basic materials, and industrials. These areas are subject to a rally in the dollar. Given the hugely negative sentiment in the U.S. Dollar, we have been warning for several weeks that a counter-trend rally was likely.

Portfolio Changes

In the meantime, we did make some adjustments to our bond portfolio to reduce some of our corporate bond exposures and increase our mortgage back and shorter-duration Treasury holdings. Such increased our “credit quality” in our bond portfolio while mildly reducing our duration to shore up volatility risk.

We also temporarily reduced our exposure to gold and gold miners due to the dollar rally. We will add back to these positions on further weakness.

Lastly, we also continue to hold a healthy allocation to cash, which we will add back to our equity holdings as the opportunity presents itself. On this part of our portfolio exposure, we agree with a comment Doug Kass made this past week:

“Longer-term investors, with timeframes measured in years and not days or weeks, in particular, should cheer the recent market dive. In my playbook, high stock prices are the enemy of the rationale buyer and low stock prices are the friend of the rational buyer. 

My experience is that traders know everything about price but little of value. Who wouldn’t rather buy at a lower price than a higher price?”

Such is why we have been digging through “value” stocks looking for opportunities most investors are overlooking to chase prices higher. There are many great opportunities, but they require patience, a strong stomach, and the ability to know the difference between short-term gains and long-term wealth building.

“The NYSE is the only place in the world that when the sign says ‘Every day high prices’, everyone gets excited. If Walmart had the same sign, instead of ‘Every day low prices’, no one would show up.” – Peter Boockvar


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

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


Portfolio Positioning “Fear / Greed” Gauge

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


Sector Model Analysis & Risk Ranges

How To Read.

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


Weekly Stock Screens

Currently, there are 3-different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

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

S&P 500 Growth Screen

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

Technical Trading Screen


Portfolio / Client Update

As discussed last week, we were expecting a rally this week, which finally materialized. Such was enough to get the “bulls” excited and declare the recent correction over.

We will likely use the current oversold condition to “average” into some of our stronger positions. We will also pick up some exposure to our “value” holdings as well. However, we are still well aware of the risk heading into the election. So whatever additions we do pick up will likely be shorter-term in nature.

Such continues to be a market primarily driven by the largest technology names, making running a more diversified portfolio less attractive. However, in the longer term, we are staunch believers that throwing caution to the wind tends to lead to poor outcomes.

As such, for now, we are content giving up some performance to hedge against a rising level of risks, both known and unknown. Importantly, it is usually never the risk we are focused on (upcoming election) that trips up the markets, but the ones we aren’t even thinking of.

Such is why we remain cautious for now.

Portfolio Changes

This past week involved very few changes to our portfolio models. We did reduce our gold and gold mining holdings temporarily against a rise in the U.S. Dollar. We will add back to those holdings once the dollar rally is complete.

We also rebalanced our bond holdings. Such was to improve credit quality, shorten the duration, and reduce risk. As such, we added shorter-duration Treasury exposure (IEF). We also reduced our corporate bond exposures (AGG) and increased our Mortgage-backed securities (MBB).

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

As an RIA PRO subscriber (You get your first 30-days free), you have access to our live 401k plan manager.

Compare your current 401k allocation to our recommendation for your company-specific plan and our on 401k model allocation.

You can also track performance, estimate future values based on your savings and expected returns, and dig down into your sector and market allocations.

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

Arete’s Observations 9/26/2020

Areté’s Observations 9/26/20

Market observations

Although the market has trended down since early September, declines have been orderly and at least partly a consolidation of big gains over the summer. The graph below shows inflows for the 3x leveraged Nasdaq 100 ETF. Needless to say, the speculative urge is still rampant.

Another area where the speculative urge still seems rampant is with small cap stocks. More sensitive than large cap stocks, small caps can produce greater returns when stocks are working, but greater losses when they aren’t. The graph below shows the case for small caps is becoming more fraught by the day as the Russell 2000 index is increasingly comprised of companies that are unprofitable. Recent research suggests this is a particular problem for small caps.

Settling the Size Matter by David Blitz and Matthias Hanauer of Robeco Quantitative Investments (h/t John Authers via “Points of Return” email, 9/23/20)

“The regression results do imply that size adds significant value when used in conjunction with quality. Taking a closer look at this result, we find that it is entirely driven by the short side of quality portfolios and breaks down for the long side. In sum, the added value of size appears to be limited to investors who short US junk stocks.”

In other words, according to the paper, the best way to make money with small caps is to short the low-quality ones. This is the exact opposite of what many investors are actually doing when they buy the Russell 2000 index as a leveraged bet on stocks in general.

Economy

There continues to be two almost diametrically opposed perspectives on the economy. From one angle, the economy appears to be on the mend.

Household net worth in the US jumped last quarter and that was largely due to gains in the stock market. Not only can net worth solve a lot of problems, but it reflects positively on economic prospects as well.

By other measures, however, the economy is still extremely weak. I have mentioned the statistics on hunger before, not least of which is because it is a real, tangible indicator of economic condition.

A new era of hunger has hit the US

“Ms Babineaux-Fontenot provides some shocking numbers. ‘I hope I’m wrong, but if I’m not’, she says, an extra 17m people in the US could be ‘food insecure’ in 2020 as a result of the pandemic. That would make a total of 54m, according to Feeding America’s calculations, up from 37.2m before the crisis. And 18m, or one in four, of those hungry people will be children.”

At very least, we can see how a focus on different measures can produce dramatically different perspectives of the economy. When the statistics on hunger are combined with the diminishing capacity of families to cover basic needs (graph below) it becomes evident there are structural problems in the economy that facilitate inequality. On one hand, overall net worth is rising rapidly; on the other, families can’t even afford to pay for basic needs on average.

Comments by the Fed chairman this week provide some important signals for investors on the subject.

Jay Powell warns recovery will suffer without stimulus

“Jay Powell, the chairman of the Federal Reserve, warned Congress that the US economic recovery would suffer if lawmakers failed to pass a new fiscal stimulus package, saying small businesses and lower-income households still needed government help.”

“’Many borrowers will benefit from these programmes, as will the overall economy, but for others, a loan that could be difficult to repay might not be the answer,’ Mr Powell said.”

By explicitly highlighting the importance of fiscal policy, Powell implicitly admitted the limits of monetary policy. That the market sold off after an uneventful Fed meeting last week points to the market’s dependence on the Fed’s largesse.

The comments were also notable for more directly addressing the issue of inequality. To date, the Fed has adamantly rejected any suggestion that it may be increasing inequality. This time, however, Powell as much as admitted that monetary policy has not been able to help small businesses or people with low incomes. By deduction then, monetary policy has provided a disproportionate benefit to owners of stocks and bonds.

We will have to see if Powell’s remarks are simply cheap words intended to mollify critics or if they represent a change in course. The test will be if stocks continue to fall. If they do, more action will be expected from the Fed. If the Fed ramps up interventions again, markets can rest assured the Fed still has their back. If the Fed doesn’t react to a continued selloff, investors will have to look for other reasons to continue believing in stocks. Regardless, it is interesting that the Fed is more directly addressing the issue of inequality.

Innovation

Cultural Innovation: The secret to building breakthrough businesses

“Procter & Gamble, for example, pursues what it calls constructive disruption. The company has designed its innovation process like a start-up’s, with a venture lab that pulls in tech entrepreneurs and a lean probe-and-learn prototyping process. That approach is not working.”

“Companies struggle because they put all their chips on one innovation paradigm—what I call better mousetraps … This is innovation as conceived by engineers and economists—a race to create the killer value proposition. It wins on functionality, convenience, reliability, price, or user experience.”

I introduced the notion of “fresh starts” in the 9/11/20 edition of Observations and since came across this article from HBR which applies slightly different language to the same concept. In short, some situations involve innovation that is linear and incremental. At other times, however, innovation involves a fundamental reimagining of what is valuable.

In a world of Covid restrictions this concept could hardly be timelier. As many of us are re-evaluating how much time we need to spend commuting, how often we need to wear business attire, where we should live, and a host of other things, what we are really doing is reflecting on what is most important to us.

“Better-mousetraps innovation is guided by quantitative ambitions: Outdo your competitors on existing notions of value. Cultural innovation operates according to qualitative ambitions: Change the understanding of what is considered valuable.”

As such, there is an enormous business opportunity to go beyond just building better mousetraps and instead to develop new goods and services that tap into some of the newly appreciated values. Since the approach by Proctor & Gamble and many other incumbent providers “is not working”, much of the opportunity is open to entrepreneurs and smaller companies. Although there will certainly also be difficulties and frictions along the way, there will also be opportunities for major breakthroughs.

Credit

Grant’s Interest Rate Observer, September 18,2020

“By intervening on an unprecedented scale, the Federal Reserve is supporting high-yield bond prices at a level that otherwise would be unimaginable in a recession, with commercial bankers wary of extending credit to all but the safest business borrowers.”

In a review of high-yield credit, Grants captured the above assessment from arguably the field’s pre-eminent authority, Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors, LLC. The comments elicit two thoughts. One relates to the artificial buoyancy of high-yield bonds. As Fridson himself acknowledges, such blessedness is fragile: “I’ve seen in the past that bonds just turn on a dime”.

Another thought is the increasing divergence between the “haves” and the “have nots” in the credit world. The difference is becoming less of a continuum and more of a distinct border. For instance, Grant’s notes that the median borrower among the 25% of least indebted companies saw leverage ratios decline last year.

Conversely, the median borrower among the 25% most indebted companies experienced leverage that almost doubled, “to 11 time Ebitda from 6.3 times last year”. For context, “an 11x net leverage number pretty much undermines a viable equity value for many HY companies …” Alas, such companies might be better labeled as “barely viable” than “high-yield”.

China

US-China: Temperature rising

Several items regarding relations between the US and China have emerged over the last couple of weeks and none of them good. Signal, a newsletter by GZero Media, chronicled several of these including, “US jabs over Hong Kong”, “Action on forced labor in Xinjiang”, “US strikes China’s Belt and Road project”, “US ban on China’s TikTok and WeChat”, “New tensions over Taiwan”, and “China flashes a trade weapon”.

While it is interesting that tensions seem to be percolating just ahead of the presidential election, it is perhaps most interesting that this is also the time that Terry Branstad, US Ambassador to China, decided to step down. As Luke Gromen noted in his Tree Rings newsletter (September 18, 2020), this action is potentially a sign of “turbulence incoming”. I agree; this seems like more than just coincidence.

Currencies

One of the hotter topics through the summer months was the weakness of the US dollar (USD). The narrative was that with unrestrained money printing and an exploding budget deficit, there was no direction for USD to go but down.

While there are clearly flaws to this portrayal, the weakening USD serves other purposes. For one, the weaker USD provides some relief to emerging markets that are suffering a double whammy of weak economic growth and weak currencies. The weaker USD also (ostensibly) provides incremental incentive for foreign entities to purchase US Treasuries which are expensive when the dollar is strong. Finally, USD also serves as a risk indicator. When volatility is high, investors flock to USD. Therefore, a weak USD signals relative tranquility in the investment landscape.

The big question is, what now? Did a weakening USD simply buy some time before things get shaken up again? Or is the recent uptick simply a short-term deviation from a broader downward trend? While I certainly don’t want to get into the game of short-term currency trading, I think the most likely scenario in the intermediate term is that USD will bounce back and that will prove extremely inconvenient for many foreign entities.

Coronavirus

US Suffers Most New COVID-19 Cases In 5 Weeks As Doctors Warn Of “Apocalyptic” Fall: Live Updates

“With many schools planning to end their semesters at the November holiday, students will disperse across the country, and some will bring the disease with them.”

“’This is beyond our wildest nightmares,’ said Gavin Yamey, a physician who directs Duke University’s Center for Policy Impact in Global Health.”

In the 8/21/20 edition of Observations I pointed out the special challenge that students returning to college presented to the effort to control the spread of the coronavirus. The facts that “campuses make an excellent breeding ground for the virus” and that many high-risk geographies were also allowing the resumption of football games seemed to create a lot of potential for increased infections.

In hindsight, this was absolutely right. Colleges and universities have been experiencing substantial outbreaks of coronavirus infections. One takeaway is that whatever measures were put into place ahead of time were not nearly enough. It didn’t have to be this way, but it was. Experience has proven that people still are not taking the threat of coronavirus seriously enough and political leaders, in general, have not been able to formulate cohesive or effective policies. Until those things change, there is no reason to expect different results.

Another takeaway is that with fall flu season right on the threshold, there is a fairly high risk of a significant second wave of infections, and one that could easily be worse than the first wave. Indeed, this is now my base expectation and one that does not seem to be getting serious consideration elsewhere. Unfortunately, there is a good chance that this will happen just as turbulence around the election develops and the economic impact of lost unemployment benefits start hitting home.

Politics

The Welding Shut of the American Mind

 “Freedom of the mind requires not only, or not even specially, the absence of legal constraints but the presence of alternative thoughts. The most successful tyranny is not the one that uses force to assure uniformity but the one that removes the awareness of other possibilities.”

“Yet if a student can – and this is most difficult and unusual – draw back, get a critical distance on what he clings to, come to doubt the ultimate value of what he loves, he has taken the first and most difficult step toward the philosophic conversion.”

This note from Ben Hunt at Epsilon Theory features a couple of quotes from Allan Bloom in his book, “The Closing of the American Mind”. Like many notes from Hunt, it can be challenging to read. Also, like other notes from Hunt, it reveals some of the most important dynamics occurring in society and politics today. If you have not reviewed the content at Epsilon Theory, I would strongly recommend doing so. The work there is invaluable for making sense of today’s crazy world.

This particular note, in one sense, speaks to the development of extreme partisanship. It is about more than partisanship, though. The note describes the process whereby minds eventually close to new and different ideas. These are important issues at about every level and remind me of Jonathan Haidt’s book, “The Righteous Mind”.

These ideas resonate with me for a couple of reasons. For one, the work consistently identifies the implications of a polarized political landscape to our roles as both investors and as citizens. In addition, the work consistently informs those of us who prefer to “seek the truth” rather than to embrace convenient narratives. Good stuff.

Inflation

The Solid Ground report by Russell Napier, 23rd July, 2020

“Savers must be in no doubt that the aim of MMT [Modern Monetary Theory] is to redistribute wealth in an economy without full democratic endorsement and, crucially, in an arbitrary form.”

“Her [Stephanie Kelton’s] goals can be met without resort to MMT but that would require overt political endorsement for a much more active fiscal policy …”

MMT has been making the rounds as a proposal to deal with excessive levels of debt. I haven’t discussed it much because I consider it to be an intellectually vacuous effort and one unworthy of serious consideration. Russell Napier’s scathing review of MMT and clinical dissection of its flaws corroborates that position.

That said, MMT is getting a lot of attention in the press and in policy circles. Napier’s analysis reveals a couple of elements of the theory that are relevant for investors. One is that the core policy aim is to “redistribute wealth … without full democratic endorsement”. The other is that this desperate measure is only being resorted to because of the lack of support for “overt political endorsement”. These are neither the makings of a benign investment environment nor a healthy democracy.

Implications for investment strategy

It is hard to observe the happenings in capital markets and to synthesize those observations and not conclude that markets are on the outer fringes of speculative excess. Whether it is tech shares, high-yield bonds, small cap stocks, or other risk assets, the signs of overreach are everywhere.

This creates a risk and an opportunity for long-term investors. The risk, of course, is getting sucked into a game of trying to make short-term profits at the expense of taking great risks. The opportunity is to step back, recognize, and prepare for a couple of big changes that are coming.

One of those changes will be with public policy. Sooner or later inflation will come and shortly after it, financial repression. These measures will make investing extremely challenging. Further, there will be very little warning; nothing will be officially announced. Napier’s warning that “there is something much more concerning – a complete refusal to discuss what impact MMT will have on savers,” is apt: These polices will arrive as Trojan horses. They will come quietly, through the back door, with nothing to suggest their risk. Investors need to get prepared – now.

I believe another change will involve cultural innovation in the field of investment services. Most services are predicated on incremental quantitative measures – slightly better performance or slightly less risk. All of these are fine when risk assets keep going up.

