Is Plinko The Best The Fed Can Do?

Is Plinko The Best The Fed Can Do?

Plinko was made famous on the TV show The Price is Right. To play the game, a contestant drops a coin into one of the many slots at the top of the Plinko board. Then they watch the coin fall, bouncing off pegs until it reaches the bottom. The contestant hopes the coin ends in a generous reward slot at the bottom.

The picture below will jog your memory.

Unfortunately, a silly game of chance like Plinko is a great analog to explain current monetary policy and its flaws.

COVID QE

When COVID shut down the economy, the Fed immediately doled out massive amounts of monetary stimulus. In the first two months of the crisis, the Fed bought nearly $3 trillion of assets via QE. That is more than twice what they purchased during the worst moments of the Great Financial Crisis. A year later and the Fed is still buying $120 billion of assets monthly.

At no time since last March, or even today, has the Fed or Congress assessed whether the amount of monetary policy or distribution method is effective or even appropriate.

Monetary policy is like a game of chance in regards to who it benefits. The Fed has minimal ability to direct where and how stimulus funds are employed. Given that, one would think our “leaders” would ask the hard questions.

K-Shape Recovery

The economic recovery has not been even. The rich have gotten disproportionately wealthier, further widening already disturbing wealth inequality trends. The poor scrap to make ends meet, relying heavily on a smorgasbord of fiscal stimulus.

A year ago, when economic forecasters were using the letters L, U, and V to describe the shape of economic recovery, Peter Atwater introduced the letter K. The basis of Peter’s prediction was lockdowns unfairly hurt some while helping others. As a simple example, consider how well takeout pizza restaurants are doing versus high-end restaurants. The drastic changes in personal and corporate consumption habits benefit some to the detriment of others.

Many executives, investors, and white-collar workers are in great economic shape, having benefited financially from the recession. At the same time, a large percentage of the population is struggling mightily. Despite the economic recovery, they remain dependent on government checks, forbearance measures, and generous jobless benefits.

The Tweet below highlights how those at the upper arm of the “K” did this past year.

Why isn’t monetary stimulus helping everyone?

Plinko Monetary Policy

The Fed’s version of monetary policy is more akin to Plinko than you might believe. Instead of dropping a coin into a slot, the Fed drops dollars on Wall Street via bond purchases (QE). Once they purchase the bonds, the path of the coin, so to speak, is determined by the will of the banks that sold them the bonds. Unlike fiscal stimulus, the Fed cannot direct money to the economic sectors and/or people in need.  The Fed relies on the so-called “trickledown effect” to help the broad population and economy.

We can think of the Fed’s Plinko board as having four “reward” scenarios at the bottom. Once the Fed buys bonds the banks essentially have four options. Their choices determine the winners and losers.

  1. The banks can sit on the new reserves and earn interest from the Fed, with no effect to the economy. In this instance, they are the only winners.
  2. They can lend reserves out for productive purposes, which benefits future economic growth. Everyone wins in this scenario.
  3. The banks can also lend reserves for consumption purposes. Such debt provides a short-term spurt of economic activity. However, it creates future economic headwinds as the debt must be paid back and consumption was pulled forward.
  4. Lastly, the banks can lend the money to speculators allowing them to increase leverage on their assets. Speculative borrowers are the winners when this occurs.

In reality, money lands in all four slots. However, slots 1, 3, and 4 are where the bulk of the Fed’s purchases are ending up.

Unlike the Price is Right, the Fed’s version of Plinko has an additional “benefit.” As we wrote in The Fed is Juicing Stocks, QE boosts equity prices.

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

Trickle Down Policy- Banks

Despite the Fed’s claims that trickle-down policy works, there is ample evidence monetary stimulus does not help the broader economy or its citizens. One need only look at the rising level of debt as a percentage of GDP or pathetic productivity growth. These problems occur in part because the Fed cannot mandate the banks use funds to lend in ways that strengthen long-term economic growth.

Not surprisingly, what we find is the banks use QE reserves to do what is best for their bottom lines.

Trickle Down Policy- Equity Prices

Who benefits from rising stock prices? To put context to the question, consider this quote from Forbes (8/31/2020):

 “The latest available government data, via the Federal Reserve from 2016, shows a relatively small share of American families (14%) are directly invested in individual stocks but a majority (52%) have some market investment mostly from owning retirement accounts such as 401(k)s.”

A mere 14% of the population owns stocks that directly affect their liquid wealth. 52%, including the 14%, own stocks via 401k plans. Any benefits of rising stock prices in retirement plans are not accessible until retirement. 48%, or about half of the population, receive no direct benefit from rising stock prices.

Don’t believe us? On February 25, 2021, Fed President Williams said:

“There is some evidence that low-interest rates can move up asset prices disproportionately held by wealthy households.”

When the Fed’s coin trickles down, there are a few select winners and many losers.

Summary

Monetary policy is a game of chance. The winners are the wealthy who benefit immensely from rising equity prices and can borrow to buy even more assets at historic low rates. The rest of the population waits and watches and hopes that something trickles down. The Fed stands idly by falsely assuming their actions have direct and quantifiable benefits.

Abnormally low interest rates and a speculative investment environment bring forward future consumption and dissuade companies and individuals from productive investments. The price tag will come tomorrow when we lack the means to pay for today’s debt and find yesterday’s consumption can fill today’s need.

The Fed’s only response will be what it has been; we didn’t do enough.

Technically Speaking: Topping Patterns Popping Up Everywhere

As I worked through this past weekend’s newsletter, I noticed that multiple markets are starting to exhibit topping patterns. It will be crucial for markets to reverse these patterns in the short-term if the bullish advance continues.

As we discussed with our RIAPRO.NET subscribers yesterday:

“The good news is that the S&P 500 held its 50-dma during its recent selloff. With the market getting back to more oversold levels, we are likely to see a counter-trend rally for a few days that could get us back above the 20-dma. It will be necessary for the rally to set new highs to negate the “head and shoulders” pattern. If the market rallies, fails, and breaks the neckline, we could well see a deeper correction ensue.”

There is an important caveat to this analysis.

The start of “head and shoulder” patterns occurs with quite some regularity during an advancing market. However, they are quite often not completed as the market moves to new highs negating the pattern. Therefore, while we are pointing this pattern out, we are not saying the market is about to go lower. Such will only be if the pattern completes with a break of the “neckline” support.

However, it is important not to dismiss this pattern entirely as it often preceded more substantial declines, as we saw in March of 2020.

Notably, we see this pattern elsewhere.

Powell Changes Rules QE, #MacroView: Powell Changes The Rules On QE.

Same Pattern Popping up Everywhere

Nasdaq Index

The “head and shoulder” pattern is defined better in the Nasdaq. Currently, the neckline support needs to hold, or we will see a more significant correction in the technology sector. With the index more oversold than the S&P 500, I suspect we will see a rally shortly in these stocks, which we will use as a “selling” opportunity to reduce exposure.

Emerging Markets

Like the Nasdaq, we see a very well-defined “head and shoulders” pattern developing here as well. Emerging Markets are very oversold at current levels, so a counter-trend bounce is likely. A failure at the 20-dma is an excellent point to reduce exposure to these cyclical sensitive areas. If economic growth weakens in the U.S., we could see a much deeper correction in Emerging Markets. Watch for a break of the neckline as a “stop-loss” for now.

International Markets

Industrialized International Markets look much the same as the S&P 500. Watch the rising neckline as a trailing “stop-loss.” A failed rally should get used as an opportunity to reduce risk to international markets. Both international and emerging markets are well ahead of any expected growth in the U.S. economy, so the risk of disappointment is high.

Powell Changes Rules QE, #MacroView: Powell Changes The Rules On QE.

Dollars & Rates Continue To Be The Key

Currently, the market is betting on perfection. With valuations high, the bullish rationalization why prices can go higher is a bet on explosive economic growth, a falling dollar, low-interest rates, and a  consumer spending surge, all while inflation remains muted.

In other words, there is a LOT of room for something to go wrong. In our view, the two key issues that have the most significant potential to undermine market confidence remain the dollar and rates.

As noted previously, everyone expects the dollar to continue to decline, and the falling dollar has been the tailwind for the emerging market, commodity, and equity-risk trade. Whatever causes the dollar to reverse will likely bring the equity market down with it.

The dollar has started building higher bottoms and is currently triggering buy signals suggesting there may be more to this rally. Given the highly negative correlation of stocks, we need to pay close attention to what happens next.

The second risk, of course, is rates. As we saw last week, the entire market complex (including small and mid-cap markets) is sensitive to sharp increases in rates. With inflationary pressures rising, input costs will have to be passed along to cash-strapped consumers or absorbed by companies with already razor-thin margins in many cases. The outcome is not acceptable in either case.

Furthermore, the spike in rates, as shown below, which corresponds with higher inflationary pressures, quickly reaches the point that something tends to break in a debt-laden economy.

With the dollar and rates both rising, it is just a function of time until something breaks. Such is why, for now, we continue to suggest using rallies to reduce exposure to equities.

Powell Changes Rules QE, #MacroView: Powell Changes The Rules On QE.

Month End S&P Technical Review

With February now closed, we can review our longer-term charts for better clarity as to overall portfolio risk and allocations.

On an intermediate-term basis, using weekly closing data as of Friday, the market is trading well into 3-standard deviations above its long-term mean. It is incredibly overbought on a weekly basis. At the same time, there is a negative divergence in relative strength (RSI), which is also a cause of concern.

Since weekly charts are slower moving, such does not mean the markets will crash immediately. Long-term charts indicate that price volatility will likely be higher in the months ahead, and investors should monitor their risk accordingly. While momentum-driven markets can remain irrational much longer than logic would predict, eventually, a reversion has always occurred.

The chart below shows the price deviation from the one-year weekly moving average. Given the divergence is almost 20%, deeper price corrections have always been nearby. (Such does not mean a market crash. A correction of 10-20% is well within norms.)

Powell Changes Rules QE, #MacroView: Powell Changes The Rules On QE.

Long-Term View Is Bearish

The monthly chart of the S&P 500 is likewise just as problematic. Again, long-term charts predict long-term outcomes and are NOT SUITABLE for trading portfolios short-term.

As shown, the deviation from long-term monthly means is extreme. Also, note the negative divergence in relative strength (going down while the market is rising,) which has previously warned of more significant corrections.

We see the same problematic setup when viewing the market’s current deviation from its 2-year monthly moving average. The current deviation has only occurred 5-times since 1960 and has always led to a correction over the next several months. (Some worse than others.)

There is little to suggest investors who are currently too “long equity risk” in portfolios now won’t eventually suffer a more severe “mean-reverting event.” 

While valuations and long-term deviations suggest problems for the markets ahead, such can remain the case for quite some time. It is this long lead time that always leads investors to believe “this time is different.” 

Because of the time required for long-term data to revert, monthly data is only useful as a guide to managing expectations, allocations, and long-term exposures. In other words, this data is not helpful if you are trading markets and chasing short-term gains. 

Repeating For Effect

Every time I post longer-term technical analysis, I get emails chastising me for “being bearish” or “missing out.”  

Therefore, let me repeat something to ensure there is no confusion.

“What this analysis DOES NOT mean is that you should ‘sell everything’ and ‘hide in cash.’”

As always, long-term portfolio management is about managing “risk” by “tweaking” things over time. We are currently primarily long equity exposure in our portfolio models, but we have raised cash as of late, heading into last week’s sell-off. (I will admit I wish I had sold more.)

As discussed this past weekend, “risk happens fast.” As such, it is essential not to react emotionally to a sell-off.

Instead, fall back on your investment discipline and strategy.

  1. Is the premise of why you bought a position previously still intact?
  2. Has anything fundamentally changed for the company?
  3. Review the positioning of your portfolio relative to the benchmark? Are you out of tolerance in your allocations?
  4. Review your positions. Are they out of tolerance relative to your sizing rules?

Last but not least, keep your portfolio management process as simplistic as possible.

  1. Trim Winning Positions back to their original portfolio weightings. (ie. Take profits)
  2. Sell Those Positions That Aren’t Working. If they don’t rally with the market during a bounce, they will decline more when the market sells off again.
  3. Move Trailing Stop Losses Up to new levels.
  4. Review Your Portfolio Allocation Relative To Your Risk Tolerance. If you have an aggressive allocation to equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

Conclusion

Nobody ever went broke taking profits.

While keeping your capital intact is hard, making up lost capital is even more challenging.

Could I be wrong? Absolutely.

If we are, we will increase our exposure back reasonably quickly. However, if the indicators warn us of something more significant, ask yourself, what’s worse?

  • Missing out temporarily on the initial stages of a longer-term advance, or;
  • Spending time getting back to even which is not the same as making money.

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 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

Cartography Corner – March 2021

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

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

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

GTA Users Guide


February 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESH1) during February 2021. In our February 2021 edition of The Cartography Corner, we wrote the following:

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

  • M4                4128.50
  • M1                3971.50
  • PMH             3862.25
  • M2                3709.00
  • Close            3705.25      
  • M3                3661.75
  • PML              3652.50
  • MTrend        3650.25      
  • M5               3552.00

Active traders can use MTrend: 3650.25 as the pivot, maintaining a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for February 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  Our analysis accurately identified the pivot point realized in February.

On Sunday night, January 31st, 2021, the market price continued its weakness from the GameStop-induced volatility of the previous week.  The market price tested our isolated clustered support levels, including our isolated pivot level, at M3: 3661.75 / PML: 3652.50 / MTrend: 3650.25.  The low price for the month was realized that night at the price of 3656.50.  By the market close of February 1st, it had rallied 109.25 points, or 2.99%, to settle at 3765.75.

The following nine trading sessions saw the market price continue its rally, reaching the high settlement price for the month on February 12th at 3931.00.  A cumulative rally from its low of 274.50 points, or 7.51%, amidst an interest rate environment that saw the Ultra-Long Bond Futures contract drop in price by roughly 7 ½ points.      

On February 16th, the equity market began to pay attention to the bond market.  The high intra-session price for February was realized during the February 16th trading session at 3929.25 however, it settled 0.80% off its high and lower than the previous trading session.  Over the final eight trading sessions of February, the market price declined 118.50 points, or 3.02%, on a settlement basis.  (The Ultra-Long Bond Futures contract declined a further 9 1/2 points.)

Conservatively, active traders following our analysis realized a gain of 1.16%.  

Figure 1:

WTI Crude Oil Futures

We continue with a review of WTI Crude Oil Futures (CLJ1) during February 2021.  In our February 2021 edition of The Cartography Corner, we wrote the following:

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

  • M4         63.95
  • M1         58.44
  • M3         55.88
  • PMH       53.94
  • Close      52.20
  • M2           50.44
  • PML        47.18  
  • MTrend  46.71              
  • M5           44.93

Active traders can use M2: 50.44 as the pivot, maintaining a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for February 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first eight trading sessions of February saw the market price ascend to, and settle above, our third isolated resistance level at M1: 58.44.  On February 11th, it consolidated before its next major push higher in price.

Over the following nine trading sessions, accompanied by higher volatility (with M1: 58.44 acting as support), the market price ascended to our isolated Monthly Upside Exhaustion level at M4: 63.95.  The high price for February was achieved on February 25th at 63.81.  For those keeping the score, that is an error of 0.2%.

Figure 3 below is a monthly candlestick chart of WTI Crude Oil with a starting date of June 2008.  As shown in the graph, the market price is at a major inflection point.

Conservatively, active traders following our analysis realized a gain of 18.6%.

Figure 2:

Figure 3:

March 2021 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESH1).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Weekly Trend         3890.69       
  • Daily Trend             3858.58
  • Current Settle         3809.25       
  • Monthly Trend        3749.19       
  • Quarterly Trend      3274.01

The relative positioning of the Trend Levels remains bullish, although the magnitude of the bullishness is weakening (Current Settle < Daily Trend < Weekly Trend & Monthly Trend creeping up to Current Settle).  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for three quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Trend Up”, settling four months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”, after having been “Trend Up” for fifteen of the past seventeen weeks.

Support/Resistance:

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

  • M4 00
  • M1   25
  • PMH     25
  • M3         25
  • Close       25      
  • MTrend     19
  • M2             50
  • PML           50         
  • M5              75

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

10-Year Treasury Note Futures

For March, we focus on 10-Year Treasury Note Futures (“Tens”).  We provide a monthly time-period analysis of TYM1.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Quarterly Trend    138-25           
  • Monthly Trend      136-10
  • Weekly Trend       134-24           
  • Daily Trend           133-08           
  • Current Settle       132-23

The relative positioning of the Trend Levels is as bearish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross; the Trend Levels are lower as the time-periods decrease.  As can be seen in the quarterly chart below, Tens are “Trend Up”, having settled above Quarterly Trend for nine quarters.  Stepping down one time-period, the monthly chart shows that Tens are “Trend Down”, having settled below Monthly Trend for five months.  Stepping down to the weekly time-period, the chart shows that Tens have been “Trend Down” for four weeks.

Figure 4 below is a quarterly candlestick chart of 10-Year Treasury Note Futures with a starting date of 4Q2005.  As shown in the graph, the market price has returned to a zone that represented peaks in 3Q2012, 3Q2016, and 3Q2019.  Time will tell if that zone now offers support.

Figure 4:

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  The signal was given the week of February 15th to anticipate a two-week high within the next four to six weeks (now, three to five weeks).  That high can be achieved this week with a trade above 135-27.  The signal was given in February to anticipate a two-month high within the next four to six months.  That high can be achieved this month with a trade above 138-06.  The signal has been given in 1Q2021 to anticipate a two-quarter high over the next four to six quarters.  That high can be achieved in 2Q2021 with a trade above 139-25.

Support/Resistance:

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

  • M4         138-18
  • PMH       137-10
  • M1         136-13
  • MTrend  136-10
  • Close      132-23
  • PML          131-31
  • M3         128-13             
  • M2         127-29                         
  • M5           125-24

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

Summary

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

Sugar Rush! Why The Economy Will Run Hot, Then Crash.

The expected “sugar rush” from more stimulus is why the economy will “run hot” then crash. As every parent knows, giving a child too much “sugar” leads to a “rush” of energy. Then comes the crash, where you find them in some odd place taking a nap.

The Coming Economic “Rush”

Recently, JP Morgan joined the rest of the Wall Street banks in predicting a surge in economic activity for 2021 of 6.4%. Of course, the entire reasoning behind the rise in activity was due to “stimulus.”

“In a note to clients, JPM’s chief economist Michael Feroli made the following forecast revisions:

  • We now look for a $1.7 trillion fiscal stimulus package (up from $900 billion) to be passed in March
  • Even before that kicks in, growth appears to be on firmer footing at the start of the year
  • All told we now expect 6.4% (4Q/4Q) GDP growth this year and 2.8% next year
  • We see the labor market getting back to full employment, or around 4% unemployment, by 2Q22 and expect core PCE inflation to reach 2.0% by 4Q22, with balanced risks around the outlook.
  • While the outlooks for growth and inflation are moving up, Fed rhetoric appears to be getting more dovish” – Zerohedge

The statement quickly lays out the premise of the “rush and crash” syndrome.

The chart below shows annual real GDP growth rates from 2008 to the present. The surge in GDP in 2021 is a continuation of the “sugar rush” of monetary interventions. However, notice economic growth “crashes” back to annual norms in 2022.

The dashed black line is the average annual growth of GDP from 2007 at just 1.7%. (Without the addition of JP Morgan’s estimates, the actual growth rate through 2020 was only 1.3%)

For reference, a rate of growth below 2% isn’t strong enough to absorb population growth.

(Note: Prior to 2000, an economic growth rate of 2% was considered “pre-recesssionary.” In order to justify excess spending and Government interventions, 2% growth is now considered a “success” of policy.”

It’s All Been Artificial

Here is the more significant issue. The vast majority of the growth in the U.S. over the last decade was due to a variety of artificial inputs which are not indefinitely sustainable. From increasing federal expenditures:

And a litany of “bailouts,” which are a function of increased debts and deficits and massive monetary interventions.

While the economy may have “appeared” to grow during this period, economic growth would have been “negative” without debt increases. The chart below shows what economic growth would be without the increases in Federal debt.

Such is why, after more than a decade of monetary and fiscal interventions totaling more than $37 Trillion and counting, the economy remains on “life support.”

(It required roughly $12 in support to generate $1 of economic growth.)

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

While the claims of a robust economy rely heavily upon a surge in consumer spending, it is a mirage of the increase in “social benefits.”

Real Incomes Not Improving

A significant problem with a bulk of the analysis put out by mainstream economists, and the media is that it often fails to examine the underlying causes. An excellent example has been that consumer incomes are surging, which will support the economic “sugar rush.” A look at the chart below would undoubtedly suggest that to be true.

However, the reality is much less optimistic when you strip out “government transfer payments.”  While the economy has rebounded, real disposable incomes remain below previous highs. Notably, of the next $1.9 trillion in stimulus, only roughly $900 billion flows to households. Such won’t boost incomes markedly.

The chart below shows the problem more clearly. As noted above, the “real” economic prosperity of household incomes has not improved markedly without government supports. Such is why, at roughly 2% economic growth, nearly 1-in-3 households are dependent on some form of government handout.

A Surge In The “Welfare Trap”

There is a massive disconnect between the “stock market” and the “real economy.” As we have discussed previously, the top 10% of income earners own nearly 90% of the stock market.

Fed Top 10% Richer, Fed Study: How We Made The Top 10% Richer Than Ever.

For the bottom 80%, which drives the bulk of personal consumption expenditures (PCE), they continue to struggle to make ends meet. Such is why the dependency on social welfare now comprises 1/3rd of total incomes. Other statistics are just as daunting.

  • 38-million Americans on food stamps
  • According to the Census Bureau, an estimated 50% of the 330 million Americans get at least one federal benefit.
  • An estimated 63 million get Social Security; 59.9 million get Medicare; 75 million get Medicaid; 5 million get housing subsidies, and 4 million get Veterans’ benefits.

Those numbers continue to rise.

Without government largesse, many individuals would be living on the street. The chart above shows all the government “welfare” programs and current levels to date.

The problem with “stimulus programs” is that you can see the immediate subsequent contraction once the benefit depletes. Since 1/3rd of incomes dependent on government transfers, it is not surprising that the economy struggles as recycled tax dollars used for consumption purposes have virtually no impact on the overall economy.

In fact, in the ongoing saga of the American economy’s demise, U.S. households are now getting more in cash handouts from the government than they are paying in taxes for the first time since the Great Depression.

Such occurs when the current administration remains enthralled with finding some universe where socialistic programs lead to sustainable economic growth.

It doesn’t.

The Coming “Crash”

As the stimulus hits consumers, they spend it rather quickly, which leads to a “sugar rush” of economic activity. Such as:

  1. Consumers use the funds to make either necessary or discretionary purchases creating demand.
  2. In anticipation of demand, companies boost “inventories.”
  3. The boost in “inventory stocking” boosts manufacturing metrics.

We are seeing this currently as manufacturing and inventory metrics surge.

As shown, the stimulus will lead to a short-term boost in PCE, which will correspond with increased economic growth. (PCE comprises nearly 70% of the calculation.)

However, there is a “dark side” to stimulus-fueled activity.

  1. Since companies know the stimulus is “temporary,” they don’t make long-term hiring and capital expenditure plans.  
  2. The increase in activity leads to an inflationary rise that companies have difficulty passing on to consumers, ultimately reducing profit margins.
  3. Again, since companies know the stimulus is temporary, they opt for “efficiencies,” such as outsourcing and automation, to lower labor and production costs. 
  4. After the stimulus gets depleted, consumers struggle with higher costs which further deteriorates their standard of living. 

Unless the Government is committed to a continuous stimulus, once the “sugar rush” fades, the economy will “crash” back to its organic state.

The bottom line is that America can’t grow its way back to prosperity on the back of social assistance. The average American is fighting to make ends meet as their living cost rises while wage growth remains stagnant.

Deflation Set To Return

That brings us to the hard truth.

If we assume even the most optimistic economic outcome of the current stimulus bill, the reality is that economic growth will remain mired in its long-term downtrend.

As the budget deficit grows over the next few years, interest payments alone will absorb a larger chunk of tax revenue. Such comes at a time when that same dollar of tax revenue only covers the entitlement spending of the 75-million baby boomers migrating into the social safety net.

By the way, the only other time government income support exceeded taxes paid was during the “Great Depression” from 1931 to 1936.

The debt problem remains a massive risk to monetary and fiscal policy. If rates rise, the negative impact on an indebted economy quickly depresses activity. More importantly, the decline in monetary velocity clearly shows that deflation is a persistent threat.

No Real Options

There are no real options unless the system is allowed to reset painfully.

Unfortunately, given we now have a decade of experience of watching monetary experiments only succeed in creating a massive “wealth gap,” maybe we should consider the alternative.

Ultimately, the Federal Reserve, and the Administration, will have to face hard choices to extricate the economy from the current “liquidity trap.”  However, history shows that political leadership never makes hard choices until those choices get forced upon them.

Most telling is the current economists’ inability, who maintain our monetary and fiscal policies, to realize the problem of trying to “cure a debt problem with more debt.”

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40 years.

As Dr. Woody Brock aptly argues:

“It is truly ‘American Gridlock’ as the real crisis lies between the choices of ‘austerity’ and continued government ‘largesse.’ One choice leads to long-term economic prosperity for all; the other doesn’t.”

Take your pick.

While we likely see a spark of inflation, it probably won’t last long. Eventually, the grip of the debt-driven deflationary cycle will regain its burdensome hold.

Viking Analytics: Weekly Gamma Band Update 3/01/2021

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

Gamma Band Update

The Gamma Band model[1] has reduced its allocation to the S&P 500 (SPX).  When the daily price closes below the Gamma Neutral or “Gamma Flip” level (currently near 3,850), the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below the lower gamma level (currently near 3,625), the model will reduce the SPX allocation to zero.

This kind of model can be appropriate for investors who want upside exposure to the stock market, while protecting against downside tail risk.  For investors conditioned to want to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.   

This is one of several signals that we publish daily in our SPX Report.  A free sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and price signals.

The Gamma Flip – Background

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

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The daily Gamma Band model has improved risk-adjusted returns by over 70% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

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

 Authors

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

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


S&P 500 Monthly Valuation & Analysis Review – 02-28-21

S&P 500 Monthly Valuation & Analysis Review – 02-28-21

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


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

Shedlock: Spending Surge Coming With More Stimulus Money

Personal income jumped a whopping 10% in January on another round of free money. With another round of $895 billion coming soon, spending will surge as more stimulus money floods the system.

Personal Income Jumps 10% In January

The Bea’s Personal Income and Outlays Report for January 2021 notes that personal income increased $1,954.7 billion (10.0 percent) in January.

Disposable personal income (DPI) increased $1,963.2 billion (11.4 percent) and personal consumption expenditures (PCE) increased $340.9 billion (2.4 percent).

Rise Due to Transfer Payments

The 10% jump in January is due to a jump in transfer payments, notably covid stimulus payments.

Transfer payments are free money or money equivalents from the Federal government. 

The category includes food stamps, a relatively stable transfer payment, and Covid stimulus items (one time and ongoing).

There was a “one time” leap in March of 2020 and another “one time” jump in January of 2021. Democrats are angling for another “one time” jump, with some Republicans in agreement. 

Personal Income and Outlays Detail

PCE, Personal Income, personal PCTR 2021-01A

Personal Income minus Transfer Payments (Red Line) is about where it was before the Covid Pandemic hit. 