When the going gets a lot tougher for financial assets, however, reaching for slightly higher returns becomes a much less valuable service. In its stead, qualitative goals such as preserving one’s wealth and managing risk take on a whole new meaning. Above all else, trustworthiness will be crucial. These changes are coming – maybe not today, and maybe not this year, but well within the investment horizon of long-term investors.  

Principles for Areté’s Observations

  1. All the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.

Comments

Please direct comments or feedback to drobertson@areteam.com.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

Technical Value Scorecard Report For The Week 09-25-20

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis, versus the assets benchmark, and on an absolute stand-alone basis.

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

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

This technical value scorecard report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary 09-25-20

  • We are going to work backward through the analysis this week to show the changes that occurred over the last week.
  • As shown in the “spaghetti” charts below, all S&P sectors are now in one of the two bottom quadrants. None of them appear to be stabilizing or trying to turn higher. We will keep an eye out for sectors moving toward the bottom right quadrant in an upward fashion.
  • Staples, discretionary, materials, and industrials remain the most overbought sectors despite reducing some frothiness last week. The reflationary recovery is being called into doubt, which if it continues, could spell trouble for the recently high flying materials and industrials sectors.
  • On a relative basis, energy and possibly the technology sectors are the only overbought industries.
  • All 12 sectors are below their respective 50 day moving averages and 4 have now fallen below their 200-day averages.
  • Mid-cap and small-caps appear to be the most overbought factors, while the more “value” oriented sectors continue to outperform.
  • On an absolute basis, every sector is now fairly valued or slightly oversold. The only exception is energy which remains grossly oversold. Energy is certainly due for a bounce, but we offer caution as it has remained overbought and technically very weak for a long time.
  • The S&P 500 is sitting just below fair value. It has reduced some of its overbought condition but appears to have more downside before we would be comfortable buying it. This should not be surprising as it is still over 4% above its 200-day moving average.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

#MacroView: The Astonishing Lack Of Value In Value

We have recently been discussing the lack of performance in value versus growth. Such is historically the case during the late-stage, exuberance-driven, bull markets. However, not everything classified as a “value stock” is necessarily a value. The problem today, more so than at any point previously, is the astonishing lack of value in “value.”

The chart is pretty stunning but needs some explanation.

The Problem With Book

Valuing a company is not a simple task. Every fundamental analyst uses different measures and adjustments to calculate a fair valuation. Importantly, there is no precise method, and each presents a different version with varying results. Such is why “value” investors often use several valuation methods in combination to gain a better perspective of the underlying business.

One such method of valuation is “book value.” Theoretically, book value represents the total amount a company is worth under a liquidation scenario. Such is the amount that the company’s creditors can expect to receive.

Book value analysis, and buying companies with low “price-to-book” ratios, has historically been a profitable venture. Companies with machinery, inventory, and equipment, and financial assets tend to have large book values. Significantly, these types of assets are easily valued and liquidated in the event of financial stress or bankruptcy.

However, today, as shown in the tweet above, such is no longer the case. With the rise in gaming, software, database, consultancies, etc., the increase in “intangible assets” has surged. Items such as patents, licenses, human capital, etc. now make up a significant portion of many company’s “value.” These types of assets are hard to value, and more difficult to liquidate. Such is especially the case with human capital, or a measure of the economic value of an employee’s skill set.

The Intangibility Of The Intangible

Here is the issue with intangible assets.

“Intangible assets are typically nonphysical assets used over the long-term. Intangible assets are often intellectual assets. Proper valuation and accounting of intangible assets are often problematic. Such is due in large part to how intangible assets are handled. The difficulty assigning value stems from the uncertainty of their future benefits. Also, the useful life of an intangible asset can be either identifiable or non-identifiable. Most intangible assets are long-term assets meaning they have a useful life of more than a year.” – Investopedia

Read the bolded sentence again.

In many cases, the value of intangible assets is often overly optimistic assumptions about the companies worth. The companies website, brand, software, permits, etc. may indeed have recognizable value today. However, in many cases, those values can change rapidly. Such is the case where there are few barriers to entry, rapid changes in consumer demand, or economic or political interference,

In other words, a company with large amounts of property, plant, and equipment has a greater definable value than one with large amounts of “human capital.”

Here is the entirety of the problem summed up nicely by Raconteur:

“Tangible assets are easy to value. They’re typically physical assets with finite monetary values, but over the years have become a smaller part of a company’s total worth. Technology disruption continues in artificial intelligence, robotics and cloud computing. As such, intangible assets have grown to represent the lion’s share of corporate valuations. But without a physical form and the ability to easily convert them into cash, working out what these assets are truly worth can be challenging.”

A Pervasive Problem

Just recently, Visual Capitalist prepared an infographic for Raconteur.

“In 2018, intangible assets for S&P 500 companies hit a record value of $21 trillion. These assets, which are not physical in nature and include things like intellectual property, have rapidly risen in importance compared to tangible assets like cash.”

Click To Enlarge

As shown, in recent years, the surge in intangible assets has become a larger share of enterprise value. The largest contributors to intangible assets are:

  • Intellectual Property
  • B2B Rights
  • Brand
  • Hard Intangibles Like “Goodwill”
  • Data
  • Non-Revenue Rights (Non-Compete Agreements)
  • Relationships
  • Public Rights

You should almost immediately grasp that while these assets may have “value” to the company, they may not hold much value during a liquidation process. Or rather, “one man’s riches are another man’s trash.” 

The Evolution

“Intangibles used to play a much smaller role than they do now, with physical assets comprising the majority of value for most enterprise companies. However, an increasingly competitive and digital economy has placed the focus on things like intellectual property, as companies race to out-innovate one another.

To measure this historical shift, Aon and the Ponemon Institute analyzed the value of intangible and tangible assets over nearly four and a half decades on the S&P 500. Here’s how they stack up:” – Visual Capitalist

“In just 43 years, intangibles have evolved from a supporting asset into a major consideration for investors – today, they make up 84% of all enterprise value on the S&P 500, a massive increase from just 17% in 1975.

Digital-centric sectors, such as internet & software and technology & IT, are heavily reliant on intangible assets. Brand Finance, which produces an annual ranking of companies based on intangible value, has companies in these sectors taking the top five spots on the 2019 edition of their report.” – Visual Capitalist

While the issues of “intangibles” should undoubtedly be a concern for “value” investors, another issue further compounding the problem. Debt and accounting gimmicks.

A Compounded Problem

As discussed previously in “EBITDA Is Bull****, the heavy use of accounting gimmicks is obfuscating the real value of publicly traded companies. As noted:

“An in-depth study by Audit Analytics revealed that 97% of companies in the S&P 500 used non-GAAP financials in 2017, up from 59% in 1996, while the average number of different non-GAAP metrics used per filing rose from 2.35 to 7.45 over two decades.

, Earnings Lies & Why Munger Says “EBITDA is Bull S***”

, Earnings Lies & Why Munger Says “EBITDA is Bull S***”

This growing divergence between the earnings calculated according to accepted accounting principles, and the ‘earnings’ touted in press releases and analyst research reports, has put investors at a disadvantage of understanding exactly what they are paying for.”

Compound the problem accounting issues with surging levels of corporate debt, and the issue becomes more apparent.

Since the onset of the pandemic, the enterprise value to GVA (gross value added) ratio has surged.

Given the Federal Reserve’s monetary injections and suppression of interest rates, it is not surprising to see companies leveraging their balance sheets. As interest rates have plunged, corporations have hit a record issuance of debt to pay dividends and other non-productive purposes.

The increased leverage of corporate balance sheets is problematic, particularly given already weak revenue growth for S&P 500 companies.

Lack Of Disclosure

The debt, accounting gimmicks, and intangible assets make it increasingly difficult for investors to determine the actual “value” of the companies they are investing in.

Currently, given the speculative nature of the investing environment, such certainly seems to be an irrelevant problem. However, in the long-run, “value” always matters in the end.

The problem, when it comes to investors, is understanding and identifying these issues, particularly in the case of intangibles. As shown in the tables above, most investors are unaware that intangible assets make up such a large percentage of overall enterprise value.

When you combine that issue with the surge in corporate debt and level of debt relative to enterprise value, it is easy to visualize the risk investors are taking on.

Visual Capitalist’s conclusion is appropriate:

The majority of intangibles are not reported on balance sheets because accounting standards do not recognize them until a transaction has occurred to support their value. While many accounting managers see this as a prudent measure to stop unsubstantiated asset values, it means that many highly valuable intangibles never appear in financial reporting. In fact, 34% of the total worth of the world’s publicly traded companies is made up of undisclosed value.

Brand Finance believes that companies should regularly value each intangible asset, including the key assumptions management made when deriving their value. This information would be extremely useful for managers, investors, and other stakeholders.”

Conclusion

Without better disclosures, a return to “mark-to-market” accounting practices, and tighter restrictions on “accounting gimmicks,” investors remain exposed to increased risks.

Of course, when executives’ compensation benefits from manipulating their earnings and speculative investors benefit during bull markets, you can understand why the rules won’t change.

That is, of course, until investors once again lose a majority of their invested wealth.

As Warren Buffett once quipped: “Price is what you pay, value is what you get.” 

With a “lack of value” in value, just make sure you know what you are paying for.

#WhatYouMissed On RIA This Week: 09-25-20

What You Missed On RIA This Week Ending 09-25-20

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

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


The Pre-Election Retirement Guide

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for. 

  • When: Saturday, October 3rd, 2020
  • Time: 9-11am
  • Where: An exclusive GoTo Webinar Event (Register Now)

What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 09-25-20


What You Missed: Video Of The Week

Market’s Sell-Off Has Been Orderly

As discussed in the video below, we had written that a 5-10% correction was likely and that it would feel worse than it was. Well, here we are, and it has. The question now is “what happens next?”



Our Best Tweets For The Week: 09-25-20

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Nick Lane: The Value Seeker Report- Spectrum Brands Holdings (NYSE: SPB)

This article is an RIA PRO exclusive for subscribers. If you are reading this article, this is a good example of the insights our subscribers read every day. Try it RISK-FREE for 30-days.

In this edition of the Value Seeker Report, we analyze an investment opportunity in Spectrum Brands Holdings (NYSE: SPB) using fundamental and technical analysis.

Overview

  • Spectrum Brands Holdings (NYSE: SPB) is a branded consumer products company with sales across the globe. With a market-cap of $2.5B, it’s a small-cap stock in the Consumer Staples sector.
  • Most of SPB’s sales are in North America (74%), followed by Europe (17%), Latin America (6%), and the Asia-Pacific region (3%). SPB’s customers mainly consist of large retailers, wholesale distributors, and residential construction companies.
  • The firm reports sales in four diverse operating segments, all themed around the home. They are Hardware & Home Improvement (36%), Home & Personal Care (28%), Global Pet Care (23%), and Home & Garden (13%). Some of SPB’s most popular brands are shown below, courtesy of a slide from the company’s recent presentation at the Barclays Global Consumer Staples Conference.
  • SPB’s stock is currently trading at $56.96 per share. Using our forecasts, we arrive at an intrinsic value of $61.18 per share. This implies an upside of 7.4% on the investment.

Pros

  • SPB has seen more recovery from its March lows than most small-cap stocks. Still, the stock still has over 13.6% to gain before recording a new 52-week high.
  • The Company has paid a quarterly dividend of $0.42 per share since it began paying them in the second quarter of 2018. The stock’s current dividend yield is 2.95%.
  • Although SPB has had a rough past, the firm is under new leadership which is implementing changes that should create value for shareholders.
  • As shown below, our forecasts indicate that SPB will produce the free cash flow required to cover its dividend and projected debt payments through 2029.
  • The stock trades at a Price to Earnings (P/E) ratio of 15.2 as shown below. When put up against the broad market on a fundamental basis, SPB is inexpensive.

Cons

  • SPB had just completed multiple divestitures and used the proceeds to pay down its large debt burden when COVID hit. Since the pandemic, SPB’s debt has increased once again to less-than-desireable levels. Solvency still isn’t an issue, though.
  • SPB operates in a mature line of business, and thus has trouble stimulating meaningful organic revenue growth. Strategic acquisitions have been a part of SPB’s growth strategy, but if not prudent, the growth could work against Management’s productivity improvement plans.

Key Assumptions

  • Revenue will grow slightly in 2020 as the pandemic has provided unexpected tailwinds for the business. We assume growth will strengthen in 2021 and fall slightly to its long term rate over the remaining forecast period. The chart below illustrates our forecasts in relation to historical revenue.   
  • We expect operating margins to increase as global restructuring plans begin to wrap up. Thereafter, margins will remain relatively steady, but drop slightly over the remainder of the forecast period. The chart below shows how our forecasts of EBITDA evolve over time.

Sensitivity Analysis

  • A brief note on why we present sensitivity analysis can be found here. SPB marks the first time we are able to demonstrate the true value of sensitivity analysis in the Value Seeker Report.
  • The analysis reveals that all else equal, if realized margins are 0.5% below our forecasts, SPB is overvalued by roughly 4.6%. Coincidentally, our investment thesis is partially based on the effect SPB’s Global Productivity Improvement Plan should have on margins.
  • Thus, we realize the stock could be overvalued if the Global Productivity Improvement Plan is less impactful than expected.

Technical Snapshot

  • SPB is testing support at its 50-day moving average. If the stock can continue to hold that level until the market finishes correcting, it faces strong resistance around $61 per share.
  • If SPB breaks below its 50-day moving average, it doesn’t encounter another level of support until its 200-day moving average, just above $50 per share.

Value Seeker Report Conclusion On SPB

  • SPB is a bit of a comeback story. One about years of mismanagement coming to an end and the beginning of a new era for shareholders. SPB’s global restructuring plans aim to improve core competencies and harness technology with the purpose of delivering shareholder value. The large divestitures in recent years serve as a landmark for the beginning of the journey, now it’s up to Management to stick to its vision and deliver results.
  • Based on our forecasts, SPB has 7.4% of upside remaining before reaching its intrinsic value.
  • While we do not plan to add SPB to our portfolio at this time, it’s undervalued and we are keeping an eye on it. Things can change, and we like the company.

For the Value Seeker Report, we utilize RIA Advisors’ Discounted Cash Flow (DCF) valuation model to evaluate the investment merits of selected stocks. Our model is based on our forecasts of free cash flow over the next ten years.

Shedlock: Consumer Mood Darkens On Employment Prospects

A Fed survey of expectations shows that the consumer mood darkens on employment and job prospects.

Job Transitions

This chart shows the changes in employment status of respondents who were  employed four months ago. The Fed survey asks individuals currently employed (excluding self-employment) whether they are working in the same job as when they submitted their last survey. 

If in the past four months they have answered that they now work for a different employer, they are classified as “With a new employer”, and otherwise they are “With the same employer”. 

Workers currently self-employed who were also self-employed four months ago are classified as “With the same employer”, and otherwise as “With a new employer.” 

Number of Job Offers

Number of Job Offers 2020-07

13.5% of individuals said they received at least one job offer in the last four months. That is down from 21.0% in July 2019. 

The average expected likelihood of receiving a job offer in the next four months dropped to 18.5% in July from 24.1% a year earlier.

Job Finding Expectations

Mean Job Finding Expectations 2020-07

The chart shows consumer expectations of finding a job in next three months if lose their job today.

Pre-Covid expectations were near 60%. They are now about 50%.

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

Huge Discrepancies In The Data

About the Survey

The Survey of Consumer Expectations is a nationally representative, Internet-based survey of a rotating panel of approximately 1,300 household heads. Respondents participate in the panel for up to twelve months, with a roughly equal number rotating in and out of the panel each month. Unlike comparable surveys based on repeated cross-sections with a different set of respondents in each wave, our panel enables us to observe the changes in expectations and behavior of the same individuals over time.

Related Articles

  1. The Recovery is Led by Part-Time, Not Full-Time Employment
  2. Women Lost More Jobs But Have Gained Them Back Faster
  3. Unemployment Claim Progress Slows to a Crawl

Given points 1-3 the darkening mood is not surprising. The Fed is far more optimistic. 

I asked Fed’s GDP and Unemployment Projections: Who Believes Them?

The Fed has great faith in surveys and expectations except when they contradict Fed groupthink.

This applies even to its own surveys.