Spending plunged (Light Green Line), then recovered on the first stimulus package. 

Free Money

PCTR Other (Yellow Line), shows another huge surge, mostly unwarranted because it was a shotgun payment to nearly everyone as opposed to being targeted to only those genuinely affected by Covid.

PCTR Other led to the jump in Personal Income (Blue Line). Another spending surge is highly likely. 

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

Not Just Congress

It’s not just Congress that is loose with money. On February 23, I commented The Fed Soothes the Market Today With More Easy Money Talk

Also note that Powell Disses Inflation and Ignores Questions From Congress About Leverage

Finally, please note Mitt Romney’s accurate blast at Biden’s stimulus plan. For details, please see Biden’s Stimulus Bill Is a $1.9 Trillion Clunker

Yes, the Democrats are angling for yet another round of “one time” stimulus free money for all. 

Despite The Fed, The Bond Market Is Hiking Rates


In this issue of “Despite The Fed, The Bond Market Is Hiking Rates.”

  • Market Review And Update
  • Bond Market Is Hiking Rates
  • Why Higher Rates Are A Real Problem
  • Portfolio Positioning
  • #MacroView: Why Stimulus Doesn’t Lead To Organic Growth
  • Sector & Market Analysis
  • 401k Plan Manager

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

Catch Up On What You Missed Last Week


Market Review & Update

Last week, we discussed that the market was likely starting to adjust for higher rates. As we stated, historically, there is little room for error as higher rates undermine one of the critical “bullish supports” that low rates justify high valuations.

This past week, rates jumped higher, putting a further pause in the stock rally for now. As we stated over the last few weeks, the upside remains limited with the money-flow sell signal still intact. (The vertical dashed blue line denotes when the signals initially triggered.)

Thursday morning before the market opened, I discussed the two areas we watch very closely: the 10-year treasury rate and the volatility index. Both were on extremely oversold signals, and if they turned higher, such would suggest a continued correction in the market. That turned out to indeed be the case.

Currently, as shown above, the money flows remain positive, but “sell signals” are firmly intact. Such suggests downward pressure on prices currently.

We do expect that market will likely muster a short-term oversold rally next week. However, the risk of a continued correction in March is likely if money flows deteriorate further. It is advisable to use any rallies to reduce equity risk and rebalance allocations accordingly.

We continue to suggest some caution. Despite media claims to the contrary, higher interest rates will matter, as we will discuss next. More importantly, they tend to matter a lot.

The Fed Is Walking Into A Trap

We sent the following market commentary out to our RIAPRO subscribers yesterday morning:

  • Jim Bullard: “The rise in bond yields is a good sign so far.”
  • Esther George “LONG-TERM YIELD RISE DOESN’T WARRANT MONETARY RESPONSE”
  • R. Bostic: FED DOESN’T NEED TO RESPOND TO YIELDS AT THIS POINT

Jerome Powell, Jim Bullard, Esther George, Raphael Bostic, and other Fed members are steadfast in their determination to use an excessive amount of monetary stimulus to promote inflation and growth. The reflationary trade and the weak dollar over the last few months are confirmation that investors believe the Fed is making headway toward its goals.

The problem is that bond investors also believe they are making progress. On Tuesday and Wednesday, Jerome Powell said that he is not concerned about inflation and will keep the monetary pedal to the metal in no uncertain terms. The quotes above are all excellent reasons for bond investors to keep selling.

Selling in the bond market became problematic this week as yields in the economically sensitive 5-and 7-year sectors rose precipitously. Previously, it was 10- and 30-year bonds taking the brunt of selling activity. The shorter, intermediate sectors largely determine mortgage, corporate, and auto borrowing rates.

They steer economic activity.

While the Fed is running accommodative monetary policy, the market is increasingly imposing tighter financial conditions.

The Fed has a choice. They can watch yields rise to the detriment of economic growth, or they can walk back monetary policy. Doing so requires tapering QE and raising rates. Either action will pose problems for overvalued equity markets based on a tailwind of easy monetary policy.

To put it bluntly, the Fed is walking into a trap where at some point, they will get forced into deciding between rescuing the bond market or the stock market.

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

Why Higher Rates Are A Problem

It is essential to understand the impact of rates on a heavily leveraged economy.

1) Economic growth is still dependent on massive levels of monetary interventions. An increase in rates curtails growth as rising borrowing costs slows consumption.

2) The Federal Reserve runs the world’s largest hedge fund with over $7.5-Trillion in assets. Long Term Capital Mgmt., which managed only $100 billion, nearly derailed the economy when rising rates caused its collapse. The Fed is 75x that size.

3) Rising interest rates will immediately slow the housing market. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in interest rates means higher borrowing costs which lowers profit margins for corporations. 

5) One of the main bullish arguments over the last 11-years remains stocks are cheap based on low interest rates. That will change very quickly.

6) The negative impact on the massive derivatives market could lead to another credit crisis as rate-spread derivatives go bust.

7) As rates increase, so do the variable rate interest payments on credit cards. With the consumer already impacted by stagnant wages, under-employment, and high costs of living; a rise in debt payments would further curtail disposable incomes. Such would lead to a contraction in spending and rising defaults. (Which are already happening as we speak)

8) Rising defaults on the debt will negatively impact banks that are still not adequately capitalized and still burdened by massive levels of bad debt.

9) Commodities, which are sensitive to the direction and strength of the global economy, will revert as economic growth slows.

10) The deficit/GDP ratio will surge as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new estimates begin to propel higher.

I could go on, but you get the idea.

Putting It In Pictures

The ramifications of rising interest rates apply to every aspect of the economy.

As rates rise, so do rates on credit card payments, auto loans, business loans, capital expenditures, leases, etc., while corporate profitability gets reduced.

Currently, the economy requires almost $4.50 in debt to manufacture $1.00 of economic growth. Given the dependence on debt to fund growth, higher interest rates would be inherently destructive.

More importantly, consumers have sunk themselves deeper into debt as well. Currently, the gap between wages and the costs of supporting the required “standard of living” is at a record. With a requirement of over $16,000 in debt to maintain living standards, there is little ability to absorb higher rates before it drastically curbs consumption. 

The annual deficit of over $4000 to make up the gap between the cost of living and current incomes increases debt loads on consumers. Higher interest rates will further absorb discretionary incomes into debt service.

“But what about those charts that show the average American has deleveraged themselves? “

The vast majority of the deleveraging only occurred in the top 20% of income earners, which you would expect. It is hard to suggest that a family barely making ends meet before the pandemic crisis suddenly found excess cash flow to pay off debt.

Interest rates matter. When rates hit a point where consumers and businesses can’t justify further indebtedness, a credit-driven economy slows down.

Portfolio Update

As noted last week, we raised cash levels in portfolios over the last couple of weeks. Notably, we had sharply reduced our bond portfolios’ duration by shifting treasuries to short-term bonds and selling mortgage-backed securities. That shift helped hedge portfolios a lot of the last few days.

We remain fairly allocated to equities at the moment, but we will likely start using counter-trend rallies to reduce risk further if the markets don’t begin firming up next week. After this week’s selloff, the market is getting fairly oversold, so a counter-trend bounce would not surprise us.

As we discussed with our RIAPRO Subscribers, some defined “bearish” patterns continue to form on the S&P 500, Nasdaq (shown below), Emerging, and International markets.

There is much commentary about the rotation to “reflation” sectors like industrials, materials, energy, etc., which will benefit from a reopening economic surge. While we already own these sectors, it is essential to remember very little “value” in the market.

We will likely see a boost in economic growth this year. However, that growth has already gotten well priced into the market at every level. Valuations are extreme across every market. Such places the market at risk of disappointment if expectations fall short.

If history is any guide, it is highly likely we will be disappointed as we move further into the year.

What To Do Now

While this past week was rough, particularly for more aggressively allocated models, it is crucial not to let short-term psychological pressures derail your investment discipline.

As we have discussed previously, “risk happens fast.” As such, it is essential not to react emotionally to a sell-off.

Instead, fall back on your investment discipline and strategy.

  1. Is the premise of why you bought a position previously still intact?
  2. Has anything fundamentally changed for the company?
  3. Review the positioning of your portfolio relative to the benchmark? Are you out of tolerance in your allocations?
  4. Review your positions. Are they out of tolerance relative to your sizing rules?

Last but not least, keep your portfolio management process as simplistic as possible.

  1. Trim Winning Positions back to their original portfolio weightings. (ie. Take profits)
  2. Sell Those Positions That Aren’t Working. If they don’t rally with the market during a bounce, they will decline more when the market sells off again.
  3. Move Trailing Stop Losses Up to new levels.
  4. Review Your Portfolio Allocation Relative To Your Risk Tolerance. If you have an aggressive allocation to equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

Nobody ever went broke taking profits.

While keeping your capital intact is hard, making up lost capital is even harder.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 73.18 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 81.18 out of a possible 100.


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

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

S&P 500 Growth Screen

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

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

Market action continues to be very sloppy, as our money flows indicators suggested. However, the volatility this past week was extremely challenging, with sharp sell-offs followed by sharp rallies. Such makes the market very hard to navigate.

With our money flow indicators still declining, we continued to reduce equity exposure and raised cash. We previously sharply reduced our bond exposures and sold our mortgage-backed securities, which “saved our bacon” this past week. Such was a point we specifically made last week:

“We shortened our bond-duration more by eliminating our mortgage holdings. When interest rates rise, the duration of mortgages can get very long, very quickly. Such would increase volatility in our bond portfolio more than we want currently.”

As always, we continue watching our indicators closely. Despite the sell-off, our indicators don’t suggest a significant correction is in the offing. However, if we break the 50-day moving average, we will get more defensive reasonably quickly.

Portfolio Changes

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

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

Portfolio Managers – Michael Lebowitz/Lance Roberts

“Just as we did with the energy sector earlier this week, the financial stocks have now gotten extremely overbought. We are taking profits in these holdings and reducing positions back to original sizing.” – 02/26/21

Equity Model:

  • Reduce GS and JPM back to 2% of the portfolio each.

ETF Model

  • Reducing XLF back to 4% of the portfolio.

“With interest rates spiking, we are worried about the impact of higher rates on not only the economy but valuations as well.” – 02/25/21

Equity Model:

  • Selling 100% of LOW

ETF Model

  • Reducing XLK by 2% of the portfolio from 13% to 11%.

“After a rather significant runup in energy stocks since the beginning of the year, we are rebalancing our positions back to portfolio weightings. We are already overweight energy stocks relative to our benchmark index, so we are just reducing our holding back to their original weightings.” – 02/24/21

Equity Model:

  • Reducing MRO and XOM back to 1% of the portfolio each.

ETF Model

  • Reducing XLE back to 3% of the portfolio.

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

Seth Levine: Using Gamestop To Uncover Biases

Using Gamestop To Uncover Biases

2021 sure picked up from where 2020 left off. As if things couldn’t get any crazier than a global pandemic, a group of retail investors seemingly organized an epic short squeeze in GameStop Corp’s stock (GME) so violent that it bankrupted a $12.5 billion hedge fund. To be sure, a lot has been said on the topic. I certainly learned a lot about the technical aspects of what transpired. However, I learned a lot about myself too. The GME event triggered some strong emotional reactions. These helped surface some deep-seated biases which was an opportunity to analyze them and improve my thinking process.

Markets have a way of expressing the culture’s dominant philosophies. After all, they’re just collections of human behaviors. Today, postmodernism and nihilism are commonplace. The recent episode with GME illustrated just this. Specifically, a nihilistic narrative took root early in the absence of facts. It was a telling sign of the times.

GameStonk

GME is, by far, this young year’s biggest investment market story. GME is a video game retailer. Faced with many fundamental challenges, its stock was heavily shorted and declining since late 2013. However, something incredible happened. GME’s stock price rocketed up from $17—where it began the year—to nearly $350 in a matter of weeks; hardly normal behavior! However, this dramatic move did not result from some surprise strategic shift. Rather, the exploitation of a volatile stock market structure uncovered by some savvy retail investors (allegedly) on the Reddit social media platform, r/wallstreetbets (WSB), was to blame.

On the surface, GME is a modern-day tale of David versus Goliath. It’s a story of the underdog, individual retail investors, taking down a mighty, short-selling hedge fund. The WSB crowd played David; Melvin Capital Management LP (Melvin Capital) was Goliath.

The Suits!

The WSB plan was simple: buy large quantities of GME stock and call options. The heavy short interest meant that as GME’s stock price rose the short-sellers would be forced to cover their trades and compound the upwards pressure. Buying call options supercharged the effect (by creating a gamma squeeze). It was a tried and true strategy. (I explained this more in a recent interview found here.)

The maneuver worked like a charm. Within a couple of weeks, GME’s stock price exploded upwards: to $50, $100, $200, $300, and flirted with $350! The shorts looked trapped. As the share price climbed so too did their loss. Soon, Goliath was mortally wounded. Two prominent hedge funds, Point72 and Citadel, stepped in to rescue Melvin Capital from insolvency.

GME’s stock price exploded upward from around $17 at the start of the year to nearly $350 as the short squeeze intensified

However, shortly after thrown this lifeline, the strangest thing occurred. Without warning, Robinhood, the WSB crowd’s brokerage of choice, restricted trading in GME (and others with a similar dynamic). This practically ended the WSB maneuver and profits. What possibly could be the cause for such a surprise? It was The Suits! They had had enough losing. It was time to step in and protect their turf.

“The Suits” is a phrase popularized by the founder of Barstool Sports, David Portnoy. It’s a metaphor for the connected cronies who seemingly control the global economy from behind the scenes. You see, Goliath rigged the investment markets. He always defeats David. The little guy never has a chance. Here, this view postulates, Citadel and Point72 were using their connections to stop the short-squeeze and protect their new investments in Melvin Capital. What else could it possibly be?

Something Else

This narrative quickly took off. I’ll admit, my mind went there too at first. Remember, the financial markets are heavily regulated. This wouldn’t be the first instance of an entrenched institution weaponizing regulatory capture against the competition.

However, I was quick to catch myself, and I’m glad I did. There simply was no evidence of foul play yet. In fact, there were no facts available at all to evaluate. Might there be other explanations, I thought?

Sure enough, this popular narrative was exposed as patently false. No, there was no conspiracy. The Suits hadn’t pulled any strings to manipulate trading. Rather, commonplace risk management practices were at play.

GME’s explosive stock price move sent its volatility through the roof. Volatility is a statistical description of a stock price’s range; the greater its move, the larger its volatility. GME’s rapid price change wreaked havoc throughout the “plumbing” of stock trading operations. Because of the various time lags involved in trading stocks, firms providing the vital services that enable stock trading to assume various forms of credit risk. They employ risk management strategies to protect their businesses and ensure smooth operations. Volatility is a critical input for these risk models. As GME’s volatility rose so too did margin requirements. Tony Greer of TG Macro expertly explains what happened here.

GME’s stock volatility exploded, leading to margin calls throughout the “financial plumbing” of stock trading operations

Robinhood’s predicament was commonplace. It was short on cash due to GME’s volatility. Connected hedge funds and The Suits played no part.

Khakis, Not Suits

So there you have it. There is no cabal of well-connected financiers tipping the scales in their favor (at least not in this case). However, the extent to which this narrative took hold surprised me. Don’t get me wrong, I’m a sucker for a good David versus Goliath story. I wanted to “go there” too. Thankfully though, I caught myself before getting too wrapped up in the seductive narrative. Quite frankly, it didn’t take much digging or time to debunk it.

Why did so many and well-intentioned people leap to this conclusion? To me, philosophy is the answer; the GME situation highlighted the huge impact it plays in our thinking, whether we know it or not. Humans are conceptual animals. Our mind’s function is to integrate facts into ever-widening concepts. It seeks to create order out of a seemingly disorderly world to expand our efficacy and ability to thrive. An unfortunate side effect is that we’re prone to mistakes.

Nihilism is one of the dominant philosophies I’ve observed this market and its participants express. This negative worldview subconsciously leaves us vulnerable to accepting notions of futility. Narratives of rigged investment markets fit neatly into nihilism’s doctrine: What, you didn’t actually expect David to beat Goliath did you? By hook or by crook, Goliath always wins, remember; always.

Personally, I find such nihilistic views to be empirically wrong. History is riddled with people beating the odds by using a better analysis, understanding, or framework to earn fortunes. While rare, they are nonetheless real and possible in this world.

Check Your Premises

In my experience, nihilism is wrong, both in the markets and in life. Given how prevalent it is, I try to keep extra vigilant to my mind wandering in such directions. This can be difficult when it’s so commonplace. Like a fish in water, it’s hard to discern the philosophy in which we’re swimming.

What transpired in GME’s stock over the past few weeks was truly astonishing. The short squeeze was of epic proportions and Robinhood’s sudden trading halt came as a surprise. To be sure, it captured many imaginations. However, the facts ultimately proved the nihilistic narrative that took hold false. Markets weren’t rigged. Rather, commonplace operational decisions underpinned Robinhood’s decision to limit trading in GME’s stock.

For me, GME was an educational moment. It was another chance to test my emotional intelligence. Luckily, I passed this time and my awareness will only make me better for the next situation … and there will be the next time. Hopefully, then to I’ll recognize my biases and either avoid a losing trade or enter one profitably.

Technical Value Scorecard Report For The Week of 2-26-21

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

Commentary 2-26-21

  • Last week we introduced our Relative inflation/deflation indicator. It is found in the upper right Fixed Income graph on the first set of charts. We made some adjustments to the index constituents this past week which can be found at the bottom of this report. The inflationary versus deflationary sectors were largely unchanged last week despite the volatility. A big reason for this was the weakness in the technology and growth sector/factors, which tend to benefit from deflation. XLU and XLP, the other deflationary sectors performed better. On the inflationary front, XLE, XLF, and XLB all outperformed the S&P. As yields move higher we will watch these sectors closely for signs that the reflationary trade may be ending. For what it’s worth there are longer-term market-implied inflation indicators, as shown in the third graph below, that turned lower in the last week.
  • Energy, Transportation, and Banks are grossly overbought, while Technology, Discretionary, Utilities, and Staples are oversold. Again, we are on the lookout for a rotation to the “deflationary” sectors.
  • The factor/index graph tells a similar story of the “haves’ and “have nots.” Momentum and QQQ are grossly oversold, while value, small/mid-cap are overbought. Keep in mind value tends to be heavily allocated to energy and financials.
  • The scatter plot continues to show a high r-squared denoting the model scores are well characterizing relative returns.
  • On an absolute basis, Transportation stocks are the most overbought with banks and energy following. Staples, utilities, healthcare, and technology are oversold, but not extremely so.
  • Discretionary now has an absolute sigma score of -4, which is off the chart and denoting a very oversold condition.
  • Most factors and indexes are hovering around fair value, as is the S&P 500 in the lower right of the second set of graphs. The NASDAQ is as oversold as it has been in at least the last 200 trading days.
  • Not surprisingly, the fixed income sectors are all grossly oversold. Note, we had to adjust the sigma scale on this graph to -4 to include a few of the sectors. High yield bonds are now oversold for the first time in a long while.

Graphs (Click on the graphs to expand)


Users Guide

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

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma 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.

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

The ETFs used in the model are as follows:

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

#MacroView: Powell Changes The Rules On QE.

The markets took a tumble to start this week as rising interest rates and inflationary pressures begin to weigh on outlooks. Those worries quickly diminished as Jerome Powell changed the rules to reassure Wall Street that “QE” is here to stay.

In his speech, he committed to reaching maximum employment and the “average” inflation rate. To wit:

“I’m confident that we can, and that we will, and we are committed, to using our tools to achieving that. The three-year time frame is actually arbitrary and chosen by us. And you know, we’re just being honest about the challenge.

We live in a time where there are significant disinflationary pressures around the world. Essentially all major advanced economies’ central banks have struggled to get to 2%. We believe we can do it, we believe we will do it. It may take more than three years, but we’ll update  our assessment every quarter. We’ll see how that goes.”

Even Fed Governer Lael Brainard echoed Powell’s statement:

“The economy remains far from our goals in terms of both employment and inflation, and it will take some time to achieve substantial further progress.”

The markets immediately interpreted these statements correctly. The Federal Reserve will not be tightening monetary policy any time soon.

Pop Stock Market Bubble, The Two Pins That Will Pop The Stock Market Bubble

The Constraints To Policy

If you re-read Powell’s statement, you should realize that he has changed Fed policy’s benchmarks.

When Ben Bernanke initially launched QE, the “constraints” around ultra-accommodative monetary policy were price stability and full employment. Those “guideposts” were  2% inflation and 5% unemployment as measured by the U-3 report from the Bureau of Labor Statistics.

Over the last decade, the Federal Reserve stated that an “accommodative policy” was necessary to achieve 2% annualized inflation. Unfortunately, inflation ran well below the target level the majority of the time.

When it came to reaching the goal of “full employment,” the Fed achieved that goal for only a brief period between 2016-2018. At this juncture, the Federal Reserve did try to lift interest rates and reduce their balance sheet. Unfortunately, as we warned, the outcome was not positive.

The issue with the U-3 report following the “Financial Crisis” was that it only “appeared” the economy regained full-employment. In reality, such was merely a function of a shrinking “labor force.” To wit:

“Furthermore, employment, which is the backbone of consumer confidence, has not increased strong enough to create sustainable economic growth above 2%. Notably, the number of full-time jobs, which are critical to sustaining a family, has continued to decline.”

Powell stimulus employment, Powell Is Wrong. More Stimulus Won&#8217;t Create Employment

“Notably, that number remains skewed due to the ‘labor force’ calculation. Even though the economy may approach ‘full-employment,’ much of that is an illusion created by the labor force’s shrinkage.”

Powell stimulus employment, Powell Is Wrong. More Stimulus Won&#8217;t Create Employment

The reality is that both inflation and “full-employment” fell well short of the promises of “monetary accommodation.”

The Fed now realizes their constraints are a trap.

Pop Stock Market Bubble, The Two Pins That Will Pop The Stock Market Bubble

Changing The Benchmarks

Very subtly, the Federal Reserve has changed their benchmarks to allow the continuation of “monetary policy” indefinitely.

I have updated the two charts above to include their two new measures of:

  • A 3-year average inflation rate of 2%; and,
  • Full-employment (assuming a 5% unemployment rate) using the U-6 measure from the BLS.

From a historical perspective, the charts below show when the Federal Reserve would have achieved either measure over the last decade.

When it comes to achieving a 3-year average inflation rate above 2%, the Fed has only temporarily achieved that goal since monetary policy implementation.

In other words, by changing the benchmark, the Fed has now assured itself excess flexibility never to tighten monetary policy in the future.

If we assume the economy does grow at a rate fast enough to generate a 3-year average inflation rate above 2%. The switch to the U-6 employment report to measure “full-employment” provides cover to dismiss the inflation hurdle. Under this new benchmark, the Federal Reserve will never achieve full-employment. Even when the U-3 rate was at an all-time low of 3%, the U-6 rate was still closer to 7% unemployment.

For stock market bulls, the good news is that “QE-Forever” is now “a thing.”

Pop Stock Market Bubble, The Two Pins That Will Pop The Stock Market Bubble

QE Won’t Fix What’s Broken.

Not surprisingly, with an implicit guarantee by the Federal Reserve of continuous “monetary accommodation,” the market rallied back strongly on this week. The problem, however, is the stock market is now thoroughly detached from the underlying economy.

Over the last decade, monetary policy inflated asset prices to more extreme levels while the real economy struggled. The Market-Cap best characterizes this detachment to the economy. Since corporations derive their revenue from economic activity, there is a logical assumption of fair valuation.

The indicator shows us that when “disconnects” between market participants and the underlying economy occur, outcomes are poor. Significantly, QE does not improve corporate profits. The correlation between the market and corporate profits as a percentage of GDP, not surprisingly, is high. With a 88% correlation, the ratio confirms the detachment from the economy.

There is additional confirmation with an 85% correlation between the S&P 500 and corporate profits growth.

Since corporate profits are a function of economic growth, the correlation is not unexpected.

Notably, the data shows the promise of “monetary policy” to boost economic growth never occurred. Economic prosperity worsened over the last decade.

Pop Stock Market Bubble, The Two Pins That Will Pop The Stock Market Bubble

A Massive “Wealth Transfer” Policy

As with all things, there are always the unintended consequences of policies that are not well thought through and ignores basic economics.

After more than a decade of monetary interventions, the results are clear.

The “rich got vastly richer.”

However, for the vast majority of  Americans:

  • Housing did not become more affordable.
  • Wall Street converted wealth from the poor to the rich by buying properties at distressed prices (which they caused) and turning them into rentals.
  • Many Americans, after a decade, are still unable to obtain financing.
  • Wage growth has been nascent and has not kept up with the real costs of living.
  • Lower corporate bond rates didn’t lead to more investment but instead increased share repurchases, which benefited “C-Suite” executives at the working class’s expense.

Instead, as discussed previously, the Fed’s policies led to a growing divergence between the stock market and the economy. To wit:

“The one lesson that we have clearly learned since the 2008 “Great Financial Crisis,” is that monetary and fiscal policy interventions do not lead to increased levels of economic wealth or prosperity. These programs acted as a wealth transfer system from the bottom 90% to the top 10%.

Since 2008 there have been rising calls for socialistic policies such as universal basic incomes, increased social welfare, and even a two-time candidate for President who an admitted socialist.

Such things would not occur if “prosperity” was flourishing within the economy. “

Such is simply because the stock market is not the economy.

Since It Didn’t Work, Do More.

The Fed’s interventions and suppressed interest rates have continued to have the opposite effect intended. I have shown the following chart below previously to illustrate this point.

From Jan 1st, 2009 through the end of 2020, the stock market rose by an astounding 200%, or roughly 18% annualized. With such a large gain in the financial markets, one would expect a proportional growth rate in the economy. 

After bailouts, QE programs, interventions, monetary and fiscal programs totaling more than $37 billion, cumulative real economic growth was just 21.52%.

While monetary interventions are supposed to be supporting economic growth through increases in consumer confidence, the outcome has been quite different.

Low to zero interest rates have incentivized non-productive debt and exacerbated the wealth gap. The massive increases in debt have harmed growth by diverting consumptive spending to debt service.

However, the hope is that while it didn’t work over the last decade, maybe doing more will be “different this time.” 

A Continuation Of Boom/Bust Cycles

While the Fed has found cover in its new “benchmarks” to continue monetary policy nearly without restriction, the outcomes are unlikely to be any different.

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40-years.

As Joseph Carson, former Chief Economist at Alliance Bernstein, concluded:

“Given the scale of fiscal stimulus, one would expect the Fed to be thinking of ‘leaning against the wind.’ But not this Fed–the Fed is using the same playbook from the Great Financial Recession, providing unneeded stimulus to a red-hot housing market.

What’s the economic and financial endgame? It’s hard to see anything but a ‘boom-bust’ scenario playing out with fast growth and rising market interest rates in 2021 and early 2022, followed by a bust in late 2022/23 when the fiscal stimulus/support dries up.

The US experienced mild recessions following the sharp drop in government military spending after the Korean and Vietnam wars—-and back then, the scale of military expenditures amounted between 2% and 4% of GDP. The ‘sugar-high’ today is unprecedented, raising the odds of a harder landing.

While mainstream economists believe more stimulus will create robust economic growth, no evidence supports the claim. 

More importantly, while the Federal Reserve may not raise interest rates any time soon, the bond market may well take care of that problem for them. As shown below, that is a process already well underway with an adverse event likely closer than many expect.