Executive – Employee Catch-22 Jeopardizes The Recovery

Executive – Employee Catch-22 Jeopardizes The Recovery


catch-22 is a paradoxical situation from which an individual cannot escape because of contradictory rules or limitations. The term was coined by Joseph Heller in his 1961 novel Catch – 22”  

 Wikipedia

The Catch-22 is this: executives will not hire until they see sustainable sales growth and employees will not spend until they feel confident about their job future.  

The challenge for executives and employees is sustainable employment. They both look for the other to take the first step to achieve sustainable employment.  The recovery will not gain momentum until executives gain confidence in future sales. Employees will not buy as much as the executives prefer until the threat of layoffs abates and hiring resumes.

Executives need to see customers actively buying goods and services for at least a quarter or two to gain baseline confidence in sustainable sales. Then, management may begin hiring. If sales fall or become weak executives freeze hiring, end contractor work and permanently lay off employees.

As such,, employees are worried about losing their jobs. A Gallup survey found more than 25% percent of all employees are concerned about future layoffs. If the present slow decline in economic activity accelerates it will cause executives to freeze hiring and consumers to further curtail spending. 

We examine the standoff from both the executive and employee perspective by discussing these points:  

  1. Executives Look for Solid Sales Growth Before Hiring
  • Small Business Owners Cut Hiring
  • All Employees Express Concern About Layoffs
  • Executive – Employee Catch 22 Likely To Resolve To Downside

Executives Look For Solid Sales Growth Before Hiring

S & P 100 corporations achieve about 65% of their sales and 70 – 75% of their profits from international sales.  World trade fell before the pandemic.  The pandemic magnifies the decline in sales and will likely delay a worldwide sales recovery.  The following chart shows world trade fell 12.5% in the 2nd Quarter of 2020, though trade activity is recovering.  Thus, most managers cannot look to weak international sales to offset weak domestic sales.

Source: CPB World Trade Monitor – 8/25/20

The next chart shows sales for corporations who rely on international sales revenue fell by 15.3%. For all corporations, sales fell by 9.8% in the 2nd Quarter.  The weakness in sales for internationally based businesses confirms the weak trade outlook. The outlook for domestic sales is uncertain without a new relief package from Congress.  Thus, managers will hesitate to make any firm hiring commitments.

Source: Factset – 8/2020

For all S &P 500 corporations earnings results for the 2nd Quarter were even worse than revenues down by 33.8% . Executives were caught off guard by the pandemic in mid – March.  Most executives were expecting the pandemic to be controlled by the summer so they maintained staffing levels. Management furloughed some employees, paid overhead costs for empty offices, and held inventories as sales dropped.  Managers try to keep costs in line with revenues.  So, when earning fell 3 times revenues they will look to cut costs. There is extreme pressure on management to cuts costs with staff at 70% of all costs, so more layoffs are likely.

Source: Factset – 8/2020

Management Places Hold On Hiring

The following chart shows new orders versus employment in manufacturing companies. The August ISM Manufacturing Survey shows increases in new orders, yet employment stalls at contraction levels. The fact that management holds off on hiring confirms their concern about sustainable sales.

Sources: Pantheon Macroeconomics, The Daily Shot – 9/2/20

This chart from the Track The Recovery Project indicates a significant decline in new job postings by 35%. We think management will continue to cut back. The decline in new job postings is another indicator of executive lack of confidence in future sales growth.

Sources: tracktherecovery.org, Quill Intelligence – 8/24/20

Permanent Layoffs Increase

The following graph shows temporary worker layoffs versus permanent worker layoffs. Temporary worker layoffs surged at the beginning of the pandemic as management thought the virus would soon be controlled. However, as virus infections increased and lockdowns stayed in place longer than expected temporary layoffs decreased while permanent layoffs increased. The increase in permanent layoffs means out-of-work adults will reduce spending until employment prospects turn positive.

Source: Bloomberg – 9/4/20

Consumer Spending Growth Not Seen

Executives are looking for solid consumer spending before resuming hiring. In highly uncertain economic conditions managers will invest in new equipment, automation, or cost cutting programs before hiring. As a last resort, if they absolutely need new staff managers, they hire temporary workers before hiring full time employees.  Managers view hiring of any new employee with a combination of confidence and risk. Supervisors hire the new worker with confidence that they will be successful in their new role. But, often it is not clear the new hire will be successful in the job for 6 – 12 months.  Plus, hiring a new employee costs 25 – 40% of their salary in overhead costs. If an executive makes a hiring mistake it is not only costly to the worker but could hurt productivity, reduce sales, or delay product development. Besides the individual candidate executives assess the general economic climate. 

Today’s deteriorating economic trends are a major concern for hiring managers. Economic headwinds include:  surging pandemic infections, falling international and domestic sales, rising trade tensions with China and allies, tightening regulations by a possibly new Congress and President, and the delaying of a fiscal stimulus package.

Small Business Owners Cut Hiring

The small business sector is the jobs engine of the U.S. economy.  In 2019, small businesses created 1.5M jobs for 64% of total business new hires. Plus, small businesses provided 50% of all economic output and 60M jobs accounting for 47% of the labor force. Profitability is a major challenge as 40% of small businesses are profitable. The other 60%  break even or losing money. Most small business owners have only 30 days of free cash flow, thus limiting their ability to handle a long term financial crisis. The following Small Business Pulse Survey found millions of small businesses struggling 47% of small businesses do not expect to return to normal operations for at least 6 months, and only 25% have done so.

Sources: Census Pulses Survey, Bloomberg – 9/4/20

The Homebase activity chart below shows small business employment at 25% below pre pandemic levels. Business hours are reduced as well. Owners are forced to lay off more workers when business hours are reduced.  Activity and mobility surveys confirm that small business sales are 40 – 50% down from pre pandemic levels in core cities and 20 – 30% below in other regions.

Source: Homebase, The Daily Shot – 9/2/20

Exodus From Cities Triggers Small Business Sales Decline

Many services businesses and restaurants in core cities face a continuing loss of customers due to a permanent shift to working from home.  Densely populated cities have seen as much as a 30% reduction in activity as professionals leave cities and purchase homes in the suburbs or lower cost rural areas. A recent survey showed 15% of workers have permanently left San Francisco for housing elsewhere. In addition, thousands of professionals have left Manhattan with the city experiencing only a 30% return of employees to offices.

Small businesses are experiencing losses in the suburbs as well.  In the suburbs of San Francisco, Google has cut catering by 80% and Facebook by 70%.

Small Business Landlords Face Looming $35 billion In Rent Due

Independent apartment building owners manage half the units rented in the U.S. Independent landlords worry about missed rent payments.  Federal CDC and state moratoriums provide rent payment forbearance until January 1st. Yet, eight million independent multiple unit owners still must make mortgage payments each month.  Thirty-three percent of renters did not make their August payment.  If these independent owners do not receive rent payments soon landlords will default on mortgage loans. Plus, they may be forced to sell their units in a weak multi-unit real estate market.  In January it will become evident how significant a problem landlord defaults will become when renters must begin paying back $35 billion due. The looming issue is that if thousands of landlords default it could impact the $11 trillion mortgage industry and property tax income to local cities and schools.

Agile Entrepreneurs Create New Businesses

Enterprising services providers shift yoga classes, and personal fitness sessions to Zoom online. Restaurants use online delivery services to customers wary of coming to their location. One restaurant offers dinner parties via Zoom, where participants receive ingredients in advance and cook with a chef. Other entrepreneurs create businesses focused on work from home consumer needs like remote learning and child care for pods of students.

Small Businesses Face Major Economic Headwinds

The challenge is that most small businesses are not funded to handle a long term sales decline for years as well as major corporations are funded to handle. In a September a Goldman Sachs survey of 860 small businesses shows that 88% of owners reported they had run out of the their Payroll Protection Plan (PPP) funds. Only 65% reported they thought they would survive through the pandemic. About 30% of owners note they will run out of cash by yearend without the renewal of PPP loans. While most owners report operating full hours, sales are down between 20 – 50% from pre pandemic levels. On the positive side there was a surge of 5 % to 14% who said they were managing the transformation of their business well.

All Employees Are Concerned About Layoffs

All types of employees are concerned about future layoffs.  As a recent Gallup survey shows 27% of workers are worried with 29M workers on unemployment and job prospects dimming.

Source: Gallup – 9/2/20

Many employees express job security concerns beyond income because their employer provides health insurance. If workers lose their job, they lose their health insurance. Jobless workers find private insurance too expensive. Holding a job with a sustainable income stream with health benefits is crucial to building consumer confidence. Possible layoffs create anxiety over income and health care such that consumers spend even less.  Job security must increase with the pandemic under control before consumer spending can grow.  

Two Distinct Employee Groups – One Secure, Other Insecure

In our post, A Tale of Two Economies we identified two groups of employees, professionals and workers. Professionals are college graduates who work from home and have job security. During the pandemic professionals are spending on cars, homes, and home improvement products.  The worker group of high school graduates are required to work at offices, stores, factories and farms.  Millions of these non-work from home employees were laid off temporarily in March. Managers hoped to rehire workers quickly after the pandemic was controlled.  The pandemic is not under control so millions of workers have been permanently laid off.  

Worker job confidence is being undermined by headlines of major layoffs at companies in major sectors like hospitality, consumer beverage, entertainment, media, auto and even high tech. Most workers are being squeezed between mounting bills and lost income. Many working class families do not have enough money even for food so they are going to food banks. The majority of 29M adults on unemployment assistance are in the workers group.

Professional and Worker Comparison

The following chart highlights the stark contrast in job, income and health situation for each group:

IndicatorsProfessionalWorker
        Education     B.A. Degree High School Diploma
        Work Location           WFH  63%     Not WFH 67%
        Employment Growth – January to June                + 2%     – 5%  to – 20%
        Unemployment Rate              8.4%           17.3%
        Rainy Days Savings – 3 months              75%             23%
        Housing             Own            Rent
        No or Slight Confidence Housing Payment              16%             34%
        Health Insurance              64%             31%
        Virus Vulnerability              1 Nominal            4 times
         

Starting with the contrast in ability to work from home versus factory, the two groups have been at opposite financial positions during the crisis.  Professionals believe they can handle the crisis. High tech employees at information services companies like Apple, Google, Facebook and Netflix feel secure as sales increase, though these high growth sales may not continue.

For professional knowledge workers across multiple sectors there actually was an increase in employment. Higher income workers had three times the number of households with ‘rainy day’ funds, two times the health insurance coverage, and are much less vulnerable to catch the coronavirus.

Yet, home owners across both employment groups are financially pinched as mortgage delinquencies surged to 8.2% in August from previous month’s 6.1%. Worker group adults face high rates of eviction, are more anxious about making house payments and have limited health insurance options.  Plus, 56% of small business are owned by high school graduates.  So, many owners will not be able to switch careers by taking a professional job at a major corporation.

Professionals Who WFH Permanently Face Possible Salary Cuts

Some professionals working remotely enjoy the same high salary and benefits packages as when they worked in their company core office location. Yet, other WFH professionals saw their salaries cut. Twitter and VMware announced salary cuts ranging from 8 – 18%  for workers who take a permanent WFH option outside the Bay Area.  We expect that as companies realize that the internet provides a way to hire other less expensive employees they will reduce salaries of remote workers.  The new reality of permanent remote work will cause pay for remote professionals to decline over time. Executives will always be looking for ways to cut costs while maintaining high levels of quality and productivity. Besides, managers will promote work from home as an alternative to office work to reduce office space costs.

Total Consumer Spending Declines by 7.3%

The following chart shows spending in all income categories is falling after a peak in early August.  The spending declines range from – 4.0% for low income consumers to -10.6% for those with high incomes. Total spending slid by 7.3% by August 30th compared to the January baseline.  The recovery in spending reached a peak in mid-August and continues to decline ever since. 

Sources: Opportunity Insight, Quill Intelligence – 9/14/20

The following chart of consumer spending versus income shows how spending stalled after a recovery. A conundrum is emerging about the actual spending of consumers, compared to their income.  The April CARES Act temporally boosted incomes. All consumers received $1,200 checks, and people on unemployment received a boost of $600 per week. Yet, when income is compared to spending adults are holding onto their cash as bank account and savings balances are surging.

Sources: Oxford Economics/Haver Analytics, The Daily Shot – 8/31/20

Consumers are still concerned with the reduction of unemployment to $300 per week in most states running out by the end of September.  Workers reporting they cannot pay for household basics from unemployment assistance rose to 50% in August compared to 27% in July.  The stall in consumer spending is confirmed by a recent leveling off of consumer expectations in the University of Michigan Consumer Expectations Index.

Source: The University of Michigan, The Daily Shot – 8/28/20

Advertisers See Possible Drop In Consumer Spending

Since last March, broadcast network advertising sales slide but held steady for digital streaming services and the social media outlets.  Advertising managers run ad budgets as a percentage of consumer sales. For existing product lines when sales drop ad spending will be reduced to reflect the sales decline.  This fall advertising contracts are being negotiated with unusual provisions to allow advertisers to drop or reschedule up to 50% of their buys.  The fact advertisers requested a 50% cut provision with no penalties shows they are concerned about a possible sharp drop in consumer spending.  Google and Facebook have 60 % of total U.S. ad spending with 71% of their revenue from advertising. A sustained advertising sales decline is likely to result in layoffs of both administrative and professional staff in these high tech giants.

Executive – Employee Catch 22 Likely To Resolve To The Downside

Economic trends favor major corporations continuing to increase market share at the expense of smaller businesses.  Professionals will retain their jobs and continue to spend, though at modest levels.  Executives will freeze hiring based on concerns about a virus second wave, world trade sales declines and possible new government regulation from a new administration. Workers in the 80% income segment working onsite will continue to face COVID-19 infection uncertainty, continuing layoffs and mounting rental debts. Headlines announcing thousands of layoffs from major companies will undermine consumer confidence. There have been 1.84M permanent corporate jobs cuts since January, the highest number since a similar period in 2001 according to Challenger, Gray and Christmas.  

Corporations With Cash May Invest

Mitigating the coming nexus events is possible spending by cash rich firms. About 40% of S & P companies still planning on stock buybacks in 2020.  Executives seeing a declining economy may opt to invest in retaining their workers to build new products and increase sales.  Announced stock buybacks of $400 billion would be better invested in productivity improvements, new product development, increased market, employee retention, sick leave and child care benefits, and paying off debt. However, it remains to be seen if executives will in fact invest in their business.

Consumer Spending May Sharply Decline in 1st Quarter 2021

The federal rent moratorium policy and a similar moratorium in California will end on December 31st.  Renters are still required to pay 25% of their total rent due by yearend and then workout a payback program with their landlord for the balance due beginning in January  Independent landlords are looking for $35 billion in rent overdue rent payments to begin in January. A nexus is building of evictions, rent and mortgage debt balances due, small business closures, permanent layoffs, the end of the $300 boost in unemployment benefits and no or a small stimulus spending package by yearend.  This cascade of financial events is likely to trigger a sharp drop in consumer spending in the 1st Quarter 2021.

Consumer Confidence Returns When They Are ‘Not Worrying’

If world trade was more robust then executives in major corporations would feel more confident in their hiring plans even if domestic markets were stalled. But,, the U.S. consumer provides 25% of world consumption.  So, major corporate executives are still looking for  U.S. consumers to drive growth even of their offshore operations.

The stalemate will resolve depending on how each side perceives the moves of the other. For consumers it is how secure they feel when they look at the hiring moves of executives.  For executives they want to see sustainable spending by consumers. Without major government intervention for relief, long term investment and virus containment the outlook is highly uncertain.  So, it is likely that the standoff will resolve to the downside until major economic interventions occur for both virus control and boosting consumer finances. In the end,  our government needs to recognize how overwhelmed most people are today.  People are worried about multiple crises coming at them from losing their job to virus infections, violence, wildfires, hurricanes and flooding.  When consumers stop worrying and feel calm spending will return.

                                                “I miss not worrying.”    September 3, 2020

                                                Susan, commented from her car after being

evacuated from fires in the Santa Cruz Mountains

and not going into a Red Cross shelter because of worries

about becoming infected by the coronavirus

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

Seth Levine: “Will NYC Die?” It’s Up To You.

“Will NYC Die?” It’s Up To You.