The Fed’s problem comes when a burst of inflation and rising rates collide with the massive debt levels overhanging the economy.

As Joseph Carson notes, the next “boom/bust” cycle is likely already in the works.

#WhatYouMissed On RIA This Week: 2-26-21

What You Missed On RIA This Week Ending 2-26-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 2-26-21


What You Missed: Video Of The Week

As I noted on Thursday morning before the market opened, money flow signals continue to suggest the markets are under pressure. Interest rates and the VIX suggest we may have more corrections to come.



Our Best Tweets For The Week: 2-26-21

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

See you next week!

Outliers: Four Ways They Can Change Our Lives (Part 1)

Outliers can change our lives.

The pesky outposts of statistical warriors are situated at the far reaches of normality.  When they breach boundaries, lives change, sometimes forever.

Why do we keep focusing on the minutiae, not the possible significant large events, in spite of the obvious evidence of their huge influence?

Nassim Taleb, The Black Swan.

Yes, the outliers. Consider them unwanted houseguests, the nascent Fredo Corleones of the statistical world. Their impacts are minimized by the academics, social scientists, and Wall Street ‘know-it-all’ pundits who believe most American households have recovered from the Great Recession.

With straight faces, they bloviate to convince us that the post-pandemic economy (whatever that is) will return to ‘normal’ by the second half of the year.

As Taleb connotes – ‘duration blindness is quite a widespread disease.’ We believe impactful adverse events are predictable in their duration when history shows us they are far from it.

The so-called intellectuals laugh defiantly in the face of considerable impact, low probability episodes that destroy the health and wealth of the masses because they’re able to paper over their outliers with massive wealth and the obeisance of the mainstream media, financial and otherwise.

Outliers just don’t get any respect but they demand it! In the face of household financial fragility, we all must think differently about risk mitigation, break away from the financial tenets designed to keep us enslaved in debt, and understand that on occasion, Fredo Corleone could possibly get us killed! (figuratively of course). Except in Michael Corleone’s case, it was literal… And close! 

Watch for Black Swans!

Taleb touts ‘Black Swans’ as events outside the lines of normal expectations. Nothing in the past, especially the recent history, points to their emergence. Yet, when these pesky statistical nightmares decide to take over from the standard or bell curve of normal-probability territory, all hell breaks loose.

Although outliers are rare, they propel with enough flame and brimstone to turn our finances and, in some cases our lives, into cinders.

I spent the Texas winter apocalypse re-reading Taleb’s classic work by the warm white light of a fully-charged Kindle. For those who haven’t picked it up, The Black Swan: Second Edition: The Impact of the Highly Improbable: With a new section on robustness and fragility by Nassim Taleb, the paperback edition is worth every bit of $12 bucks. What you’ll learn about our illusion of understanding (especially in a world littered with social media) is worth ten times the book’s price.

You see, society (social media participants, especially) suffers from an incredible illusory gift. An electronic form of cerebral foreplay where most believe the world is understandable and more predictable than it is. In other words, users consider their opinions as gospel; they also overvalue factual information yet hold little regard for the ‘gray’ that clouds every fact.

I usually re-read my highlighted version of The Black Swan later in the year. This time, it kept me warm (my brain cells anyway) during one of the coldest Februarys on record for Texas. Re-reading Taleb keeps me grounded and humbled by uncommon events that seemingly occur every decade.

Most pundits discount the ongoing damage of outliers.

The pundits still stomp their feet and jump Evel Knievel canyon-leaps of defiance. They continue to tell us that outliers occur every 100, 1,000, 5,000 years (pick a number). Why people listen to these jokers is beyond me. The masses hope they’re correct. That way, we never need to prepare because there’s ZERO excitement in preparation. It’s too long term, too nebulous, takes too much discipline. Blah, blah, blah.

So, with that, I share with readers the outliers, the frontier fighters you most likely believe never will breach your main personal, financial boundaries until they do.

Here are two of four outlier statements that will change your life (part 2 next week):

I won’t live long enough to be old. 

I hear this one often. I’m grudgingly prepared for the outlier even though I believe I won’t live long enough to be elderly. If you’re one of those people who also think they won’t live long enough to need income beyond what mortality tables indicate, ask yourself this question (like I do when I think I know everything):

What if I’m wrong?

Longevity or living beyond the confines of mortality tables is a risk. Most likely, you’ll require additional guaranteed income to supplement Social Security to generate lifetime retirement cash flow.

As Danny and I say on our radio hour – “Income is the lifeblood of retirement.” Growth is a secondary goal, at least over the rate of inflation of your household. However, income is everything. We have clients who own little in variable assets like stocks and bonds yet live comfortably because they:  1. Have pensions (what the heck are those?) 2. Execute smart Social Security claiming strategies.

As I’ve written in the past, using income annuities to replace bonds in a diversified portfolio can be very useful, whether it’s laddering single-premium-immediate annuities or adding income riders to fixed indexed annuities. Low-fee income annuities (American College Professor Dr. Wade Pfau refers to them as the term insurance of the annuity world) provide a predictable stream of income that can outlast the income received from bonds currently at historically low rates.

SPIAs are splendidly simple – Provide a life insurance company a lump sum, and they pay you or you and a spouse for life. That’s it. I consider SPIAs a formidable replacement for the pension your employer no longer provides.

Why allocate a portion of your portfolio to lifetime income vehicles? 

I’ll list them in the order of importance:

Above-average life expectancies. On average, American males live to 76.1 years; females add five years to 81.1. Suppose you or your and spouse have a family history of longevity and enjoy excellent health along with life-prolonging habits like exercise and a healthy diet. In that case, an SPIA may be a viable addition to a traditional stock and bond portfolio.

Retirement plan survival deficiency. Life has a way of altering good financial intentions. If lucky, you have a solid 20 years to save uninterrupted. Along that path may come unexpected life changes like divorce, a major illness, job loss, and let’s not forget the portfolio-busting bear markets or worse. 

If working longer, saving more, part-time employment in retirement, and smart Social Security decisions don’t dramatically improve the probability of financial plan success, then consider an SPIA to complement Social Security so that your household never runs out of money.

A legacy intent. Studies indicate that purchasing an inflation-indexed SPIA at retirement reduces portfolio depletion and allows for a larger inheritance for those who believe leaving a legacy to children and grandchildren is an important goal.

You can add income riders or addendums to FIAs to convert them to income annuities deferred to some period in the future, usually ten years or longer.

Riders add ongoing annual costs to annuities, so complete formal financial planning before considering guaranteed income riders to determine whether there’s a household retirement funding shortfall.

An RIA rule:

If your investment portfolio has a greater than 30% probability of depletion in retirement  before you and your spouse run out of time on the planet, annuitizing a portion of retirement assets should be considered along with a plan to maximize Social Security benefits. 

Also, let me share with you what I consider “retirement nirvana.” That’s when all your fixed retirement expenses or needs get covered from the income you and your spouse cannot outlive. What a relief. No worry about market cycles (more on that later).

Be careful with your Social Security claiming decision!

Also, don’t minimize the importance of Social Security. Forget the emotional voice in your head that advises – “I need to get out of the system what I put into it.” That kind of financial myopia will shortchange you and, more than likely, a surviving non-working spouse.

Break it down: Social Security is an inflation-adjusted annuity! And what are annuities supposed to do? Provide income for life. So, re-think it. Consider Social Security a consumption asset, not a portfolio investment.

Like a fire, you seek it to be the hottest it can burn when the greatest warmth is required. After you’re gone, who cares if the fire dies too? Just in case I do live longer, I’d be thankful to have as much income coming in as possible. That’s why we suggest, in most cases, that recipients wait until age 70 to claim benefits.

What about reverse mortgages? 

For those with a majority of their wealth in primary residences, home equity conversion mortgages may be employed to generate ‘annuity’ payments from a portion of home equity.

The horror stories about these products are overblown and aged. The most astute of planners and academics study and understand how those who seek to age in place, incorporating the equity from a primary residence in a retirement income strategy or as a method to meet long-term care costs, can no longer be ignored. Those who talk down these products speak out of lack of knowledge and fall easily for pervasive false narratives.

Reverse mortgages have several layers of costs (nothing like they were in the past), and it pays for consumers to shop around for the best deals. To qualify for a reverse mortgage, the homeowner must be 62, the home must be a primary residence, and the debt limited to mortgage debt.

A reverse mortgage line of credit can help!

One of the smartest strategies is to establish a reverse mortgage line of credit at age 62, leave it untapped and allowed to grow along with the value of the home. The line can get tapped for long-term care expenses. Also, instead of a credit line, qualified homeowners can begin tenure payments, a lifetime income strategy as long as they remain in a home, maintain it, and pay property taxes.

In years where portfolios are down, the reverse mortgage line can be used for income, thus buying time for the portfolio to recover. Once assets recover, you can use rebalancing proceeds or gains to pay back the reverse mortgage loan, consequently restoring the credit line.

Our planning software allows our team to consider a reverse mortgage in the analysis. Those plans have a high probability of success. We explain that income is as necessary as water when it comes to retirement. For many retirees, converting a home’s glacier into the water of income using a reverse mortgage will be required for retirement liquidity survival.

American College Professor Wade Pfau and Bob French, CFA, are thought leaders on reverse mortgage education and have created the best reverse mortgage calculator I’ve studied. To access the calculator and invaluable analysis of reverse mortgages, click here.

My kids will take care of me in my old age!

Many people flippantly assume their children will be their caregivers in the case of a long-term care episode (without even discussing the topic with them!) Or they don’t plan for such an outlier because it could never happen to them.’ Remember – only one outlier can change everything! 

People tend to avoid the topic (outlier) of long-term care defined as financial and caregiver resources required to perform daily activities such as bathing and dressing. Services range from temporary home health services to full-time care through assisted living or memory care.

At RIA, we find that investors are hesitant to confront this topic. It’s understandable. After all,  the mitigation of long-term care risk is expensive. People barely save enough for retirement, overall. Imagine planning for the possible additional six-figure burden of long-term care services.

Long-term care insurance can be confusing.

Also, consumers don’t understand how coverage works, premiums can skyrocket every few years, break constrained budgets, and insurance underwriting can be challenging. Notably, over 30% of those who apply for traditional long-term care coverage get rejected for health reasons. ‘

Realistically, after age 62, premiums become cost-prohibitive for consumers. It’s in their mid-sixties we find people scramble to put together some patchwork plan. We call long-term care the ‘financial elephant in the room.’ You can try to lift it and move it to another area of your financial house; however, wherever you go, there is!

As we often discuss on the radio,  long-term care expenses are the greatest threat to a secure retirement. Based on a recent study, over 53% of Boomers are confident about managing long-term care costs, yet the majority have nothing set aside.

The results lead me to conclude there’s a dangerous and robust case of DENIAL going on. Is there more to the story? Since 50% of middle-income Boomers maintain less than $5,000 in emergency reserves, saving for retirement AND retirement care is most likely too burdensome.

Dementia. One of the greatest risks.

One of the most significant concerns is the risk mitigation that accompanies a long-term illness such as dementia. Those who suffer can remain physically healthy for years yet require 24-hour surveillance. Think about the financial and human resources costs for such a disease. It’s tough to fathom.

According to ALZ. Org, the number of seniors living with Alzheimer’s is increasing rapidly. Currently, an estimated 5.8 million Americans age 65 and older live with the disease. By 2050, a projected 13.8 million people over 65 will be dealing with Alzheimer’s dementia. Family members and unpaid caregivers provide a staggering $244 billion worth of care. Keep in mind, almost two-thirds of Americans with Alzheimer’s are women.

The cost and timing of long-term care insurance. 

I’m not going to lie. Long-term care insurance isn’t cheap.  According to the American Association for Long-Term Care Insurance, the best age to apply is in your mid-fifties. To obtain coverage, the current condition of your health matters, or you may not qualify.

Only 38% of those aged 60-69 qualify. Even if healthy, at a point in life, especially around the mid-sixties, premiums are known to be a household budget nightmare. For example, a couple both age 60 in a preferred health class can wind up paying close to $5,000 a year in premiums and will likely experience premium increases over time.

The number of insurance carriers is shrinking – down to less than 12 from more than 100. Recently, Genworth, one of the heavy hitter providers of long-term care insurance temporarily suspended sales of traditional individual policies and an annuity product designed to provide income to cover long-term costs such as nursing home stays.

If you’re astute enough to plan for retirement care and concerned about the impact of dual premiums on the household budget, including saving for other goals, work with a Certified Financial Planner® to create a scenario to consider at least partial coverage for the spouse with a greater probability of longevity. For example, on average, women outlive men by seven years. Also, close to two-thirds of Americans with Alzheimer’s are women.

Oh, and when it comes to the kids?

I find it too painful to interrupt my daughter’s life and impact her physical, emotional, and financial health by providing long-term assistance to her dad.

The role of caregivers.

According to www.caregiver.org, 44 million Americans provide $37 billion hours of unpaid informal care for adult family members and friends with chronic illnesses and conditions. Women give over 75% of caregiving support.

Caregiving roles will do nothing but blossom in importance as the 65+ age cohort doubles by 2030. There will be a tremendous negative impact, financial and emotional, on family caregivers who will possibly need to suspend employment, dramatically interrupt their own lives to assist loved ones who require assistance with daily living activities.

Parents should begin a dialogue with adult children to determine if or how they may become caregivers. Armed with information learned from discussion, I have helped children prepare for some form of caregiving for parents.

An example.

A 47-year-old client has added financial support for parents as a specific needs-based goal in her plan; another recently purchased a larger one-story home with an additional and easily accessible bedroom and bath. Another has commenced building a granny pod on his property for his elderly (and still independent) mother. All these actions have taken place due to open, continuous dialogue with parents and siblings.

Also, elder parents have been receptive to allocating financial resources to aid caregiver children. Siblings who reside too far away to provide day-to-day support have been willing to offer financial support as well.

A caregiver situation shouldn’t corner children to change their lives. If you’re a parent, ask children if they’d be willing to provide care. Have a discussion. As an adult child, don’t be afraid to query parents about how they plan to cover long-term care expenses.

Outliers aren’t pleasant.

Outliers aren’t fun. Take it from the people in Texas. Outliers don’t get much respect until their upon us. Shining a light into the dark corners of extreme probabilities can be the difference between survival and disaster.

Do you know how to expose outliers? Showcase them front and center through holistic financial planning. A comprehensive financial plan outlines the risks one can absorb and risks to mitigate.

Not even Fredo could argue with such sage advice.

In Part 2, I’ll cover the outliers that can derail your investment plan.

Will “Go Crazy” Drive The Bear Out Of Hibernation?

Will “Go Crazy” Drive The Bear Out Of Hibernation?

The economy will “go crazy” this summer.” There is not a day that goes by in which we do not hear an economic forecast with an extreme optimism based on pent-up demand.

The argument certainly appears plausible and is widely subscribed to by professionals. To wit, JP Morgan: “we expect consumers to blowout expectations for the rest of the year.” Per Business Insider: “Goldman Sachs raised its forecast for 2021 US gross-domestic-product growth to 6.8% from 6.6%.”

To help put context around whether the economy will “go crazy,” we focus on consumer spending habits during the lockdown and the financial means which drove those habits.

If the “go crazy” scenario is correct, monetary velocity will rise and ignite a powder keg of money supply. Inflation could ramp up beyond levels that comfort the Fed and/or markets.

The optimistic forecast appears, at first blush, good for stocks. We make the case that his thesis may signal springtime for the hibernating bear.

Is There Pent Up Demand?

Before we discuss the elephant bear in the room, let’s consider the merits of the “go crazy” thesis. How might consumer habits change when consumers are free to go anywhere and do anything?

Retail Sales, despite a severe recession, are 6.00% higher than in January of 2020. Is spending “pent-up”? To answer the question, we decompose retail sales into its sector components.

As shown below, the variance in sales changes versus the prior year is significant. Not surprisingly, gas stations, restaurants and bars, and clothes and electronics appliance stores had a tough year.  However, the nine other economic sectors saw improvements in sales versus 2019. The highlighted box points to aggregate changes in Retail Sales.

We have little doubt the four sectors with declines will post more robust sales once consumers are comfortable returning to those establishments. There is no doubt; pent-up demand will boost those sectors.

Spending Rotation versus More Spending

Even if we assume the four sectors witness a pickup in business, can we also presume consumers will continue to spend freely in the sectors they were spending in last year? The questions below provide a few examples to help you answer the question.

  • Can non-store retailers continue to steal business from brick and mortar stores at last year’s pace?
  • Will consumers have a strong desire to buy outdoor sporting goods when they can be inside with friends and family again?
  • If people eat out more and return to bars, will food and beverage stores sustain recent sales growth?
  • With the ability to go to the movies, eat out, and go on vacation, for example, will people spend as much time working on their houses and gardens?

The graph below provides perspective for the last question. As shown, sales of building materials and garden supplies are running well above historical norms. With more time to “go crazy,” people will likely have less time to work on their houses and gardens. We think it is highly likely this sector will run below average for some time.

Our spending habits temporarily changed last year, but consumer spending in aggregate rose. Spending anomalies of last year will lead to new irregularities when the economy reopens. However, it’s not clear, in aggregate, there is significant pent-up demand.

To further consider if consumers will “go crazy,” we need to consider their financial means.

Thank you, Uncle Sam

Direct checks from the government (transfer payments), forbearance of mortgage, rent, and student loan payments, generous unemployment benefits, and other assistance from the CARES Act significantly boosted incomes and, therefore, the ability to spend. As the chart below shows, transfer payments provided 31% more income than would have been the case without stimulus.

The boost to income is not permanent. As such, real disposable income is gravitating back to its prior trend.

The bounty of stimulus significantly boosted the sales of all kinds of goods and services. Barring more stimulus, consumers will be left to spend within their means.

Spending vs Income

The currently elevated unemployment rate, historic weekly jobless claimants, and stagnant wages are not supportive of a rash of spending this summer. That said, personal savings have increased, and credit card debt has fallen over the last year. Despite weak income, consumers may spend down savings and increase debt loads to facilitate spending. The caveat being that consumers may continue on their frugal path if they are concerned with their job prospects.

The wildcard in this analysis is the Federal government. More stimulus, especially direct checks to people, will boost consumption. January Retail Sales rose 6% on the back of the latest round of “stimy” checks.

Barring more massive stimulus directly to people, a jump in credit card usage, or a drawdown of savings, it’s hard to make the case that consumers have the means in aggregate to “go crazy.”

We do not rule out the “go crazy” thesis, but it’s not the slam dunk it appears to be either.

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

Fed Denial

The problem with the “go crazy” thesis is inflation. Inflation has been tepid as the velocity of money has fallen sharply, offsetting the surge in the money supply. If consumer spending increases rapidly, monetary velocity will increase, creating inflationary pressures. For more on the interplay of velocity and money supply, please read our article- The Fed’s Inconvenient Truth.

If inflation were to spike due to a surge in economic activity, the pressure on the Fed to reduce QE and potentially discuss higher interest rates will rise.

That said, the Fed will not back down easily.  On February 10, 2021, Powell stated:

“We’ve seen 3 decades of lower and more stable inflation.” “As the economy re-opens, we may see a burst of spending,” he says, adding. “Again though, my expectation would be that will be neither large nor sustained.”

A week later, the Fed minutes echoed his sentiment as follows:

“Many participants stressed the importance of distinguishing between such one-time changes in relative prices and changes in the underlying trend for inflation, noting that changes in relative prices could temporarily raise measured inflation but would be unlikely to have a lasting effect.”

If consumers “go crazy,” monetary velocity will increase. Couple that with the continuation of massive monetary stimulus, and you have the ingredients for inflation. Whether said inflation is temporary or not is far from certain. What is likely more certain is that the bond markets will not be pleased.

Bond Vigilantes

Bond yields have been rising consistently since August 2020. While yields are still very low, they are approaching levels that are becoming concerning to the equity markets.

Since the Fed came in with bazookas blazing in March of 2020, equity markets have surged higher. In its wake are corporate earnings and economic growth, which have a lot to be desired. In other words, stock market gains are not supported by fundamentals. Excessive liquidity supports prices.

Regardless of whether the Fed reacts to inflation or not, the markets will grow increasingly uncomfortable with inflation. As such, expectations for the Fed to reduce QE will increase. And the justification for current stock prices will erode.

For a market riding high on the back of excessive monetary policy, a “go crazy” situation might awaken the hibernating bear.  

Summary

As they say, be careful what you wish for. If consumers unleash inflationary pressures and more robust economic growth, monetary policy or even expectations for monetary policy will change.

The seemingly omnipotent Fed may find themselves cornered by rising interest rates, rising inflation expectations, and falling asset prices. They may have no option but to reverse the stimulus.

Given the current egregious level of equity valuations, all investors should think deeply about what it would take for the Fed to take their foot off the monetary gas pedal. “Go crazy” might be the rationale.

Technically Speaking: Blowing Up The “Everything Bubble”

Recently, I discussed the “Two Pins That Pop The Bubble,” specifically noting the risk of rising interest rates and inflation. However, the real threat is not just the stock market bubble’s deflation but rather blowing up the “everything bubble.”

During previous periods in financial history, the focus was primarily on the deflation of a singular market bubble. Such was a point we touched on in “Extraordinary Popular Delusions:” The two tables below show the history of bubbles and what they all had in common.

extraordinary delusions madness crowds, Extraordinary Popular Delusions &#038; The Madness Of Crowdsextraordinary delusions madness crowds, Extraordinary Popular Delusions &#038; The Madness Of Crowds

The flood of liquidity and ultra-accommodative monetary policies has simultaneously inflated multiple bubbles. Stocks, bonds, real estate, and speculative investments have all experienced historic inflations.

The byproduct of cheap debt and liquidity is the explosion of household net worth as a percentage of disposable personal income. Starting in the early 80s, as President Reagan deregulated the banking system, net worth exploded through massive leverage increases. Such was made possible by four decades of continually falling interest rates and inflation.

Another view is to look at the expansion of net worth relative to GDP growth. Of course, the massive deviation would not be possible without the massive increases in leverage over the last 40-years.

However, ironically, while it appears that Americans are far more wealthy, in reality, it is only a small fraction of the population that has benefitted. A point we made in “The Fed Made The Top 10% Richer.”

Fed Top 10% Richer, Fed Study: How We Made The Top 10% Richer Than Ever.

This framework is the basis for the rest of our discussion on the coming deflation of the “Everything Bubble.” 

The Stock Bubble

There is little argument that financial markets are currently in a “bubble.”  The monthly chart of the S&P 500 shows the deviation from long-term monthly means at levels not seen since 1990.

As discussed in “Yes, There Is A Stock Market Bubble,” valuations are just a reflection of the underlying psychology at the second-highest level in history. As noted:

If market bubbles are about ‘psychology,’ as represented by investors’ herding behavior, then price and valuations are reflections of that psychology. In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise.”

Stock Market Bubble, Yes, Virginia. There Is A Stock Market Bubble.

During a “market mania,”  investors must continue to rationalize overpaying for assets to keep prices moving higher. Over the last decade, the most common justification remains that low discount rates justify high valuations.

The problem comes when interest rates rise. Throughout history, an unexpected surge in interest rates has repeatedly led to poor investor outcomes.

Despite media rhetoric that “rising rates” aren’t a problem for the stock market, history suggests they are. Given the massive surge in corporate leverage promulgated by weak economic growth, higher rates will quickly impact corporate profitability and financing activities.

As history shows, such collisions have often left a trail of bodies in its wake.

The Real Estate Bubble

Currently, there is also a “bubble” once again in housing as a continual suppression of borrowing costs, loose lending policies, and a flood of stimulus has led to a historical surge in home prices. As we noted previously in “There Is No Supply Shortage,” home price appreciation has once again eclipsed long-term price trends.

The current overvaluation in homes, of course, is driven by record-low mortgage rates.

However, as noted above, that economic support will quickly reverse as interest rates rise. Given there is a surging demand for homes, just as with the stock market, when rates rise, there will be a rush to sell to a diminishing pool of buyers.

Also, as with the stock market, owned by the top 20% of income earners, most houses bought were by that same fraction of the population. (Higher incomes and nearly perfect credit.)

Given the sharp rise in prices, the resulting price decline will likely be equally as quick.

The Bond Bubble

Of course, there is nowhere more at risk from higher rates than the bond market itself. Given that “yield” is a function of price, there is a perfectly negative correlation between prices and interest rates.

I pointed out before the “pandemic-driven shut-down” the 2019 yield-curve inversion was signaling a problem with the bond market. To wit:

“The magnitude of the Fed’s response was also a function of “panic” based more on “recency bias” than facts. The Fed quickly returned to the “Financial Crisis” playbook to anticipate events that may occur in the credit markets rather than responding to outcomes.

There is a difference.

The Financial Crisis was a problem with the banking system. The COVID-19 pandemic is a health crisis.”

The Federal Reserve problem is they have now pushed “yield spreads” across the entirety of the credit spectrum to record lows. The Fed’s suppression of rates to “bail-out” the bond market in the short-term has created a long-term problem of “mispricing risk.”

That mispricing of risk, or rather the creation of “moral hazard,” in the credit markets created a record number of “zombie” companies in the process.

moral hazard, Neel Kashkari Is The Definition Of &#8220;Moral Hazard&#8221;

Eventually, when rates rise enough, these “zombie” companies will be unable to refinance debt for their continued survival. Once bankruptcies begin to spike uncontrollably, investors will demand to get paid for their investment risk. As shown, such has occurred in the past with relatively dismal outcomes.

As they found out back in March, the Fed can only buy a small fraction of corporate bonds without disrupting the market.

The risk is a surge in rates and defaults, greater or faster than the Federal Reserve can absorb.

The Unwinding

What should be clear is that if the rise in interest rates approaches 2% or higher, there are many problems embedded in an economy laden with nearly $85 trillion in debt.

The debt problem exposes the Fed’s most significant risk. Given economic growth remained elusive over the last decade, it is unlikely doubling the Fed’s balance sheet will improve future outcomes. The failure to recognize the impact of ongoing monetary policies, given a decade of experience of surging debt and deficits inhibiting organic growth, is problematic.

moral hazard, Neel Kashkari Is The Definition Of &#8220;Moral Hazard&#8221;

The US economy is literally on perpetual life support. Recent events show too clearly that unless fiscal and monetary stimulus continues, the economy will fail and, by extension, the stock market.

However, the Fed currently has no choice.

Such is the consequence, and problem, of getting caught in a “liquidity trap.”

What the average person fails to understand is that the next “financial crisis” will not just be a stock market crash, a housing bust, or a collapse in bond prices.

It could be the simultaneous implosion of all three.

Whatever causes that change in sentiment is unknown to me or anyone else. 

I am not saying with certainty it will happen, as I hope sanity prevails and actions are taken to mitigate the consequences.

Unfortunately, history suggests such is unlikely to be the case.

Viking Analytics: Weekly Gamma Band Update 2/22/2021

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

Gamma Band Update

The Gamma Band model continues to maintain 100% allocation to the S&P 500 (SPX).  When the daily price closes below the Gamma Neutral or “Gamma Flip” level (currently near 3,875), the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below 3,640, the model will reduce the SPX allocation to zero.

This kind of model can be appropriate for investors who want upside exposure to the stock market, while protecting against downside tail risk.  It might seem counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.   

This is one of several signals that we publish daily in our SPX Report.  A free sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and price signals.

The Gamma Flip – Background

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

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The Gamma Band model has improved risk-adjusted returns by over 70% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

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

Authors

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

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


The Only Reason To Be “Bearish” Is “No One Is Bearish”

I had to do a double-take recently when reading a CNBC headline that stated: “The only reason to be bearish is there’s no reason to be bearish.”