“It’s up to you New York, New York” — Frank Sinatra, Theme From New York, New York

The magnitude of change that the coronavirus (COVID) ushered in is truly astonishing. It’s upheaved industries, professions, and the very fabric of many lives. Among the apparent victims in New York City (NYC). Not only are businesses such as hotels, restaurants, bars, and theaters struggling to operate, but the city is rapidly depopulating. Watching my friends leave and my favorite places close is incredibly sad. Like many, I find myself wondering: Is the NYC that I love so dearly dead for good? Or will it bounce back?

NYC Is My Home

NYC is my home. Sure, I’ve lived here most of my life. More importantly, though, it’s where my heart lies. I work here, met my wife here, and am raising a family here. Most of my friends and family are also nearby. I love NYC: the energy; the walkability; the variety; the aesthetic; the activities; the food; the music; the sports; the entertainment; the people. There’s simply no other place on Earth I’d rather live.

Of course, I daydream of elsewhere. NYC’s benefits carry a hefty price tag—a nauseating cost of living. I make trade-offs to living here. Thus, I often try to imagine a better place: a dense city, with world-class art, food, entertainment, nightlife; with competitive jobs, a temperate climate, access to nature, no traffic, and above all, a lower cost of living. I’ve yet to best NYC.

The hollowing out of this city shakes me to my core. My stakes are high. I have significant amounts of human and financial capital invested here, so I often wonder about its future. Are NYC’s best days behind it? Should I cut my losses and move on? Or should I sit tight and wait for its ensuing recovery?

Start Spreading the News

Much has been said about NYC’s current state of affairs. To some, it’s curtains for the Big Apple. The internet has made it easier than ever for people and businesses to move away. Movers are so busy with fleeing New Yorkers that they are turning people away! With the people goes NYC’s culture, food, and energy. Buildings will vacate and high taxes will keep people away. NYC is dead forever. To be sure, the argument is good.

There won’t be business opportunities for years. Businesses move on. People move on. It will be cheaper for businesses to function more remotely and bandwidth is only getting faster.

James Altucher, NYC IS DEAD FOREVER. HERE’S WHY

To others, the best has yet to come. NYC has been here before. It’s been down and out only to come roaring back better than ever: 9/11, the ‘70s, etc. Why? Because NYC has a unique energy and attitude that technology can’t recreate; because New Yorkers are tough; because when you cram millions of people onto a tiny island amazing things happen; because greatness is rare and you just don’t walk away from greatness. Here too, I’m in agreement.

Real, live, inspiring human energy exists when we coagulate together in crazy places like New York City.

Jerry Seinfeld, So You Think New York Is ‘Dead’

I’ll Make a Brand New Start of It

Plenty of prominent (and not so prominent) people have voiced their opinions. However, I’m not big on predictions. Rather, I will attempt to apply what I learned from Philip Tetlock’s and Dan Gardner’s insightful Superforecasting book. I’ll start with a base assumption and updated it as time progresses.

It’s tough to make predictions, especially about the future.

Yogi Berra

First, I’ll form an “outside view” using the historical record of big, culturally important cities. Then, I’ll look at NYC’s specific attributes to construct an “inside view.” Lastly, I’ll compile a list of signposts to monitor as time unfolds. This last piece should help me evaluate down which path NYC is progressing.

These Little Town Blues

The argument that NYC will bounce back because it always has is weak, in my view. To be sure this has been a trustworthy heuristic over our lifetimes. However, a rudimentary scan of history reveals its shortcomings. In the U.S., cities such as Detroit, Philadelphia, and Chicago were once prominent cultural centers. Even a walk through downtown Cleveland reveals remnants of grandeur in its architecture and public monuments. However, all have lost their luster.

The same can be said for Buenos Ares, Caracas, and Beirut whose international prominence significantly waned. Lastly, there are the renowned cities of antiquity such as Carthage, Constantinople, and Cairo that no longer sit at civilization’s epicenter. Thus, cities do in fact die.

Yet, not all suffer this fate. The likes of London, Paris, and Rome have been important cultural centers for eons. Thus, an outside view of NYC provides evidence for either outcome. Renaissance is not certain.

I Want to Be a Part of It

Next, I’ll need to form an inside view by teasing out NYC’s unique attributes. Both articles above correctly identify that NYC is not so much a geography as it is a culture. Whether it’s business, music, film, theater, museums, sports, ethnic diversity, comedy, nightlife, architecture, or food, NYC ranks among the top places in the world to find the best. This is no accident.

Note that climate, natural beauty, or other physical attributes do not make the list. NYC’s virtues are all man-made. The crucial ingredient are humans. Said simply, it’s the people that make NYC great. The composition of its population will dictate NYC’s direction.

These Vagabond Shoes

The central role that culture plays is precisely the challenge with prognosticating NYC’s future. The people are currently in flux. While anecdotes are plentiful, reliable estimates are not. One analysis of U.S. Postal Service data estimates that 16,000 addresses changed from NYC to Connecticut through June 2020. Another one pegs total NYC move-outs around 40,000 to 50,000. Let’s face it, these are guesses at best.

However, there are some “harder” data to evaluate. Manhattan vacancy rates are the highest level in over a decade and rents appear to be falling. These more clearly indicate people vacating NYC.

Manhattan residential vacancy rates are at the highest level in over a decade

While the trend seems negative, its magnitude and duration are unknown. How many people moved out temporarily, just for the lockdown period? Did many move just for the summer? How many will return if/when they can no longer work from home fulltime? What about when schools fully reopen? Will many return if the cost of living falls? How many would have moved anyway absent COVID? These are all open and complicating questions as there are many motivations at play.

Manhattan residential rents are falling fast

Right Through the Very Heart of It

In my view, neither renaissance nor ruin is obvious from this cursory examination of inside and outside views. While my conclusion is vague, it’s valuable nonetheless. I’ve narrowed the lynchpin down to people. So goes the people, so goes NYC. For now, I remain open to either option for NYC and will update my stance as new facts develop?

But what exactly should I be looking for? What are the essentials components of the NYC culture that I love? What specifically about “people” is important?

I Wanna Wake up in a City That Doesn’t Sleep

What I love about NYC is its productiveness; the rugged individualism; the intense drive to suck the marrow out of life, and the willingness to make hard trade-offs to do so. To be sure, these are my preferences. With the top of mind, I can compile some signposts that can clue me in to the culture’s trend.

At the top of my list is the upcoming mayoral election. While I’m not into the red-team vs. blue-team of today’s politics, I do find political philosophy important. It reflects the deep principles by which people live. Since political offices are literally filled by a popularity contest (even if just two options are presented in the voting booth), elections can provide some insight into the culture. They reveal the dominant political philosophy.

Usually, I find little difference among candidates (hence my apathy). However, given the state of NYC, I’d view a win for (another) extreme left or right-wing candidate as a clear warning signal to me. Liberty is the lifeblood of my beloved NYC culture. A continuation down the current path will bleed out the patient (ask me to elaborate in the comment section if you’re interested in why).

The other items on my list are more obvious: trends in crime, vacancies, and riots. The last item—social unrest—is particularly important in light of recent events. Productiveness requires respect for property rights. If productive people leave, the cultural decline is inevitable.

It’s up to You (Us)

To me, whether NYC rebounds or breaks the way of Detroit or Beirut is an open question. Those asserting strong views appear to be acting on emotion alone. Both historical precedents and NYC-specific issues suggest that either fate is possible. This is because NYC is a culture more than geography.

Due to COVID, many dramatic changes are happening at once. NYC’s fate is potentially one. However, we need not be paralyzed by uncertainty, succumb to emotion, or turn to heuristics (like NYC always comes back). Rather, we can look for signposts that corroborate either scenario.

For now, my life depends on NYC’s fate. I neither want to witness its destruction nor miss its renaissance. This is a trade I want to get right.

So what’s it going to be New York? It’s up to you (us).

The Future Promise Of Value Versus The Allure of Growth

The Future Promise Of Value Versus The Allure of Growth

Many investors, especially those with limited investment experience, are declaring that value investing is dead.

If one’s investment experience runs over the last ten years, who can blame them? Since 2010, growth stocks have outperformed value stocks, on average, by 6.11% a year.

If one’s experience runs deeper, and/or they appreciate history, they may have a different perspective. Over the last 100 years, including the last ten, value has outperformed growth by 3.19% a year.

So, is value dead or does value offer incredible opportunities versus growth?

All value and growth data in this article comes from Kenneth French and Dartmouth University. In particular, we use the HML factor from the Data tab. 

What are Value and Growth?

Value stocks can be defined in many different ways. The basic premise, however, is the inclusion of stocks trading at a low price relative to their fundamentals; low price-to-earnings, low price-to-book, low price-to-sales, etc. The benefit of buying value stocks is the expectation that prices return to fair value. Quite often, the return benefits from above-market dividends. Equally important, buying a discounted asset reduces your risk.

Like value, there is no simple formula defining growth stocks. Growth stocks are companies whose earnings are expected to grow at a faster rate than the market. Because of the promise of future earnings, these stocks tend to trade at valuation premiums. Fewer of these stocks have meaningful dividends to bolster returns. Assets trading at a premium have a more daunting risk profile.

There is an appeal to owning value stocks and growth stocks. Mr. Market, however, makes deciding between the two difficult. At times, the premium for growth stocks can far exceed their potential growth. Frequently in such times, value is neglected and offers enormous relative performance potential. Other times growth stocks may be beaten down and offer a cheap entry point versus value stocks that have traded up to, or through, their fair value.

Historical Perspective

We firmly believe in mean reversion. The extreme highs for one asset class will eventually normalize closer to the long-term average. Often this occurs after dropping well below the long-term average. There is no example in the history of markets where mean reversion did not exert influence.

As mentioned, value has underperformed growth annually by 6.11% over the past decade. Over the last 100 years, value beats growth by 3.19% annually.

The graph below shows the rolling five year total returns for value versus growth.

As shown, there are very few five year periods where growth beats value. 82 percent of the time value outperforms growth. If we exclude the last ten years and the 1930’s the percentage climbs to 96%.

It is also notable that periods of value underperformance are followed by periods of strong outperformance. As we will highlight, this was last on display in the technology bubble of the late 1990s. From July of 2001 to July of 2006, value outperformed growth by nearly 150%.

As the chart above illustrates, the current period of value underperformance is the most extreme both in terms of duration and magnitude. Mean reversion argues that this trend will soon shift back to favor value.

Tech Boom and Bust

The graph below details the value-growth under- and outperformance of the late 1990s and early 2000s.

The chart tracks the cumulative net performance of value stocks versus growth stocks between 1998 and 2002. Like today, investors caught up in the tech boom only cared about growth. They bought into every story about the promise of technology. At the same time, companies trading with low valuations and steadily rising earnings are being thrown by the wayside.

In just two years, as markets rose to record-breaking valuations, growth beat value by 37.64%. However, when the markets came to their senses in early 2000, value rose from the dead. From low to high, just two years later, value beat growth by over 70%.

Value investors that held to their beliefs, stuck with their discipline, and shunned growth stocks may have lost the day in the late 1990s but won the battle. Not only did value stocks provide a great return but they provided a nice cushion. Owning value stocks in the early 2000s not only limited losses but actually produced gains in a down market.

20 Years Later

The experiences of the tech boom and bust have been long forgotten by most investors. There are a few value investors remaining today who are aware of what happened then. Like then, they are waiting for a second showing, but the wait is tedious.

The graph below shows that over the last two years growth has beaten value by 45%, 7% more than the two years leading into the tech bust.

Like the 1990s, every investor is chasing the same set of growth stocks. Today, they go by the name of FANGS. In the late 90s, they were called the Big Five.

The magnitude growth outperformance is amplified today due to the overwhelming popularity of passive investing. Those companies with the largest market caps receive a disproportionate percentage of investable dollars. Companies with the largest market caps today are predominantly growth companies.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

2000 vs 2020

While the two periods may appear similar in their speculative nature and the value – growth divide, their fundamental backdrops are worlds apart.

In 2000, share prices of growth stocks, and in particular specific tech high flyers, got ahead of themselves. Their future earnings, however, had strong economic and fundamental underpinnings. Today they do not.

GDP was growing annually at 3.2% in the 1990s. That compares to 2% over the last ten years and most likely below 1.5% in the future. In the 1990s, debt as a percentage of GDP was a fraction of what it is today. Productivity growth was much stronger twenty years ago than today as well. In the 1990s, companies invested in their future development. Today they prefer to buy back stock and neglect their future earnings capabilities.

Today’s economy is not backed by organic growth and strong productivity, but rather debt and fiscal and monetary schemes. Given the environment, the argument for speculation over reliable earnings growth is befuddling. 

Summary

If you appreciate history and understand that hangovers follow periods of excess, this article should be compelling. Growth’s recent outperformance over value goes beyond any historical precedence. Accordingly, any future underperformance, like its outperformance, might be one for the record books.

Exact timing on trend changes are difficult to predict.  Growth may have already peaked versus value, or it may still have months or years to go. Regardless, the current period provides us precious time. Time to research stocks and slowly add value stocks to our portfolios. Adding value may seem futile like the late 1990s, but we know how that ended.

Sector Buy/Sell Review: 09-22-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 09-22-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when, but what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. Currently, markets and sectors are back to “stupid” overbought on many levels. We advise caution.

SECTOR BUY/SELL REVIEW: 09-22-20

Basic Materials

  • A common theme through today’s update is the exit of the “reflation” trade. Markets had been hoping for additional “fiscal support” from Congress. However, with the election looming, a need for a budget negotiation to avoid a “shutdown,” and now a battle over replacing a Supreme Court Justice, the odds of a fiscal deal getting done is minuscule.
  • Looking at XLB, the sell-off yesterday was the reflection of the exit of the reflation trade. You will see the same in Industrials and Transportation, which were all down more than 3%. 
  • The setup for the sell-off was present, as noted last week, “with XLB pushing into very overbought conditions with a historically high ‘buy signal,’ there seems to be a lot less reward in the sector currently. It isn’t advisable to chase the sector now. Look to buy on dips and short-term oversold conditions.”
  • That opportunity is coming but still has more work to do first.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
    • Stop-Loss moved up to $60
  • Long-Term Positioning: Bearish

Communications

  • The correction in communications continued on Monday, but the sector has become oversold short-term.
  • We suggested taking profits and reducing risks, and that correction has now happened. 
  • XLC did fail to hold the 50-dma and has become oversold. Look for a bounce into resistance to reduce exposure and take profits if needed. 
  • Adding a trading position is possible with a very tight stop at $56.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Bearish

Energy

  • Energy continues to fail. We were stopped out of our XOM position previously.
  • Energy is deeply oversold and due for a bounce. However, there is not much support for the sector currently, particularly if we get a dollar rally, which we see some early signs.
  • With supports taken out, there is no reason to add exposure here. Wait for a bottom to form and the sector to show some signs of life first.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Neutral

Financials

  • Financials continue to underperform and remain a sector to avoid currently.
  • XLF sold off yesterday on news of massive money laundering and the realization no more financial support is coming. 
  • The sell-off yesterday violated support and confirms the failure of the 200-dma. 
  • Banks remain out of favor. 
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • As noted, like materials, XLI sold off sharply on Monday under the premise of no more fiscal support, which will kill the economic reflation trade. 
  • We have grossly reduced our exposure to the sector and are looking for a better opportunity to add back to our position. We may finally get that opportunity closer to $72.
  • As suggested previously, take profits and rebalance risk. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bearish

Technology

  • Technology stocks, and the Nasdaq, found some buying yesterday after a fairly brutal correction over the last couple of weeks. 
  • While the sector remains overbought and extended well above long-term averages, the index should try to find short-term support. 
  • The risk remains to the downside for now. But with the “reflation” trade taking a hit, the money will likely flow back into the “previous winners” for now. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Stop-loss set at $105
  • Long-Term Positioning: Bullish

Staples

  • Over the last couple of weeks, we have discussed the correction of XLP. 
  • That correction came and has pushed XLP down to its 50-dma. It needs to hold support here and is getting sufficiently oversold enough to do that. 
  • However, we need to see buyers begin to step in. 
  • Rebalance holdings and tighten up stop-losses on any rallies for now. We are likely not “out of the woods,” just yet. 
  • We are moving our stop-loss alert to $60 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Real Estate

  • Another aspect of the “reflation” trade was also in XLRE. Without more fiscal support, there will likely be a further impact on real estate, particularly on the commercial side. 
  • On Monday, XLRE violated the 200-dma support sharply but did push back into more extreme oversold territory. 
  • With XLRE oversold, I would expect to see a rally this week. Use that rally to lighten up exposure for now. 
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Sold WELL last week.
  • Long-Term Positioning: Bullish

Utilities

  • XLU has been struggling with resistance at the 200-dma and failed again with Monday’s sell-off.
  • Utilities also broke support at the 50-dma. The performance has been disappointing. 
  • The sector is oversold and is potentially in a better position relative to other sectors of the market, particularly for “defensive” positioning.
  • However, we did reduce our exposure last week by selling our holding in AEP.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Sold AEP last week. 
  • Long-Term Positioning: Bullish

Health Care

  • XLV broke below its 50-dma and needed to hold support at the previous market highs.
  • With the sector back to oversold short-term, there will likely be an opportunity to add exposure somewhere ahead. 
  • The 200-dma is now essential support for XLV and needs to hold, along with the previous tops going back to 2018. 
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • XLY has corrected back to its 50-dma and is holding support for now. 
  • However, it has not become oversold yet, which suggests there is potentially more downside risk. 
  • Without more fiscal support, the money flows into discretionary stocks could well see some weakness.
  • Take profits and hedge risk. 
  • Stop-loss set at $130
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • Last week. “The rally in XTN remains exceptionally extended.” 
  • The sector took a beating on Friday as the realization of no more fiscal support puts the “economic reflation” trade, and this sector, in particular, under pressure.
  • The sector is still very overbought. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and will wait for a correction to add back to our holdings. 
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Bearish

Technically Speaking: Market Realized No Help Is Coming

Last week, we asked the question: Is everything ‘priced in?'” On Monday, the market realized no help is coming as the political backdrop worsened markedly.

However, we need to back up a little bit to discuss how we got here. In the middle of August, we wrote “Close But No Cigar,” which addressed the potential of a market correction due to the extreme positioning in markets. To wit:

“With the markets overbought on several measures, there is a downside risk heading into the end of the month. These risks come from several fronts we will discuss momentarily. However, from a technical perspective, the downside risk is about 5.6% to the 50-dma and 9.4% to the 200-dma. (Shown above)

A 5-10% decline in any given year is not outside of the norm. However, since investors have entirely forgotten what a drop feels like, a 5-10% slide will ‘feel’ worse than it is.”

At that time, there seemed to be little to worry about. The Federal Reserve was remaining accommodative to the markets, and expectations of additional monetary support were high. Expectations were high that Congress would pass other fiscal measures to support the recessionary economy soon.

More money meant higher markets, hence the speculative bias.

As I stated then, the market was overbought on multiple measures, which typically coincides with short-term market peaks and corrections. That overbought condition, combined with more extreme speculative positioning by investors, provided the fuel for a correction when it came.

All that was needed as a “catalyst” to trigger the selling.

Remembering 2016

I liked David Rosenberg’s note yesterday on the current correction:

“The stock market has really gone through a change of complexion — to a far greater degree than the last corrective phase in June when valuations, momentum, leverage, and sentiment were less extreme than was the case heading into this current period.”

Last week, we noted a list of concerns relating to the market, which could undoubtedly pressure markets lower. One of those, in particular, was the lack of additional “fiscal stimulus” coming from Congress.

Over the weekend, and summed up in the video below, a collision of events brought concerns to the forefront.

The death of Supreme Court Justice Ruth Ginsberg has sparked a replay of the 2016 passing of Justice Scalia. At that time, President Obama wanted to appoint a replacement for Scalia even as the Presidential election was just a few months away. Congress got into a contested debate over whether a justice should be selected so close to an election. That debate is again on display as President Trump wants to appoint a replacement for Ginsberg as soon as possible. Still, the Democratically controlled Congress is fighting to delay it until after the election.

Politically, this is an incredibly important appointment. Since justices get appointed for life, if President Trump adds another “conservative” justice to the Supreme Court, rulings on more liberal causes could be stymied for a decade or more.

A Collision Of Events

Why is this important to the market? Because Congress is facing three different events that have removed the focus from additional financial support for the economy.

  1. With the election fast approaching, Congress does not want to pass a fiscal support bill to help the other Presidential candidate. Such is why there are dueling bills between the House and Senate currently.  
  2. September ends the 2020 fiscal year of Congress. Such requires either a “budget,” or another C.R. (Continuing Resolution) to fund the government and avoid another shut-down.
  3. Lastly, the death of RBG will have the entire Democratic Party, which controls the House, focused on how to stop President Trump from nominating a replacement before the election. All Trump needs is a simple majority in the Senate to confirm a justice that he can likely get. 

As I discussed with our RIAPro Subscribers in this morning’s “Sector Trading Review,” the realization of “no more fiscal support” killed the “economic reflation” trade yesterday.

“A common theme through today’s update is the exit of the ‘reflation’ trade. Markets had been hoping for additional ‘fiscal support’ from Congress. However, with the election looming, a need for a budget negotiation to avoid a ‘shutdown,’ and now a battle over replacing a Supreme Court Justice, the odds of a fiscal deal getting done is minuscule.

Looking at XLB, the sell-off yesterday reflected the exit of the reflation trade. You will see the same in Industrials, and Transportation as well which were all down in excess of 3%.”

In short, this all presents a problem which markets discovered Monday morning – “no more monetary support.” 

(Click the banner below to get notified of our daily “3-minutes” videos.”

Winter Is Coming Value, Winter Is Coming. Is It Time For “Value” To Shine? 08-28-20

The Fed Is Limited

At the September FOMC meeting, Jerome Powell made a critical statement overlooked by the majority of the mainstream media.

“Federal Reserve Board Chairman Jerome Powell warned Wednesday that a lack of further fiscal support from Congress and President Trump could “scar and damage” a U.S. economy restrained by the coronavirus pandemic.

‘If there’s no follow-up on that, if there isn’t additional support and there isn’t a job for some of those people who are from industries where it’s going to be very hard to find new work. That will start to show up in economic activity. It’ll also show up in things like evictions and foreclosures and things that will scar and damage the economy.’” – The Hill

The Federal Reserve is trying to plug a hole that fiscal policy was widely expected to fill by now. However, the Fed’s ability to expand on current programs is limited to the Treasury Department’s issuance of additional debt. Without another “fiscal relief” bill, there isn’t enough debt issuance to support another round of interventions by the Fed. 

Currently, the Federal Reserve is continuing to run “Quantitative Easing” at $120 billion per month, but much of that is just replacing bills that are maturing. As shown below, the Fed’s balance sheet has been stagnating since June as the uptake from its various programs has waned.

Short-Term Bearishness

The realization the Federal Reserve will likely not get any “fiscal support” from Washington in the short-term is problematic for the markets. Without fiscal support, the Fed is limited in its monetary response. Rates are already at zero, and economic data is beginning to show signs of weakening as the “direct checks” and “expanded U.I. benefits” to households has run out. 

The subsequent selling in the market has led to increased short-term bearishness in the markets. As shown below, markets are very oversold short-term on several measures. Furthermore, the bounce of support yesterday suggests we could see a follow-through rally back to the 50-dma, which will act as crucial overhead resistance short-term.

Furthermore, besides being oversold, there is the largest net-short position on the Nasdaq we have seen since 2008.

As we showed our RIAPro Subscribers (30-Day Risk-Free Trial), the sharp sell-off in Technology specifically pulled the sector out of its Risk/Reward range.

Such short-term bearishness provides a good backdrop for a short-term rally over the next few days. Be careful you don’t “panic sell” the market; use counter-trend bounces to reduce risk logically.

S&P 3750 Light Train, Technically Speaking: S&P 3750. Is It The Light, Or A Train?

There Is Downside Risk

As noted previously:

“The reason we suggest selling any rally is because, until the pattern changes, the market  exhibiting all traits of a “topping process.”

  • Weak participation
  • Failure at long-term resistance
  • Extreme bullish speculation
  • Negative divergences in relative strength

We can show this in a long-term monthly chart.”

Since 2009, whenever the monthly MACD “buy signal” was this elevated, it typically correlated to a short- to intermediate-term market peak.

Such also correlates with weaker economic data showing up. Weaker economic data translates into reduced earnings outlooks for companies. During the last 30-days, 2021 estimates for the S&P 500 have declined by an additional $5/share. Furthermore, those estimates are down nearly $30 from the original forecast in January 2020. Yet, markets remain only slightly off all-time highs.

Still A Sellable Rally

As noted in this past weekend’s missive, we still expect a “reflexive rally” given the short-term oversold condition of the market. However, we still expect there could be further downside risk over the intermediate-term.

The current correction is the 4th of 10% or more over the last 3-years. Do not dismiss this lightly as Sentiment Trader noted on Monday:

We have discussed previously, the pickup in volatility over the last couple of years is more akin to a broader “topping” process for the markets. Outcomes from such have not been outstanding. 

However, given the more bearish tone to the market, and the extreme net short position on the Nasdaq, it won’t take much to elicit a “short-covering” rally. Some “encouraging” words from the White House promising fiscal support, or a Fed speaker suggesting monetary action, would do the trick.

While either would give the markets a short-term lift, we suggest using rallies to reduce risk, for now.

We suspect that given the rather numerous headwinds currently facing the markets, from the Fed to the election, a failure at lower highs would not be surprising.

TPA Analytics: Top 10 Buys & Sells As Of 09-21-20

Note from the RIAPro Team:

We are proud to offer TPA Analytics to you at a deeply discounted price. TPA has been serving institutional clients with their trading ideas and strategies. Now you can add the same long-short strategies and ideas to your portfolio as well.

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

As a subscriber, you will receive real-time alerts of trading activity by TPA and a minimum of 2-reports each week.

Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points.


These are high conviction stocks that TPA has recommended recently. They are technically positive for “buys,” or negative for “sells.” They are also trading at, or near, the recommended action price levels.

Viking Analytics: Weekly Gamma Band Update 9/21/2020

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

Gamma Band Update 09/21/20

  • From an options market analysis perspective, the SPX continues to sit at an important inflection point. Some of our indicators have turned cautious, while at least one indicator remains bullish.
  • Friday, September 18th was the important “quad witching” quarterly expiration, and the market was treated to a week of volatility.
  • The S&P 500 (SPX) has traded and closed in and around the Gamma Neutral level all week, and closed below to end the week. The Gamma Neutral level has shifted slightly higher.
  • Since the SPX has higher volatility below Gamma Neutral, our indicator has reduced SPX exposure to 50% out of 100%.
  • If the SPX closes on a daily basis below the lower band (currently near 3,110), our indicator will cut SPX exposure to 0%.
  • Our options Smart Money Indicator remains bullish, however, and we discuss this in greater detail below.
  • SPX skew, which measures the relative cost of puts to calls, is in our view neutral at the moment.

Smart Money Residual Index

This indicator compares “smart money” options buying versus “hot money” options buying.  Generally, smart money will purchase options to ensure stable returns over a longer-term.  Smart money has in-depth knowledge and data in support of their options activity. In contrast, “Hot money” acts based on speculation, seeking a large payoff.

At the moment, hot money is more cautious than smart money, and the back-test supports a long position during this time.  When the Residual Sentiment Index in the second graph turns to red, then this model will cut all equity exposure to zero.  When the market is in the red regime below, the market has an overall negative return.

SPX Skew – the Price of Protection

We also consider the cost of buying puts versus the cost of buying calls.  When puts have a big premium to calls, then the market is seen to have extreme fear (in the red zone below).  During the September sell-off through Friday, the premium for buying puts has declined.  This is surprising considering the news narratives seem to indicate heightened market anxiety.  We consider skew to be neither bullish nor bearish at the moment.

Gamma Band Background

Market participants are increasingly aware of how the options markets can affect the equity markets in a way that can be viewed as the “tail wagging the dog.” 

We created a simple Gamma Band indicator to demonstrate the effectiveness of the Gamma Neutral level in reducing equity tail risk.  In our model, we compare the daily close of the SPX to the Gamma Neutral and Lower band levels to adjust our equity exposure allocation from 0% to 100%.   This is a “slow” but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish faster, daily signals in a portfolio model which we call Thor’s Shield.   Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

We back-tested this strategy from 2007 to the present and realized an 80% increase in risk-adjusted returns (measured by the Sharpe ratio).  The annual volatility of this approach, versus a long-only position, falls from 21% to 10%. 

Authors

Viking Analytics is a quantitative research firm that creates tools to navigate complex markets.  If you would like to learn more, please visit our website, or download a complimentary report.

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

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


Value, Margin Of Safety, & The Art Of Doing Nothing

Over the last several months, we have discussed the remarkable underperformance of value versus growth. While many investors quickly dismiss the performance gap under the guise of “this time is different,” it has important longer-term implications. In today’s missive, we want to discuss value, the margin of safety, and the real art of “doing nothing.” 

This Time Is Different

A recent MarketWatch article made an argument for why this time is different than previous cycles.

“Investors seem to want to embrace a value tilt – stocks that will do well as the economic recovery gathers steam. However, they continue to fall back on the tried-and-true growth stocks that have done well so far, through more uncertain times. But what if those old ‘value’ and ‘growth’ frameworks are the wrong way to measure market moves?”

If you re-read the statement closely, there are a couple of issues that stand out.

  1. If “individuals” continue to “fall back” into the stocks that are rising with the market, then they are “speculating” by chasing prices rather than “buying value.” 
  2. There is nothing wrong with the “growth” and “value” frameworks, expect in periods where they don’t fit the speculative fervor of the market.

Investing Versus Speculation

Currently, the majority of investors are simply chasing performance. However, why would you NOT expect this to be the case. On a daily basis the media, and WallStreet, continually press investors to chase prices higher by deeming “this time to be different.” 

However, this is where we can begin to understand the difference between investing based on value versus speculating for short-term gains.

Let me give you an example:

You are playing a hand of stud poker, and the dealer deals you this hand:

How would you bet? A lot, a little, or would you fold? 

Even a cursory understanding of the game of poker suggests other players are probably holding better hands than you. Instinctively, you know this and you would tend to “fold” and wait for the next hand.

Now, is this operation “investing” or “speculation?” 

The answer should be obvious. When you engage in an operation where the outcome is primarily derived from “luck,” more than “skill,” it is speculation.

Phillip Carret, who wrote The Art of Speculation (1930), defined this more elegantly:

“Speculation, may be defined as the purchase or sale of securities or commodities in expectation of profiting by fluctuations in their prices.”

Chasing markets is the purest form of speculation. It is merely a bet on prices going higher rather than determining if the price paid for those assets is at a discount to fair value.

Value, #MacroView: Value Is Dead. Long Live Value Investing

The Discounting Of Value

What the quote from MarketWatch espouses is that of the “Greater Fool Theory.”

“The greater fool theory states that it is possible to make money buying securities, whether or not they are overvalued, and sell them for a profit at a later date. Such is because there will always be someone (i.e. a bigger or greater fool) else willing to pay a higher price.”

Such is also the purest definition of market speculation.

Benjamin Graham, along with David Dodd, attempted a precise definition of investing and speculation in their seminal work Security Analysis (1934).

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

Graham also noted why individuals should be concerned when they read articles espousing “this time is different.” 

“The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern.” – The Intelligent Investor

Given the sharp rise in markets since March, it is not surprising the media pushes a host of excuses to justify overpaying for assets. However, as Graham goes on to note, the media should take a different track.

We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all its dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.” – Ben Graham, The Intelligent Investor

Why Value Investing Wins The Long-Game

Throughout market history, investors repeatedly abandon the principles of value investing and maintaining a “margin of safety” during periods of exuberance. Ultimately, those investors paid a dear price for their speculation. “Overpaying for value” has repeatedly led to poor financial outcomes.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

What Is A “Margin Of Safety”

Ben Graham heavily espoused the importance of amargin of safety” in the investment operation. The margin of safety suggests an investor only purchases securities when their market price is significantly below their intrinsic value.

“Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety” – Ben Graham

Followers of Ben Graham’s teachings have a deep history of long-term investing success from Warren Buffett to Seth Klarman:

“The best investments have a considerable margin of safety. This is Benjamin Graham’s concept of buying at a sufficient discount that even bad luck or the vicissitudes of the business cycle won’t derail an investment. As when you build a bridge that can hold 30-ton trucks but only drive ten-ton trucks across it, you would never want your investment fortunes to be dependent on everything going perfectly, every assumption proving accurate, every break going your way.” – Seth Klarman

The reality of investing is that rarely does everything “break” the right way. Having a “margin of safety” provides a cushion against the unexpected when it occurs.

An Example Of Intrinsic Value

Investing using a “margin of safety” is not as easy as it sounds. The vast majority of retail investors today do “no research” on the companies in which they invest. They look to the financial media, websites, and tweets to tell them what to buy. Or worse yet, they just buy what is “winning” in the short-term.

The reality is that the concept of a margin of safety is found only by researching to discover the company’s qualitative and quantitative factors. Such work includes understanding the firm’s management, governance, industry performance, assets, and earnings. From there, the investor must derive the security’s intrinsic value.

The following is a report on CVS Health. We regularly provide such reports to our RIAPRO Subscribers (30-day Risk-Free Trial). The report is a condensed version of analysis we use to determine the intrinsic value of a potential investment opportunity.

Nick Lane: The Value Seeker Report- CVS Health (NYSE: CVS)

Once you have done your homework, the market price is then used as the point of comparison to calculate the margin of safety. As noted in the CVS report:

“CVS is currently priced at a deep discount to its intrinsic value. We forecast that roughly 47.1% of upside remains on the stock.”

Such is why Warren Buffett declares the “margin of safety” as one of his “cornerstones of investing.” He, like us, applies as much as a 50% discount to the intrinsic value of a stock to determine price targets.

However, in a market that is overvalued on many metrics, finding value becomes difficult. Furthermore, holding value when it is underperforming the “hot stocks” in the market, is even more challenging.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

Art Of Doing Nothing

Currently, value investing is clearly out of favor. It hasn’t worked well for so long it is not surprising the media has declared “value investing dead.” As we showed in that article:

“The graph below charts ten-year annualized total returns (dividends included) for value stocks versus growth stocks. The most recent data point representing 2019, covering the years 2009 through 201-, stands at negative 2.86%. Such indicates value stocks have underperformed growth stocks by 2.86% on average in each of the last ten years.”

Value, #MacroView: Value Is Dead. Long Live Value Investing

There are two critical takeaways from the graph above:

  • Over the last 90 years, value stocks have outperformed growth stocks by an average of 4.44% per year (orange line).
  • There have only been eight ten-year periods over the last 90 years (total of 90 ten-year periods) when value stocks underperformed growth stocks. Two of these occurred during the Great Depression, and one spanned the 1990s leading into the Tech bust of 2001. The other five are recent, representing the years 2014 through 2019.

Mirror Opposites

“The chart shows the difference in the performance of the “value vs growth” index. That index is compared to a pure growth index with each based on a $100 investment. While value investing has always provided consistent returns, there are times when growth outperforms value. The periods when “value investing” has the greatest outperformance, as noted by the “blue shaded” areas, are notable.”

Value, #MacroView: Value Is Dead. Long Live Value Investing

So, what should investors do when they can’t find real value in which to invest? While the media says you must always remain invested regardless of the outcome, there is an option. Do nothing.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

The Art Of Doing Nothing

Such was a point Jesse Felder recently noted:

Perhaps the most important lesson about investing I’ve learned is when there is nothing to do, do nothing. The problem is nothing may actually be the hardest thing to do. We all want to feel like we are being proactive and that requires doing something even when there’s nothing to be done. So it takes a great deal of discipline to resist the urge to do something and commit to doing nothing. In that way, however, committing to doing nothing is probably the most proactive thing to do.

His comment defines “investment” versus “speculation.” 

When investing, we seek to deploy capital in an operation with potential to deliver a high return on that investment. Therefore, logically, if no such opportunity with the required “margin of safety” exists, then the best operation is to “do nothing.” 

You wouldn’t overpay for a piece of real estate. You shop for the best price on everything from televisions to autos. Yet, when it comes to investing, why would you pay any price for a future stream of cashflows?

Conclusion

Another way to think about this is to realize that the vast majority of mistakes investors make come out of a feeling of needing to do something, of being proactive, rather than simply waiting patiently to react to a truly fantastic opportunity. Rather than react only to true opportunity, they react to social pressure or envy when they see their neighbor making a “killing” in dot-com stocks, ala 2000, or residential real estate, ala 2005, or in call options today.” – Jesse Felder

As is always the case, it may seem for a while that investors are making money “hand over fist” while the market is rising. However, the stories are just as plentiful about what happens as the inevitable downturn vaporizes capital in an instant.

I agree with Jesse’s conclusion:

Right now, due to the extraordinary circumstances in the world, politics, the economy, monetary policy, and more, the urge to do something is greater than normal. However, the opportunity to put money to work is simply not there. At least not yet. But it’s coming. And until it does, the most proactive thing an investor can do is simply commit to doing nothing. Understanding that that is not a passive decision, but a very proactive one, indeed.

Major Market Buy-Sell Review: 09-21-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 09-21-20

There are three primary components to each Major Market Buy/Sell chart in this RIAPro review:

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

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

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

Major Market Buy/Sell Review 09-21-20

S&P 500 Index

  • As noted last week: “While we suspect we will see some attempts at “dip buying,” there is a high degree of risk to the market still.” 
  • That attempt failed into Friday’s close during options expiration. The market is now oversold short-term, so look for a tradable rally next week.
  • The break of the 50-dma sets the market up for a test of the 200-dma. It will be very important the market rallies and closes above the 50-dma next week. 
  • We continue to suggest using rallies to reduce risk and take profits for now.
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow remains in overbought territory but is holding the 50-dma more now.
  • Use rallies to sell into for now and reduce risk. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • QQQ’s outperformance of SPY turned down last week as Tech stocks received the brunt of the selloff for a third week. 
  • The QQQ’s are now decently oversold. Look for a rally next week to get back above the 50-dma. If not, the decline will test the 200-dma. 
  • Use rallies next week to reduce risk and raise cash. 
  • There is a tradable opportunity for major tech stocks next week. Keep stops very close.
  • Short-Term Positioning: Bearish.
    • Last Week: No changes this week.
    • This Week: Taking profits.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps failed the 50-dma this past week, putting the 200-dma into focus. 
  • The bullish news is the 50-dma did cross above the 200-dma which does add support for small caps at $62.
  • Small-cap is testing the 200-dma. It must hold these levels but the index is not grossly oversold. Risk is to the downside currently. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $60
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. However, MDY held up better than SLY last week. 
  • MDY is testing its 50-dma and holding for now. That must continue next week, otherwise, we will see a test of the 200-dma. 
  • We continue to avoid mid-caps for the time being until relative performance improves.
  • The $330 stop-loss remains. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $330
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets have performed better on a relative basis during the correction and have turned up relative to the S&P 500.
  • EEM is working off the overbought condition. If it can hold support and complete the process there will be a tradeable opportunity.
  • The dollar decline, responsible for EEM performance, is well overdone. Look for a counter-trend rally, which will push EEM lower. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $40 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • EFA is performing better and holding support at the 50-dma.
  • The dollar is extremely oversold, so a rally in the dollar could impact the EFA. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • We noted last week that “Oil is currently 3-standard deviations oversold so a bounce is likely next week. However, a continued dollar rally could halt that.”
  • The rally in oil occurred but did little to help the energy sector. 
  • Oil is currently testing resistance at the 200-dma. It needs to clear that if energy is going to get a lift. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long in our current position in IAU, but as noted last week, “after taking profits previously, we used the correction back to support to add a little to both IAU and GDX.”
  • Gold is consolidating and is close to testing support at the 50-dma where it must hold. We are looking to increase our exposure if that support holds. 
  • Set stops at $175
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions.
    • Stop-loss moved up to $175
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds continued to hold up last week and is continuing its consolidation process. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold position.
    • This Week: Hold positions.
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar continues to hold support for now, but the oversold condition is more extreme.
  • Given a large number of analysts with “bearish” forecasts on the dollar, the probability of a dollar rally has risen. 
  • Traders can add positions to hedge portfolios, but there is not likely a colossal move available currently given the current market dynamics. 
  • Stop-loss adjusted to $92.

The Pre-Election Correction Continues, Is It Over?


In this issue of “The Pre-Election Correction Continues, Is It Over?”

  • The Correction Continues
  • A Historical Look At Pre- And Post-Election Years
  • Will Policy Matter
  • Portfolio Positioning Update
  • MacroView: A Permanent Shift To Valuations
  • Sector & Market Analysis
  • 401k Plan Manager

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


We Need You To Manage Our Growth.

Are you a strong advisor who wants to grow your practice? We need partners we can work with to manage our lead flow. If you are ready to move your practice forward, we would love to talk.

This Week 08-28-20, #WhatYouMissed On RIA This Week: 08-28-20

Catch Up On What You Missed Last Week


The Correction Continues

Over the last couple of weeks, we have been discussing the ongoing market correction. As we stated last week:

“As shown in the chart below, we had suggested a correction back to previous market highs was likely but could extend to the 50-dma. So far, the correction has played out much as we anticipated.”

However, we also said:

“However, while we expect a rally next week, due to the short-term oversold condition of the market, there is a downside risk to the 200-dma, which is another 5% lower from current levels. Such would entail a near 14% decline from the peak, which is well within the historical norms of corrections during any given year.”

On Friday, due to the “quad-witching options expiration” (when all options contracts for the current strike month expire and rollover), the market gave up support at the 50-dma, as shown below.

The good news, if you want to call it that, is the market did hold a previous level of minor support and remains oversold short-term.

As such, the break of the 50-dma must recover early next week, or it will put the 200-dma into focus. That is currently about 7% lower than where we closed on Friday.

However, as shown below, the markets are very oversold short-term, so a tradeable “bounce” remains very likely in the next few days. If the bounce fails at either the 50- or 20-dma’s overhead, as shown above, such could well confirm an ongoing correction process.

Importantly, as noted previously, this correction was not unexpected and fell in line with historical pre-election market cycles.

Is the correction over? As noted we are likely to get a tradeable bounce next week, but as we will discuss next, there could be more downside pressure in October heading into the election.

Presidential Elections & Market Outcomes

There has been a fair bit of concern about the upcoming election. Given the rampant rhetoric between the right and left, such is not surprising. The Republicans claim that Biden will crash the market. The Democrats suggest the same with President Trump.

From a portfolio management perspective, what we need to understand is what happens during election years to stock markets and investor returns.

Since 1833, the Dow Jones industrial average has gained an average of 10.4% in the year before a presidential election, and nearly 6%, on average, in the election year. By contrast, the first and second years of a president’s term see average gains of 2.5% and 4.2%, respectively. A notable recent exception to decent election-year returns: 2008, when the Dow sank nearly 34%. (Returns are based on price only and exclude dividends.)” – Kiplinger

The data in the table below varies a bit from Kiplinger as it uses total returns. Since 1833, markets have gained in 35 of those years, with losses in only 11.

Since President Rosevelt’s victory in 1944, there have only been two losses during presidential election years: 2000 and 2008. Those two years corresponded with the “Dot.com Crash” and the “Financial Crisis.” On average, stocks produced their second-best performance in Presidential election years.

With a “win ratio” of 76%, the odds are high that markets will continue their winning ways. However, I would caution completely dismissing the not so insignificant 24% chance that a bear market could reassert itself, given the current economic weakness.

Furthermore, given the current 12-year duration of the ongoing bull market, the more extreme deviations from long-term means, and ongoing valuation issues, a “Vegas handicapper” might increase those odds a bit.

Will Policies Matter

The short answer is, “Yes.” However, not in the short-term.

Presidential platforms are primarily “advertising” to get your vote. As such, a politician will promise many things that, in hindsight, rarely get accomplished.

Therefore, while there currently much debate about whose policies will be better for the stock market, historically and statistically speaking, it doesn’t matter much.

A look back at all election years since 1960 shows an average increase in the market of nearly 2.2% annually.

However, that number is heavily skewed by the decline during the 2008 “Financial Crisis.” If we extract that one year, returns jump to 7.7% annually in election years.

Importantly, note in both cases the slump in returns during September and October. As we stated above, the current market correction falls nicely in line with historical norms.

The Great Divide

While you may feel strongly about one party or the other when it comes to politics, it doesn’t matter much when it comes to your money.

Such is particularly the case today.

“For the second election in a row, voters will cast ballots for the candidate they dislike less, not whose policies they like more.” – Lance Roberts, Real Investment Show

What the market already understands is with the parties more deeply divided than at any other single point in history; the likelihood of any policies getting passed is slim. (2017 was the latest data from a 2019 report. That gap is even larger currently as Social Media fuels the divide.)

The one thing markets do seem to prefer – “political gridlock.”

“A split Congress historically has been better for stocks, which tend to like that one party doesn’t have too much sway. Stocks gained close to 30% in 1985, 2013 and 2019, all under a split Congress, according to LPL Financial. The average S&P 500 gain with a divided Congress was 17.2% while GDP growth averaged 2.8%.” – USA Today

It’s Not A Risk-Free Outcome

What we can derive from the data is the odds suggest the market will end this year on a positive note. However, such says little about next year. If you go back to our data table above, the 1st year of a new Presidential cycle is roughly a 50/50 outcome. It is also the lowest average return year going back to 1833.

Furthermore, from the election and 2021, outcomes are overly dependent on many things continuing to go “right.”

  1. Avoidance of a “double-dip” recession. (Without more Fiscal stimulus, this is a plausible risk.)
  2. The Fed continues expanding monetary policy. (There is currently no indication of this.)
  3. The consumer will need to expand their current debt-driven consumption. (This is a risk without more fiscal stimulus or sustainable economic growth.)
  4. There is a marked improvement in both corporate earnings and profitability. (This will likely be the case as mass layoffs will benefit bottom-line profitability. However, top-line sales remain at risk due to items #1 and #3.)
  5. A sharp improvement in employment, rising wages, and falling jobless claims will signal a sustainable economic recovery. (There is currently little indication this is the case outside the bounce from the March shutdown.)

These risks are all undoubtedly possible.

However, when combined with the longest-running bull market in history, high-valuations, and excessive speculation, the risks of something going wrong indeed have risen.

(While most financial media types present bull and bear markets in percentages, which is deceiving because a 100% gain and a 50% loss are the same thing, it worth noting what happens to investors by viewing cumulative point gains and losses. In every case, the majority of the previous point gain is lost during the full-market cycle.)

So, how do you position your portfolio into the election?

Portfolio Positioning For An Unknown Election Outcome

Over the last few weeks, we have repeatedly discussed the idea of reducing risk, hedging, and rebalancing portfolios. Part of this was undoubtedly due to the overly exuberant rise from the March lows and the potential for an unexpected election outcome. As we noted in “Tending The Garden:” 

“Taking these actions has TWO specific benefits depending on what happens in the market next.

  1. If the market corrects, these actions clear out the ‘weeds’ and allow for protection of capital against a subsequent decline.
  2. If the market continues to rally, then the portfolio has been cleaned up and new positions can be added to participate in the next leg of the advance.

No one knows for sure where markets are headed in the next week, much less the next month, quarter, year, or five years. What we do know is not managing ‘risk’ to hedge against a decline is more detrimental to the achievement of long-term investment goals.”

That advice continues to play well in setting up your portfolio for the election. As we have laid out, the historical odds suggest that markets will rise regardless of the electoral outcome. However, those are averages. In 2000 and 2008, investors didn’t get the “average.”

Such is why it is always important to prepare for the unexpected. While you certainly wouldn’t speed down a freeway “blindfolded,” it makes little sense not to be prepared for an unexpected outcome.

Holding a little extra cash, increasing positioning in Treasury bonds, and adding some “value” to your portfolio will help reduce the risk of a sharp decline in the months ahead. Once the market signals an “all clear,” you can take “your foot off the brake,” and speed to your destination.

Of course, it never hurts to always “wear your seatbelt.” 


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

Since we publish the Major Market review on Monday and Sector Review on Tuesday, we are replacing this section with Stock Screens to help you generate ideas for your portfolios. 

Weekly Stock Screens

Currently, there are 3-different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

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

S&P 500 Growth Screen

Value Screen

Technical Trading Screen


Portfolio / Client Update

If you have a few minutes, please watch my interview with MacroVoices. It is a good encapsulation of what our thoughts are currently and what we are watching for in our portfolio management process.