It is indeed hard to argue the point. As the article explained:

A majority of investors finally agree the V-shaped recovery is at play,” according to the Bank of America Global Fund Manager Survey. Plus, a record percentage of money managers believe that global growth is at an all-time high.”

Key Findings

  • More than 90% of investors believe the economy will be more robust in 2021, with a consensus it’s a V-shape recovery. For the first time since January 2020, chief investment officers want to increase capital spending rather than improve balance sheets.
  • Fund managers’ allocation to cash is down to 3.8%, the lowest since March 2013. Such was just before the “taper tantrum” era under former Federal Reserve Chairman Ben Bernanke.

  • Allocations to stocks and commodities are the highest since February 2011.

  • The survey shows a preference towards cyclical stocks, high exposure to commodities, emerging markets, industrials, and banks relative to the past 10-years.

  • Only 13% of respondents said stocks are in a bubble.

As the survey notes:

“Stocks are hovering around all-time highs as investors bet on a successful rollout of the Covid-19 vaccine, economic reopening, and expectations for more fiscal stimulus.”

What could go wrong?

3-Risks In 2021

“According to [Hyman] Miskey, events leading up to a crisis start with a ‘displacement,’ some exogenous, outside shock to the macroeconomic system. The nature of this displacement varies from one speculative boom to another. An unanticipated change to monetary policy might constitute such a displacement. Some economists who think markets have it right and governments wrong, blame ‘policy switching for some financial instability.” – Charles Kindleberger

While it is clear that a “speculative mania” exists, such will remain the case until an “exogenous event” creates financial instability. As the survey noted, there are “risks” to the outlook.

“Investors say potential risks include the vaccine rollout, inflation, crowded trades in tech, long bitcoin trades, and shorting the dollar trades.”

Given ample evidence that “everyone is in the pool,” markets are vulnerable to 3-risks.

  1. More stimulus and direct checks into the economy lead to an inflationary spike that causes an anticipated monetary policy change.
  2. The current rise in interest rates continues with rising inflation until it impacts a debt-laden economy. Such would force the Fed to implement “yield curve control.” 
  3. The dollar, which has an enormous net-short position against it, reverses and moves higher, pulling in foreign reserves, causing a short-squeeze on the dollar. 

The reality is that all three could be a simultaneous problem. Given the high correlation between inflation and interest rates, higher yields will attract reserves from countries faced with economic weakness and negative-yielding debt. Such would lead to a stronger dollar quickly reversing the tailwinds that have supported the equity rally since March.

The Dollar Risk

We think this is potentially the most significant risk we face currently and something we noted just recently.

The one thing that always trips of the market is the one thing that no one is paying attention to. For me, that risk lies with the US Dollar. As noted previously, everyone expects the dollar to continue to decline, and the falling dollar has been the tailwind for the emerging market, commodity, and equity ‘risk-on’ trade. Whatever causes the dollar to reverse will likely bring the equity market down with it.”

Very quietly, the dollar has been rising and recently broke above and successfully held its 50-dma. With a substantial net short position outstanding, a further rise could trigger shorts to begin covering, pushing the dollar up further.

COT Dollar Rates Warning, Technically Speaking: COT &#8211; Dollar &#038; Rates Issue A Warning

As noted, such would not support equity markets due to the non-correlation between the dollar and equities. Most importantly, a surging dollar, with rising interest rates, could put a severe dent in the “reflation trade.”

The Problem With Monetary Policy

There is also the problem of monetary policy. As discussed in “Moral Hazard,” investors are chasing risk assets higher because they believe they have an insurance policy against losses, a.k.a. the Fed.

However, this brings us to the one question everyone should be asking:

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

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

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

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

Everyone Is In The Pool, Everyone Is In The Pool. More Buyers Needed. 01-15-21

The stock market has returned more than 164% since the 2007 peak, which is more than 3.8x the growth in corporate sales, and 7.5x more than GDP.

But, for the 10% of the population that owns 90% of the stock market, the sentiment is now getting extreme.

The Problem With Low Rates

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

Maybe. But the argument suggests rates are low BECAUSE the economy is healthy and operating near full capacity. However, the reality is quite different, as the always insightful Dr. John Hussman pointed out:

“Make no mistake: the main contributors to the illusion of permanent prosperity have been decidedly cyclical factors.

Again, when interest rates are low because growth is also low, no valuation premium is ‘justified’ at all. In the present environment, investors are inviting disastrous losses by paying the highest S&P 500 price/revenue ratio in history. They are also paying the highest median price/revenue ratio in history across S&P 500 component stocks (more than 50% beyond the 2000 peak, because extreme valuations in that episode were focused on much narrower subset of stocks than at present). Glorious past returns and record valuations are a Potemkin Village with a barren field behind it.”

Valuation measures suggest investments made today will not provide returns much above zero over the next decade.

That is just the math.

Lot’s Of Exuberance

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

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

Michael’s point is very apropos, particularly today, given the more extreme allocations to equities by investors currently.

The reality is that strongly rising asset prices, mainly driven by emotional exuberance, “hide” investment mistakes in the short term. Poor, or deteriorating fundamentals, excessive valuations, and rising credit risk often get ignored as prices increase. Unfortunately, it is only after the damage is done the realization of those “risks” occurs.

As Michael stated:

“Most investors believe the Fed will protect their investments from any and all harm, but that cannot go on forever. When the Fed attempts to extricate itself from the market one day, that is when the music stops, and the blame game begins.”

No Reason To Be Bearish

“In every stock market cycle there is a dominant investor who captures the market’s zeitgeist by incorporating and reflecting the ideas and beliefs of the times.” – Doug Kass

Whether it was the Janus 20 fund in the late ’90s or ARK Investments currently, there was always a belief “this time was different,” and some transformative technology had changed market dynamics.

Currently, there seems to be “no reason” to be bearish on the markets. Rates are low, monetary policy is flowing, and there are hopes the economy will eventually recover. However, as noted, there are certainly risks to that outlook.

It is important to remember that markets run in full cycles (up and down). While the bullish “up” cycle lasts twice as long as the bearish “down” cycle, the damage to investors is not a result of lagging markets as they arise but in capturing the inevitable reversion. Such is something I will discuss in more detail in an upcoming article.

Currently, the markets are indeed in a liquidity-driven upcycle. With margin debt at records, stock prices in a near-vertical rise, and “junk bond yields” at record lows, the bullish media continues to suggest there is no reason for concern.

Maybe There Is?

But maybe that is just the reason to be concerned.

“The object of speculation may vary widely from one mania or bubble to the next. At a late stage, speculation tends to detach itself from really valuable objects and turn to delusive ones. A larger and larger group of people seeks to become rich without a real understanding of the processes involved. Not surprisingly, swindler and catchpenny schemes flourish.” – Kindleberger

When “everyone is in the pool,” it is an excellent time to remember a basic premise of investing from our post on trading rules: 

Opportunities are made up far easier than lost capital.” – Todd Harris

Will The Economy Replace Ten Million Jobs By 2022?

“Employment will bounce back to pre-pandemic levels by December 31st, 2021.” – Bank of America

Popular forecasts call for a return to pre-pandemic levels of employment and economic activity by yearend. Really? We are not so sure.  The economy lost over 22M jobs between February 2020 and today. The recovery has gained 12M jobs leaving a deficit of 10.7M jobs to replace. This post evaluates trends in employment, hiring, and worker job concerns to determine if this robust forecast to gain 10.7M jobs in 11 months is likely. We begin with a review of automation and job growth at the corporate level from an executive perspective. Next is a look at the worker perspective, a review of automation in various industries, an examination of small business hiring, and an outline of entrepreneur activity. Finally, we offer an outlook for total employment and ideas for sustainable job growth.

Executives Focus On Cutting Costs and Staff

As the pandemic rages on, executives are laser-focused on increasing productivity, reducing costs, and implementing programs to reduce staff. The pandemic accelerates the trend toward automation and staff reductions.  Executive searches for artificial intelligence, automation software, and new business process robotics grew by 5 – 15 % in 2020. Workers in the office or plant require social distancing, desks spaced 6 feet apart, plastic separator sheeting, continuous surface disinfecting,  and periodic temperature testing.  Implementing these pandemic office changes is expensive.

As one COO at a global manufacturer declared, “bringing workers back during the pandemic is expensive, we have to cut costs, I can get 10x – 20x return on automation investments instead.” An October 2020 World Economic Forum survey global executives and found that 43% planned staff reductions.  Executives are busy hiring new leaders for automation deployments. Gartner Group reports that S & P 100 companies will employ 20% more automation architects in 2021 than last year, and 90 % of companies will be hiring  automation experts by 2025.

Automation Goes Beyond Repetitive Task Replacement to ‘Digital Assistants’

Manufacturing companies have deployed automation systems for the past 20 years achieving lower cost and productivity improvements.  Automation reduced the need for hiring workers as well. A Federal Reserve survey showed that U.S. manufacturers had increased output by 20% in 2018 with the same number of workers employed in 2000.

Now automation of knowledge worker jobs is beginning to take hold in financial and services-based businesses.  In the past year, corporations are investing heavily in Robotic Process Automation (RPA) software that supports ‘machine learning,’ artificial intelligence, and business process automation.  New RPA software packages enable non-programming workers to build programs that create ‘digital assistants’ for their job. Enabling workers close to the business process to be automated reduces time to implement and takes the programming load off central IT departments. To counter the need for hiring more software and information services professionals, companies install RPA software. Thus, even ‘secure’ information services jobs may be at risk due to smart software.

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

A CNBC survey found 37% of workers, 18- 24 years old, were worried about their job replacement by artificial intelligence systems in the next five years. A national average of 27% of all workers was concerned about losing their jobs due to artificial intelligence.

Source: CNBC – 11/7/19

Most early-career workers are internet fluent and know software systems’ capabilities to replace their jobs, says Dan Schwabel, Director of Research for Future Workplace. As they use systems like Siri and Alexa and begin programming, they realize that a smart software service could do their job in the not too distant future.

Workers Across Many Sectors Are Concerned About Automation Job Elimination

The following chart shows 45% of Advertising and Marketing workers to 33% of staff in Insurance are concerned with robots and AI eliminating their jobs.

Source: CNBC – 11/7/19

The pandemic has caused a pause in hiring with workers furloughed or others working remotely.  This pause provides managers with the opportunity to explore new ways to automate labor-intensive tasks. Simultaneously, it offers a chance to deploy AI tests to see how robots can do some knowledge workers’ tasks.

In advertising, creative work producing ad content will be challenging to automate.  But, smart software systems can make ad placement, client management, and reporting more efficient and customer responsive.  Accounting and back-office repetitive tasks and customer communication can all be managed by intelligent services. In transportation, Tesla and other electric vehicle manufacturers are building autonomous delivery trucks.  Farmers use computer-based weather systems synchronized with watering system controls to add intelligence to crop growing and management. The Pennsylvania Turnpike laid off 500 toll booth workers and replaced them with computer automated toll taking machines.

Small Business Hiring Continues To Decline

Small businesses in core cities like San Francisco and New York have seen 33 – 60% declines in revenues as lockdowns in December and January almost completely shut down sales.  Restaurants survived by offering takeout food for pickup but still experience sales losses of 50% more.

Small businesses nationwide report a drop in employment of 30%. And, a lack of commuters in many major cities of 75 – 80% has caused owners to close and furlough employees until commuter traffic returns.  In the following chart from Homebase, hiring increased into the fall but since has fallen off.

Sources: Homebase, The Daily Shot – 1/21/21

Small businesses employed 60.6M workers in 2020.  With 30% fewer employees, a possible 18.1M small business workers are permanently or temporarily unemployed.  Many restaurants’ closing has caused significant layoffs in the restaurant and bar industry and executives plan on not rehiring 35% of their employees in 2021.

The good news is the pandemic has triggered a new wave of entrepreneurship across the country. Employees and owners of businesses that were closed are the primary founders of many of these new businesses.

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

Entrepreneurs Are Creating New Jobs

The Census Department reports 4.4M new businesses started in 2020, for a yearly increase of 900k new firms over 2019. Cooks laid off by restaurants are starting their own takeout food businesses.  Daycare workers laid off with a talent for pastry making are running dessert take out businesses.

Women owned 47% of all small businesses in 2019, according to a report by American Express. But, the U.S. Chamber of Commerce reports that only 47% of female-owned small businesses owned by women reported business was ‘good’ compared to 62% of male-owned companies. So, when the pandemic forced small businesses to close, women were more likely than men to return home.   Women entrepreneurs are pivoting their businesses quickly. A female personal fitness studio owner had just opened a studio last March. When business lockdowns were declared, she shifted her business to virtual sessions and successfully built a customer base. She now has over 100 participants in each virtual session of 4 sessions per day.

Women laid off in many services businesses or who left companies to take care of children at home have started various home-based businesses. One Macy’s store clerk let go last April started a wig business now grossing enough to pay her rent per month in the Bronx. LinkedIn found the number of women who changed their job title to ‘founder’ from a worker role had doubled in the 4th quarter of 2020. However, an analysis by the Women’s National Law Center of Bureau of Labor Statistics shows that 6M women have lost jobs since February of last year.  So, it’s not clear that all the new businesses started by women will create enough jobs to make up the female jobs deficit.

Manufacturers Are Hiring Too

Orders for products were continuing to grow as manufacturers try to keep up with demand.  The pandemic has forced some manufacturers to shift managers into factory floor roles. These managers fill in for workers out due to illness, taking care of children, or just anxious about returning to the factory floor.  There were over 500k new job openings in manufacturing for last December.