Over the last week, we have taken some further actions to reduce risk during the recent decline. In the short-term, the market is very oversold, and it is imperative the market regains and holds the 50-dma next week. We suspect that will be the case on Monday.

The downside risk is minimal at the moment. As such, we have continued to reposition the portfolio by raising some cash and adding some additional “value” based holdings. We will look to add to some of our stronger growth companies using this pullback to do so.

As we have noted previously, over the next few months, we continue to consolidate our portfolio holdings to reduce our total holdings from 32 to 25. Such will provide us with the ability to concentrate positions a bit more to increase overall portfolio yield, while also improving performance on a relative basis. Also, fewer positions simplify the process of hedging portfolio risks.

If you have any questions, all the advisors at RIA have been briefed on the strategy and will be happy to discuss it with you.

Portfolio Changes

This past week involved very few changes to the Equity Portfolio. 

After a long grind, RTX finally broke out of its consolidation and began to improve technically. We have owned the position previously, so adding it back to the portfolio was a simple process. As always, we start with a small position and build into it.

As part of our consolidation process, we have sold WELL and AEP. We are currently overweight in Utilities and Real Estate, which have been underperforming, so we trimmed out the laggards in our portfolio and will add to our stronger positions.

There were no changes to the ETF Portfolio this week.

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

As an RIA PRO subscriber (You get your first 30-days free), you have access to our live 401k plan manager.

Compare your current 401k allocation to our recommendation for your company-specific plan and our on 401k model allocation.

You can also track performance, estimate future values based on your savings and expected returns, and dig down into your sector and market allocations.

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

Technical Value Scorecard Report For The Week 09-18-20

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis, versus the assets benchmark, and on an absolute stand-alone basis.

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

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

This technical value scorecard report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary 09-18-20

  • To repeat from last week, the first set of 8 graphs below were recently revised to directly compare the score and the normalized score (sigma).
  • On a relative value basis for the S&P, Materials, Industrials, and Transportations are now very overbought. The leaders of the last few months, Technology and Communications, are now the most oversold sectors. XLE, the worst sector of the previous few months, had the best performance versus the S&P in the last week (+4.2%).
  • Value versus growth is showing signs of life. Both the score and normalized score are overbought. That is a first in a long while. Its too early to declare the value trade is on, but it is worth following closely becuase it could be powerful source of outperformance once it gets going in earnest.
  • On an absolute basis, the leaders and laggards mentioned above are the same. Energy continues to be the most oversold but is improving. The S&P 500, as shown in the graph, is finally back to fair value. The NASDAQ is the most oversold index, with developed markets (EFA) the most overbought.
  • We now have “spaghetti graphs” in the weekly lineup. These graphs for each sector allow us to simultaneously compare each sectors momemtum with its respective RIA Pro score. The square at the end of the line is the current reading. The graphs span 8 weeks.
  • Notice that XLI, XLB, and XTN are now in the upper righthand quadrant, while XLC and XLK are now in the lower lefthand quadrant.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

Nick Lane: The Value Seeker Report- PetMed Express (NasdaqGS: PETS)

This article is an RIA PRO exclusive for subscribers. If you are reading this article, this is a good example of the insights our subscribers read every day. Try it RISK-FREE for 30-days.

In this edition of the Value Seeker Report, we analyze an investment opportunity in PetMed Express (NasdaqGS: PETS) using fundamental and technical analysis.

Overview

  • The COVID pandemic has bolstered demand for e-commerce almost everywhere you look. For example, pet care has seen a significant increase in e-commerce traffic for products ranging from toys to medication.
  • PetMed Express (PETS) is America’s largest pet pharmacy. Its market cap is $606.7M, which makes it a small-cap stock.
  • PETS does all of its business direct-to-consumer through the e-commerce channel. Its primary competitor in this space is Chewy (NYSE: CHWY). However, PETS focuses mainly on prescription and over-the-counter (OTC) medications, while CHWY ships a broad spectrum of products.
  • PETS’ stock is currently trading at $30.38 per share. Using our forecasts, we arrive at an intrinsic value of $41.14 per share. This implies an upside of 35.3% on the investment.

Pros

  • The market had briefly priced in the benefit PETS will receive from the pandemic as early as March. Although, following PETS’ last earnings report, investors have tempered their expectations. As a result, PETS’ stock would need to appreciate over 38% in order to reach its August peak once again.
  • The Firm has paid a quarterly dividend since 2015. In May, PETS raised its quarterly payout to $0.28 per share from $0.27 per share previously. The stock’s current dividend yield is 3.6%.
  • As shown below, our forecasts indicate that PETS will produce the free cash flow necessary to raise its dividend by $0.04 per share annually over the forecast period.
  • The stock trades at a Price to Earnings (P/E) ratio of 21.1. This isn’t particularly low, but investors should view the recent dividend increase as an indication of higher future earnings expectations. 

Cons

  • PETS operates under a debt-free capital structure. With all the recent criticism of non-productive debt issuance, you may be thinking this point was misplaced. It wasn’t. Just as too much debt can be problematic, businesses that don’t utilize enough debt can destroy value for shareholders.
  • The Company appears to be self-financing operations by keeping a substantial balance of excess cash. If PETS were to perform even a mini leveraged-recapitalization, equity holders would be better off.  
  • PETS is susceptible to increased future competition. It has seen increasing profit margins in the last few years and is now experiencing bolstered demand. Thus, this is an inviting situation for potential new entrants.

Key Assumptions

  • PETS’ historical revenue growth has been anything but impressive. However, management has inspired modest growth with recent investmets. As shown below, we forecast revenue growth to remain modest yet steady over the forecast period.
  • We forecast PETS’ operating margins to increase slightly in 2020, then taper off rather quickly as competition builds. We expect margins to finally settle for the long-term near their 2015 level. Our forecasts of operating profit are shown below.
  • PETS will begin reinvesting more capital in the business to facilitate modest growth over the forecast period.

Sensitivity Analysis

  • A brief note on why we present sensitivity analysis can be found here.
  • Management’s efficiency in allocating capital will play a crucial role in determining the intrinsic value of PETS. Fortunately, there is a sizable margin for error.

Technical Snapshot

  • PETS recently closed above its 200-day moving average after a brief violation of that level. If PETS holds above its 200-day moving average, it won’t face resistance until it tests the 50-day moving average just below $33 per share.

Value Seeker Report Conclusion On PETS

  • Based on our forecasts, PETS offers 35.3% of upside at the current price.
  • PETS is a good company with a convincing story, steady cash flows, and decent price. Having said that, we won’t be purchasing the stock, yet. It will remain on our radar, along with some other value stocks, and we may add it to our portfolios at a later date.

For the Value Seeker Report, we utilize RIA Advisors’ Discounted Cash Flow (DCF) valuation model to evaluate the investment merits of selected stocks. Our model is based on our forecasts of free cash flow over the next ten years.

#MacroView: Newton, Physics & The Market Bubble

I have previously discussed the importance of understanding how “physics” plays a crucial role in the stock market. As Sir Issac Newton once discovered, “what goes up, must come down.”

Andy Kessler, via the Wall Street Journal, recently discussed a similar point with respect to the momentum in stock prices. To wit:

“Does this sound familiar: Smart guy owns stock in March at $200, sells it in June at around $600, but then buys it back in July and August for between $900 and $1,000. By September it’s back at $200. Ouch. Tesla this year? Yahoo in 2000? Nope. That was Sir Isaac Newton getting pulled into the great momentum trade of the South Sea Co., which cratered 300 years ago this month. He lost the equivalent of more than $3 million today. Newton, whose second law of motion is about the momentum of a body equaling the force acting on it, didn’t know that works for stocks too.”

To understand what happened to the South Sea Corporation, you need a bit of history.

The South Sea History

In 1720, in return for a loan of £7 million to finance the war against France, the House of Lords passed the South Sea Bill, which allowed the South Sea Company a monopoly in trade with South America.

England was already a financial disaster and was struggling to finance its war with France. As debts mounted, England needed a solution to stay afloat. The scheme was that in exchange for exclusive trading rights, the South Sea Company would underwrite the English National Debt. At that time, the debt stood at £30 million and carried a 5% interest coupon from the Government. The South Sea company converted the Government debt into its own shares. They would collect the interest from the Government and then pass it on to their shareholders.

Interesting Absurdities

At the time, England was in the midst of rampant market speculation. As soon as the South Sea Company concluded its deal with Parliament, the shares surged to more than 10 times their value. As South Sea Company shares bubbled up to incredible new heights, numerous other joint-stock companies IPO’d to take advantage of the booming investor demand for speculative investments.

Many of these new companies made outrageous, and often fraudulent, claims about their business ventures for the purpose of raising capital and boosting share prices. Here are some examples of these companies’ business proposals (History House, 1997):

  • Supplying the town of Deal with fresh water.
  • Trading in hair.
  • Assuring of seamen’s wages.
  • Importing pitch and tar, and other naval stores, from North Britain and America.
  • Insuring of horses.
  • Improving the art of making soap.
  • Improving gardens.
  • The insuring and increasing children’s fortunes.
  • A wheel for perpetual motion.
  • Importing walnut-trees from Virginia.
  • The making of rape-oil.
  • Paying pensions to widows and others, at a small discount. 
  • Making iron with pit coal.
  • Transmutation of quicksilver into a malleable fine metal.
  • For carrying on an undertaking of great advantage; but nobody to know what it is.

A Speculative Mania

However, in the midst of the “mania,”  things like valuation, revenue, or even viable business models didn’t matter. It was the “Fear Of Missing Out,” which sucked investors into the fray without regard for the underlying risk.

Though South Sea Company shares were skyrocketing, the company’s profitability was mediocre at best, despite abundant promises of future growth by company directors.

The eventual selloff in Company shares was exacerbated by a previous plan of lending investors money to buy its shares. This “margin loan,” meant that many shareholders had to sell their shares to cover the plan’s first installment of payments.

As South Sea Company and other “bubble” company share prices imploded, speculators who had purchased shares on credit went bankrupt. The popping of the South Sea Bubble then resulted in a contagion that spread across Europe.

Newton’s Folly

Sir Issac Newton, the brilliant mathematician, was an early investor in South Sea Corporation. Newton quickly made a lot of money and recognized the early stages of a speculative mania. Knowing that it would eventually end badly, he liquidated his stake at a large profit.

However, after he exited, South Sea stock experienced one of the most legendary rises in history. As the bubble kept inflating, Newton allowed his emotions to overtake his previous logic and he jumped back into the shares. Unfortunately, it was near the peak.

It is noteworthy that once Newton decided to go back into South Sea stock, he moved essentially all his financial assets into it. In general, Newton was intimately familiar with commodities and finance. As Master of the Mint, his post required him to make many decisions that depended on market prices and conditions.

The story of Newton’s losses in the South Sea Bubble has become one of the most famous in popular finance literature. While surveying his losses, Newton allegedly said that he could “calculate the motions of the heavenly bodies, but not the madness of people.”

For More On The History Of Speculative Bubbles: “Devil Take The Hindmost.”

History Never Repeats, But It Rhymes

Throughout financial history, markets have evolved from one speculative “bubble,” to bust, to the next with each one being believed “it was different this time.” 

The slides below are from a presentation I made to a large mutual fund company.

What we some common denominators between all previous bubbles and now.

The table below shows a listing of assets classes that have experienced bubbles throughout history, with the ones related to the current environment highlighted in yellow.

It is not hard to see the similarities between today and the previous market bubbles in history. Investors are currently chasing “new technology” stocks from Zoom to Tesla, piling into speculative call options, and piling into leverage. What could possibly go wrong?

Oh, by the way, the slides above are from a 2008 presentation just one month before the Lehman crisis.

The point here is that speculative cycles are always the same.

The Speculative Cycle

Charles Kindleberger suggested that speculative manias typically commence with a “displacement” which excites speculative interest. The displacement may come from either an entirely new object of investment (IPO) or from increased profitability of established investments.

The speculation is then reinforced by a “positive feedback” loop from rising prices. which ultimately induces “inexperienced investors” to enter the market. As the positive feedback loop continues, and the “euphoria” increases, retail investors then begin to “leverage” their risk in the market as “rationality” weakens.

The full cycle is shown below.

During the course of the mania, speculation becomes more diffused and spreads to different asset classes. New companies are floated to take advantage of the euphoria, and investors leverage their gains using derivatives, stock loans, and leveraged instruments.

As the mania leads to complacency, fraud and manipulation enter the market place. Eventually, the market crashes and speculators are wiped out. The Government and Regulators react by passing new laws and legislations to ensure the previous events never happen again.

The Latest Mania

Let’s go back to Andy for a moment:

“When bull markets get going, investors come out of the woodwork to pile in. These momentum investors—I call them momos—figure if a stock is going up, it will keep going up. But usually, there is some source of hot air inflating stocks: either a structural anomaly that fools investors into thinking ever-rising stock prices are real or a source of capital that buys, buys, buys—proverbial ‘dumb money.’ Think of it as a giant fireplace bellows, an accordion-like contraption that pumps in fresh oxygen to keep flames growing.” – Andy Kessler

We have seen these manias repeated throughout history.

  • In 1929 you could buy stocks with as little as a 5% down payment
  • The 1960s and ’70s had the Nifty Fifty bubble.
  •  In 1987 it was a rising dollar, portfolio insurance, and major investments by the Japanese into U.S. real estate.
  • In 2000, it was the new paradigm of the internet and the influx of new online trading firms like E*Trade creating liquidity issues in Nasdaq stocks. Additionally, record numbers of companies were being brought public by Wall Street to fill investor demand.
  • In 2008, subprime mortgages, low interest rates, and lax lending policies, combined with a litany of derivative products inflated massive bubbles in debt instruments.

In 2020?

What about today? Look back at the chart of the South Sea Company above. Now, the one below.

See any similarities.

Yes, that’s Tesla

However, you can’t solely blame the Federal Reserve as noted by Andy:

“Most simply blame the Federal Reserve—especially today, with its zero-interest-rate policy—for pumping the hot air that gets the momos going. Fair enough, but that’s only part of the story. Long market runs have always allured investors who figure they’re smart to jump in, even if it’s late.

Everyone forgets the adage, ‘Don’t mistake brains for a bull market.'”

This Time Is Different

As stated, while no two financial manias are ever alike, the end results are always the same.

Are there any similarities in today’s market? You decide.

“From SPACs, or special purpose acquisition companies, which are modern-day blind pools that often don’t end well. Today’s momos also chase stock splits, which mean nothing for a company’s actual value. Same for a new listing in indexes like the S&P 500. Isaac Newton could explain the math.” – Andy Kessler

You get the idea. But one of the tell-tale indications is the speculative chase of “zombie” companies which are only still alive primarily due to the Federal Reserve’s interventions.

Fixing The Cause Of The Crash

Historically, all market crashes have been the result of things unrelated to valuation levels. Issues such as liquidity, government actions, monetary policy mistakes, recessions, or inflationary spikes are the culprits that trigger the “reversion in sentiment.”

Importantly, the “bubbles” and “busts” are never the same.  

I previously quoted Bob Bronson on this point:

It can be most reasonably assumed that markets are efficient enough that every bubble is significantly different than the previous one. A new bubble will always be different from the previous one(s). Such is since investors will only bid prices to extreme overvaluation levels if they are sure it is not repeating what led to the previous bubbles. Comparing the current extreme overvaluation to the dotcom is intellectually silly.

I would argue that when comparisons to previous bubbles become most popular, it’s a reliable timing marker of the top in a current bubble. As an analogy, no matter how thoroughly a fatal car crash is studied, there will still be other fatal car crashes. Such is true even if we avoid all previous accident-causing mistakes.”

Comparing the current market to any previous period in the market is rather pointless. The current market is not like 1995, 1999, or 2007? Valuations, economics, drivers, etc. are all different from cycle to the next.

Most importantly, however, the financial markets always adapt to the cause of the previous “fatal crash.”

Unfortunately, that adaptation won’t prevent the next one.

Yes, this time is different.

“Like all bubbles, it ends when the money runs out.” – Andy Kessler

#WhatYouMissed On RIA This Week: 09-18-20

What You Missed On RIA This Week Ending 09-18-20

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

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


We Need You To Manage Our Growth.

Are you a strong advisor who wants to grow your practice? We need partners we can work with to manage our lead flow. If you are ready to move your practice forward, we would love to talk.

This Week 08-28-20, #WhatYouMissed On RIA This Week: 08-28-20

What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 09-18-20


What You Missed: Video Of The Week

What Fed Said And Didn’t Ssay

Michael Lebowitz joined me yesterday to discuss what the Fed said and didn’t say about more monetary support for the market. Of course, we also cover the market and why Wall Street is happy to bring you IPO’s.



Our Best Tweets For The Week: 09-18-20

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

TPA Analytics: Economist Explains Why Economy May Be Rough


Note from the RIAPro Team:

We are proud to offer TPA Analytics to you at a deeply discounted price. TPA has been serving institutional clients with their trading ideas and strategies. Now you can add the same long-short strategies and ideas to your portfolio as well.

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

As a subscriber, you will receive real-time alerts of trading activity by TPA and a minimum of 2-reports each week.

Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points.

Using RIAPro To Screen For Value

For the last couple of months, we have been discussing the idea of adding more “value” based stocks to portfolios. The reason is that “value” provides a hedge against “risk” due to its inherent “margin of safety” as discussed this week. Today, we will use RIAPro to screen for value-based stocks.

If you are new to the RIAPro system, it is set up in a process to follow:

  1. Dashboard – start your research by reviewing our latest market commentary, trades, articles, and tweets. Then check the news headlines, alerts, dividends, and earnings for the stocks in your watch list and portfolios.
  2. Macro – The next step is to get a “macro” view of the markets. Get an overview of major asset and sector performance. Also, look at sentiment, notable movers, currencies, and market internals. 
  3. Ideas – Once you have an idea about the direction of the markets, start generating some investable ideas. The “active trader” page condenses the market into areas with the best and worst momentum, relative strength, and MACD. You can also have ideas generated for you on the “Lists” page or “Scan” for your ideas.
  4. Research – Once you find an investment idea, its time to drill down and look at the technical performance, compare it to its peers, check out the analyst rankings, or search for stocks based on dividends, earnings, splits, or high yield. 
  5. Portfolio – Of course, once you generate your idea, you can then add it to your portfolio, watchlist, or add an alert to be notified when it hits your target entry price.

Okay, with this brief understanding of the “flow” of the site, let’s review how to “scan” for “value” on RIAPro.

Screen For Value

The first step is to head over to the IDEAS tab and click on the SCAN tab.

Once you get into the “scan” page, you will find a variety of options. (Note: we have recently added a new data feed. Future updates will include the ability to scan for specific fundamental factors of your choosing.)

While the “scan page” has several “technical options” to scan for, we have provided three specific “scores” to help identify the top fundamental candidates. These are the:

  • Piotroski “F” Score
  • Mohanram “G” Score
  • RIAPro Rank

Understanding The “Score” Systems

To use the “scores” efficiently, you need to understand what they encompass. The following are brief explanations, but I have provided links to the underlying research papers.

Piotroski “F” Score

“The Piotroski F-score is a number between 0 and 9 and assesses the strength of the company’s financial position. The score quantifies the stocks with the best value (9- being the best).

Here is the link to the research paper for further explanation.

The score is calculated based on 9-fundamental criteria divided into 3-groups.

Profitability

    1. Return on Assets 
    2. Operating Cash Flow 
    3. Change in Return of Assets (ROA) 
    4. Accruals

Leverage, Liquidity, and Source of Funds

    1. Change in Leverage (long-term) ratio 
    2. Change in Current ratio 
    3. A change in the number of shares outstanding.

Operating Efficiency

    1. Change in Gross Margin
    2. Change in Asset Turnover ratio 

As you can see, these items are all very fundamental, so we can quickly “scan” for “fundamental strength” by scanning for stocks ranked between 8 and 9.

Begin by selecting S&P Stocks in the “Category” field. Then, choose the option in the Piotroski box for stocks >=6. Lastly, click the Piotroski column to sort from highest to lowest, as shown below.

You now have a list of fundamentally strong stocks to begin to research. However, this is where the other scores can help refine the process.

Mohanram “G” Score

Partha Mohanram’s G-Score analysis, which was inspired by the Piotroski F-Score, uses a similar fundamental algorithm to identify low “book value to price” companies. The G-Score has eight factors grouped into three main growth stock signals. Those factors are as follows:

Growth Signals

    1. Return on assets (ROA) is greater than the industry median.
    2. Cashflow ROA exceeds the industry median.
    3. Cashflow from operations exceeds net income.

Stability Signals

    1. Earnings variability is less than the contemporaneous industry median (CIM)
    2. Sales growth variability is less than the CIM

Accounting Conservatism

    1. R&D deflated by beginning assets is greater than the CIM
    2. Capital expenditure deflated by beginning assets is greater than the CIM
    3. Advertising expenditures deflated by beginning assets is greater than the CIM

Here is a link to the research paper for further explanation.

The difference between the “G” score and the “F” score is that the score focuses on the fundamental factors related to “Growth” companies.

Begin by selecting S&P Stocks in the “Category” field. Then, choose the option in the Mohanram box for stocks >=6. Lastly, click the Mohanram column to sort from highest to lowest, as shown below.

You will see a very different grouping of stocks arise with this scoring system. Interestingly, while the Mohanram scores are high, the Piotroski scores are substantially lower.

Such is where the RIAPro Rank comes into play.

RIAPro Rank

The RIAPro rank is a scoring system based on the earnings growth trends of companies. Ultimately, if earnings are not growing, eventually the price will be reflective of the issue. The scoring system has 5-levels:

  1. Strong Buy
  2. Buy
  3. Hold
  4. Sell
  5. Strong Sell

Begin by selecting S&P Stocks in the “Category” field. Then, choose the option in the RIAPro box for “Buy and Strong Buy.” Lastly, click the RIAPro Rank column to sort from highest to lowest, as shown below.

Putting In All Together

Now that you have a better understanding of the different ranking systems, you can start to combine and refine your lists to find candidates for your portfolio.

For example, since we are looking for “fundamental value,” let’s screen for stocks in the S&P 500 index with high Piotroski “F” scores. Let’s also add a “Strong Buy and Buy” RIAPro ranking into the scan to make sure the company’s earnings trends are positive.

There are 53 candidates on the scan at the time I ran this. I have only shown the top-7, for this example.

Digging In

However, now that we have a potential list of candidates, we can “dig in” into each of the companies a bit more by clicking the “+” symbol, which is next to the ticker. For example, let’s take a look at one of our current RIAPro Equity Portfolio holdingsCRM (SalesForce).

When you click on the “+” sign, a pop-out window will provide you all of the data from the “Research” tab without having to leave the scan page.

You can also use the “scan” page streamline your choices further by adding in “technical overlays” such as moving averages, performance, volatility, momentum, etc.

Conclusion

In the coming months, we will be adding a variety of other screening options to help you deepen your research further. We will also provide more models from which you can choose and follow.

Screening for value in the current market environment is challenging. As noted in our recent articles, there is currently a deep underperformance of “value stocks.” If you are focused more on short-term growth, you may want to concentrate your scans on more “technical factors.”

However, if you do choose to go down the “value” path, you are going to have to be very patient and follow some basic rules.

  1. Understand that your performance relative to the market will lag in the short-term. 
  2. Despite a stock being a “fundamental value,” such does not mean you can abandon “risk” management and capital preservation strategies. (Maintain stop levels)
  3. Realize that some value stocks may well turn out to be “value traps.” Such is always a danger when digging into companies that appear to fundamentally cheap but aren’t. 
  4. Lastly, start small into your positions and add to them as your fundamental and value thesis begins to show positive results. Then scale “up” into the position over time.

I hope you find this guide useful.

If you have comments or suggestions for additional features or guides, please email us.

Growth or Value? Take Our Blind Taste Test

Growth or Value? Take Our Blind Taste Test

Given limited resources, it should be no surprise that we aim to maximize the value of our everyday purchases. In most cases, we seek to optimize between acquiring the best product at the most reasonable price.

Intriguingly, most investors do not apply the same discretion when investing their hard-earned wealth. Think about the problem: we seek value when we spend our wealth, but few seek value in protecting and growing their wealth.

In this article, we give a blind taste test. From this, we hope to show you how the lack of discernment, blindly picking stocks based on cache, and yesterday’s momentum is winning out over the logic of maximizing value through prudent intellectual rigor.

Blind Taste Test

Imagine going to your favorite winery and being presented with three bottles of wine. The bottles do not have labels or prices. You smell each wine’s aroma and then take a sip from each bottle. After the tasting, you decide to buy the bottle of wine you like the most.

The vintner then shares with you the price of each bottle. Taste and cost are the two factors that you must weigh to make a decision. Wine snobs may disagree, but to be honest, do you need anything more to buy a bottle of wine? While impossible to quantify, most people will unknowingly compute a ratio of sorts comparing the taste to price. The ratio will likely dictate the decision-making process.

Our wine buying calculus may look something like the table below. The taste scale is from 1 to 10, 1 for the worst, and 10 for the best.

The ratio column allows us to compare price to taste. The wine with the lowest ratio is the one, by our assessment, that provides the best taste per dollar. Which wine would you choose?

We opt for wine B. While it’s not the cheapest, it is the tastiest. Importantly, it gives us the most value per dollar.

Blind Equity Valuations

Now, let’s do a similar exercise comparing three stocks.

Instead of using a price to taste ratio, as above, we provide a host of fundamental data and ratios to help you pick a favorite. We leave out the names of the companies and the stock tickers.

Put your imaginary blindfold on and pick your favorite stock.

Stocks A and B are in the retail trade, and stock C is in the medical industry. Specifically, stock A is classified by Zack’s as Retail/Restaurants, stock B as Retail/Pharmacies, and stock C as Medical/Biomedical and Genetics.

Ownership of stocks, just like ownership of any corporation, represents a claim on the future earnings and cash flows of the company. As such, we share recent revenue and net income growth trends of the three companies.

We now have some appreciation for sales and earnings trends over the last decade. You can think of this to some degree as taste. The table below offers more clues about “taste” as well as price and value.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

The Moment of Truth: Pick a stock

Now comes the moment of truth. We gave you a sample of three companies. We fully recognize you are missing insight into each company’s prospects. With that said, these are well-established companies in very competitive businesses. Trends of the past five and ten years should provide useful guidance for future growth.

Now pick the stock you would prefer to own.

Did you pick the stock with the surging stock price, high momentum score, and extreme valuation ratios? Or did you choose from one of the two others with cheap valuations, decent dividend yields, yet poor price performance?

If the object was to pick the stock that did the best in prior periods, the answer is easy. You, however, now must select the stock most likely to provide the best returns in the future.

Which one gives you the most value for the money?

Remove Your Blindfold

  • A is Chipotle (CMG).
  • B is CVS (CVS).
  • C is Bristol Meyers (BMY).

Summary

Like wine, investors have their preferences for types of stocks. We know the allure of chasing a stock like CMG is powerful. Who does not want triple-digit gains? If we could invest in hindsight, we would all choose CMG. Unfortunately, all gains and losses are in the past. We can only look forward and try to assess which stocks will provide us with the greatest reward per dollar cost in the future. Most frequently, that strategy also includes protection against steep losses.

With CMG’s lofty valuations and relatively weak earnings and revenue trends, is it worth paying many multiples of the cost of CVS and BMY? Maybe CMG investors are banking on a surge in sales and a sharp reduction in their competition. Possibly there are new bestselling products or innovative product lines to which they will shift. If so, CMG may be at a more reasonable price than we portray. One thing is sure, CMG must sell a lot of burritos to justify their current valuation.

From a pure momentum-based short-term (speculative) trading perspective, CMG may be worth reviewing. However, to maximize the value of our investment dollars in the longer run, we vastly prefer value stocks like CVS or BMY.

Sector Buy/Sell Review: 09-15-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 09-15-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine not only decision making about what to own and when, but what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. Currently, markets and sectors are back to “stupid” overbought on many levels. We advise caution.

SECTOR BUY/SELL REVIEW: 09-15-20

Basic Materials

  • Looking at XLB, you would not guess we were in an economic recession. Nonetheless, XLB is outperforming the S&P 500 index for the first time in a long while.
  • With XLB pushing into very overbought conditions with a historically high “buy signal,” there seems to be a lot less reward in the sector currently. 
  • It isn’t advisable to chase the sector currently. Look to buy on dips and short-term oversold conditions.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
    • Stop-Loss moved up to $60
  • Long-Term Positioning: Bearish

Communications

  • We noted previously that “XLC has pushed into extremes with the largest deviation from the 200-dma in its history, 3-standard deviations above the 50-dma, and the most overbought buy signal ever. A correction is coming. It is just a question of “when” and “what causes it.”
  • We suggested taking profits and reducing risks, and that correction has now happened. 
  • Currently, XLC is trying to hold the 50-dma but has not become oversold as of yet.
  • Adding a trading position is possible with a very tight stop at $58.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Reduced position by 1%. Will continue doing so until a correction occurs.
  • Long-Term Positioning: Bearish

Energy

  • Energy continues to fail. We were stopped out of our XOM position last week. 
  • Energy is deeply oversold and due for a bounce. However, there is not a lot of support for the sector currently, particularly if we get a dollar rally. 
  • With supports taken out, there is no reason to add exposure here. Wait for a bottom to form and the sector to show some signs of life first.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Sold XOM in both portfolios.
  • Stop-loss violated.
  • Long-Term Positioning: Neutral

Financials

  • Financials continue to underperform and remain a sector to avoid currently.
  • However, XLF did hold up better than the market during the recent decline. 
  • As noted previously, the 200-dma continues to be a problem for XLF.
  • The bit of pickup on rotation was disappointing, and banks remain out of favor for now.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • Industrials remain extremely extended and overbought.
  • Like materials, industrials are well ahead of the underlying fundamentals. We have grossly reduced our exposure to the sector and are looking for a better opportunity to add back to our position.
  • As suggested previously, take profits and rebalance risk. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bearish

Technology

  • Technology stocks, and the Nasdaq, have finally started the long-overdue correction. 
  • While the sector remains overbought and extended well above long-term means, the index is trying to hold the 50-dma and the breakout support of the upper bullish trendline. 
  • We used the pullback to add mildly to our technology positions after taking profits previously. These are “rental trades” we will sell into any short-term rally. 
  • The risk remains to the downside for now.
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Added 1% to XLK previously.
  • Stop-loss set at $105
  • Long-Term Positioning: Bullish

Staples

  • As noted previously, “XLP is overbought and is trading at 3-standard deviations above the mean. A correction is coming; timing is the only question.”
  • That correction came but has likely not concluded as of yet. XLP remains elevated above both short and long-term means. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $60 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Sold PG and added slightly to CLX
  • Long-Term Positioning: Bullish

Real Estate

  • XLRE has triggered a buy signal and is holding support at the 200-dma. 
  • We added some exposure back to REITs previously, and we expect some offsetting pickup if the rest of the market begins to correct. 
  • Move stops up to $35.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Looking to add more the XLRE if the sector maintains performance.
  • Long-Term Positioning: Bullish

Utilities

  • XLU has been struggling with resistance at the 200-dma.
  • However, Utilities are holding support at the 50-dma, and we expect we should see a pick up in performance if interest rates pull back. 
  • The sector is oversold and is potentially in a better position relative to other sectors of the market, particularly for “defensive” positioning.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV finally corrected back to the 50-dma and is holding. 
  • With the sector back to oversold short-term, there is a tradeable opportunity. 
  • Trading positions are possible. Put a stop at $104.
  • The 200-dma is now essential support for XLV and needs to hold, along with the previous tops going back to 2018. 
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • XLY continues to trade at extremes and is at the most significant deviation from its 200-dma in history. 
  • The same goes for its buy signal. 
  • I have no idea what trips this sector up, but it is coming, and the correction will be substantial. For now, the sector continues to hold up as the chase for AMZN continues.
  • Take profits and hedge risk. 
  • Stop-loss set at $130
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • The rally in XTN remains exceptionally extended. 
  • The sector is performing better but is grossly overbought. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and will wait for a correction to add back to our holdings. 
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Bearish