Source: Bureau of Labor Statistics – 1/22/21

The irony is that with millions on unemployment, these positions should be quickly filled. Yet, manufacturers often compete with fulfillment and warehousing companies for workers. Amazon is hiring 100,000 new workers over the next year to support its surging ecommerce business. Companies are asking employees to work on multiple shifts to handle the additional production volume.  The following graph shows hours worked have returned to near pre-pandemic levels while the number of workers has leveled off at – 5%.

Sources: The Wall Street Journal, St. Louis Federal Reserve – 1/9/21

Companies are raising wages as one Wisconsin manufacturer found they could not get workers to come onto the factory floor for $11.00 @hr. So the firm raised entry-level wages to $15.00 @hr.  A generator producer in Ohio has added a shift overnight so workers with school-age children. The overnight shift allowed workers to be home during the day to assist their children with online learning.

The Number of Permanently Laid Off Workers Is Increasing

While temporary layoffs have declined significantly, the number of permanent job losers has continued to climb.  The number of claimants for continuing unemployment benefits jumped by 2.5M for the week of January 23rd to 20.4M as the extended benefits bill from Congress enabled states to offer longer-term payments. The 20.4M level of continuing claims is 10 times the rate for 1 year ago before lockdowns! Another major concern, workers unemployed for greater than 27 weeks has increased to 39.5% of total jobless workers.

Sources: Federal Reserve of St. Louis, Bureau of Labor Statistics, The Daily Shot  – 2/5/21

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

The following  chart shows that job searches for new positions have spiraled down as job prospects dimmed in January. Further, searches continue to decline since a peak right at the onset of the pandemic last March.  Search activity in all major sectors consumer, industrial, real estate, services  and transportation fell in January.

Sources: Google Trends, Arbor Research, The Daily Shot – 2/9/21

Indeed reports that job opening listings are now .7% higher than in February of 2020. The Labor Department announced 6.6M job openings for January holding steady from December of 2020. There is a significant mismatch of skills  of millions of unemployed workers and millions of information services and factory job openings.

The continuing growth of permanently laid-off workers is a challenge to build a strong foundation for an economic recovery. If workers are not working, they are saving what money they have and not increasing discretionary spending. There is an urgent need for a significant job development and training program for unemployed workers to fill millions of open jobs. On February 10th, Fed Chairman Jay Powell told the New York Economic Club that a national jobs strategy and program is the top priority for the recovery.

Workers Are Still Worried About Employment & No Raises

The Bloomberg Consumer Comfort index shows consumers’ comfort about the future economy is 20 points below their confidence level at the pre-pandemic level.

Sources: Bloomberg, The Daily Shot – 1/21/21

The future employment component of the Comfort Index has consistently been declining over the past several months.

Only 15%  of small businesses are planning on offering their workers raises in the next six months. Worse yet, nationally, few consumers have confidence they will receive a raise in the next six months

Sources: Refinitiv Datastream, TS Lombard, NFIB, Conference Board, The Daily Shot – 2/1/21

Employment Growth Is Stalled – Yet There Are Growth Opportunities 

The labor market for January stalled, as this chart shows there were only 49k new jobs and job losses in December, 202 were revised upward to 227k.

Sources: Panetheon Macroeconomics, The Daily Shot – 2/5/21

Countering the loss of jobs in services, hospitality, and small business are the millions of startup companies founded by innovative entrepreneurs.

We have noted the massive mismatch between job openings and the skills of the unemployed. To overcome the skills deficit, the Biden administration has proposed a Clean Air & Jobs Act Proposal for 10M new jobs by investing in climate projects and infrastructure for the economy. The proposal includes Job training, career development, and placement programs.  The initiative comes with a $2T price tag.  It will be interesting to see if the program will pass a divided Congress.  It seems like the most likely bill to pass will be about $1.2T.

Will Job Creation Overcome Permanent Unemployment Drag?

Growth in manufacturing job openings is helpful, yet manufacturing accounts for only 9% of all employment.  A major challenge is the mixed picture in services sectors where information systems seems to be the only growth sector.

Plus, with 50% of S & P 500 companies reporting sales of -.54% in the 4th Quarter 2020, executives’ reluctance to hire will harden.   As we noted in our post Catch 22 – Employee & Executives, both sides of the employment equation will be monitoring each other.  Each side is waiting for the other to make a major move in either hiring or spending. But, executives hold the power to hire and will wait for consistent sales over a quarter or two.  The first indication that hiring is improving is growth in temporary employment with full time hiring to follow. In January, there was an increase of 80k temporary jobs.  Monitoring hiring of temporary worker over the quarter will tell us more about a possible shift in labor demand.

The ‘Bounce Back’ In Employment Is Likely To Take 2-3 Years 

The workplace has experienced a once in 100 years shock. The virus attack shattered traditional worker, and executive assumptions about how and where work is done. Executives are now deploying new work systems, processes, and measures that increase productivity and reduce staffing.    Job growth efforts face significant headwinds from virus-driven lockdowns. Lockdowns continue in most states, with corporations extending work from home policies until the end of 2021. Delayed vaccination programs have stalled the phasing out of lockdown programs.

At the earliest, the CDC does not expect ‘herd immunity’ until late summer of 2021.  Thus, opening the economy will be a slow process over the summer into the fall. The narrative that employment will ‘bounce back’ by the 2nd half of 2021 to February, 2020 levels is unlikely. Employment back to pre-pandemic levels is more likely to take 2-3 years after worries of virus infection have disappeared. When employment is growing at robust levels consumers will spend again..  Entrepreneurs starting new businesses will fuel job creation but face significant headwinds from a stagnant economy.

We Need Entrepreneurship, Productive Investments  & Trade For A Growing Economy 

Consumers anxious about their jobs will continue to save, not spend except on essentials. Their lack of spending will delay hiring and economic growth beyond the end of the pandemic. A return to a growth economy will require consumers to spend, executives to hire, and normal mobility patterns to resume.  All these factors will take time to build against the overhang of federal debt, corporate debt, and housing debt.  A return to solid entrepreneurship, a focus on productive investments, and the renewal of robust international trade are ways to build a growing economy.


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

The Markets May Be Starting To Worry About Rates


In this issue of “The Markets, May Be Starting To Worry About Rates.”

  • Market Review And Update
  • Are Rates About To Cause A Problem
  • Risk Appetite Is Extreme
  • Portfolio Positioning
  • #MacroView: Why Stimulus Doesn’t Lead To Organic Growth
  • Sector & Market Analysis
  • 401k Plan Manager

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


RIA Advisors Can Now Manage Your 401k Plan

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

Catch Up On What You Missed Last Week


Quick Note

This past week was interesting.

I live in a suburb of Houston, Texas, and was one of the 2.6 million that lost power and water for several days. It was an exciting adventure in survival as our house’s temperature dropped below freezing and ice formed on our emergency water supply in the bathtub.

However, between sitting in cars to charge the laptop and phone batteries and warm up a bit to figuring out how to make coffee on a gas stove, everyone made it through. The lesson we all relearned during this event is not to take for granted even the smallest luxuries in life or each other.

This week’s newsletter will be abbreviated as I still don’t have access to everything just yet. However, by next week, we should be back to normal.

Market Review & Update

I previously stated that with the market already trading 2-standard deviations above the 50-dma, further upside could be limited. Such was the case as markets struggled all week to hold gains in a very narrow range. (Horizontal dashed lines.)

Currently, the money flow signals remain positive, but “sell signals” did trigger as of the close on Friday. While the money flow itself remains strongly positive, the “sell signals” continue to suggest downward pressure on prices currently. However, given the more extreme overbought and bullish conditions, there is a risk of a deeper correction over the next few weeks.

Importantly, as discussed last week, while we will certainly warn you of when our indicators turn lower, the problem remains two-fold:

  1. The indicators don’t distinguish between a 5% correction and a 20% drawdown; and,
  2. Secondly, the corrections often occur so quickly you don’t have much time to decide just how defensive you need to be. 

In other words, it is often advantageous to pare risk by “leaving the party a little early.”  

Are Rates About To Cause A Problem

The question we need to answer is why the market has been struggling as of late. As we touched on last week, investors may be starting to factor in the twin threats of higher inflation and interest rates. To wit:

“With an economy pushing $85 trillion in debt, the entire premise of the ‘consumption function,’ as well as ‘valuation justification’ for the stock market, is based on low-interest rates. However, that is rapidly ending as the rise in rates is now approaching a “danger zone” for the markets.”

As discussed in our #Macroview report yesterday, interest rates are rapidly approaching the 1.5% to 2.0% barrier, where higher payments will collide with disposable income. Historically, such has not ended well for markets.

The rise in interest rates is much more problematic than most suspect. Higher interest payments reduce capital expenditures, threatens refinancing, and spreads through the economy like a virus.

As noted by Laura Cooper yesterday:

“The writing may soon be on the wall for the buy-everything-but-bonds rally, with focus on inflation fears and subsequent Fed tightening. Yet it’s rising real yields that might prove to be the ultimate stumbling block for the risk rally.”

Little Margin For Error

Higher rates also quickly undermine one of the critical “bullish supports” of the last decade:

“In a heavily indebted economy, increases in rates are problematic for markets whose valuation premise relies on low rates.”

“Each time rates have ‘spiked’ in the past; it has generally preceded a mild to a severe market correction.

As is often stated, ‘a crisis happens slowly, then all at once.’

So, how did the Federal Reserve get themselves into this trap?

‘Slowly, and then all at once.’”

When combined with higher inflationary pressures due to stimulus injections, such becomes problematic. Higher borrowing costs and inflation compresses corporate profit margins and reduces real consumption as wages fail to increase commensurately.

While the Fed continues to suggest they will let “inflation run hot” for a while, the problem is that the real economy won’t. The impacts of higher payments and costs will derail consumptive spending very quickly, given the real economy is still massively dependent on “life support.”

Equally problematic is when the stock market suddenly realizes that higher rates have derailed a primary thesis of overpaying for value.

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

Risk Appetite Is Extreme

It seems as if with each passing week, we have continued to point out levels of exuberance either rarely or never, seen historically. This past week continues to see increasing levels of exuberance on many fronts.

One that I will discuss more in Monday’s blog is the fact that “no one is bearish.” Of course, that may be reason enough to be concerned.

As Bob Farrell once noted:

“When all experts agree, something else tends to happen.”

We must consider two issues.

The first is that current levels of speculation have increased the risk of a more extreme reversion. As physics’s fundamental laws suggest, a rubber-band stretched to its limit will experience a move of equal intensity in the opposite direction.

The second problem is the demise of the T.I.N.A. (There Is No Alternative) trade.

“The problem today is that the relationship between the 10 year US note yield and the S&P dividend yield has reversed. With risk-free rates of return rising, the 10 year US note now does provide an alternative – especially with the S&P dividend yield plummeting.” – Doug Kass

When “risk” becomes realized, there is now a “safe” alternative.

The shift will likely not be subtle.

Portfolio Update

From a portfolio management perspective, we have started to raise cash and reduce our equity risk somewhat. Our bond portfolio now has a very short duration, and high cash levels are acting as an early hedge against volatility.

We are not getting overly aggressive on hedging risk just yet as the money flow indicators, as shown above, remain supportive. However, that signal is beginning to get more extended, and the market is starting to show early signs of deterioration.

As I stated in the open, sometimes we need to act in advance of the correction. Such is particularly the case when there is excess speculation that can lead to very sharp single-day declines that make it extremely difficult to take appropriate actions amid a “panic-driven” sell-off.

Conclusion

If you missed this week’s post on Howard Marks on “speculative manias,” it is a good analysis of what we are dealing with currently.

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

“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 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 not only on how you answer that question but how you manage the inherent risk.

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

As many of those found out during the Gamestop saga:

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


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 86.87 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 91.8 out of a possible 100.


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

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

S&P 500 Growth Screen

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

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

Last week, I noted that price action was beginning to get a bit more “sloppy.” That continued into this week.

With our money flow indicators now starting to return to more extreme levels, we have begun the process of raising cash and reducing risk accordingly. We will continue this process over the next couple of weeks as we head into March, where the risk of a short-term correction grows.

This past week we shortened our bond-duration more by eliminating our mortgage holdings. When interest rates rise, the duration of mortgages can get very long, very quickly. Such would increase volatility in our bond portfolio more than we want currently.

As always, we continue watching our indicators closely. We still think this rally may have one or two weeks left, but that window is growing shorter.

We will make changes accordingly.

Portfolio Changes

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

** Equity Portfolio – Trade Update ***

Portfolio Managers – Michael Lebowitz/Lance Roberts

“We sold all of our position in WMT today following not only a disappointing earnings announcement but also very lackluster guidance for the rest of the year. We will re-evaluate the position in the future if warranted.” – 02-18-21

Equity/Sector Portfolio

  • Sell 100% Of Walmart (WMT)

We sold our position in AMD. This is a first step in reducing our equity exposure as we are seeing signs a correction is on the horizon. AMD appears technically vulnerable as well.  We are adding back to our stake in PLTR after taking profits previously. The recent correction has gotten the position back to support and extremely oversold. – 02-17-21

Equity/Sector Portfolio

  • Sell 100% of AMD

“We reduced our fixed income exposure by selling our entire position in MBB (mortgage ETF) and buying, in its place, 10% of SHY (1-3yr Tsy). We are concerned that further selling in the fixed income markets would raise the duration of mortgages and create forced selling by leveraged institutional holders of mortgages. Given the low yield of mortgages, the risk-reward is not worth the risk.” – 02-16-21

Equity/Sector Portfolio

  • Sell all MBB 13%
  • Buy 10% SHY

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

The Two Pins That Will Pop The Stock Market Bubble

Yes. We are in a stock market bubble. The only question is, what will be the issue that eventually pops it? We alluded to this answer in Friday’s #MacroView discussing why more “Stimulus Won’t Create Economic Growth.”

As discussed in our previous article, if market bubbles are about “psychology,” as represented by investors’ herding behavior, then price and valuations reflect that psychology.

In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise. Let me show you an elementary example of what I mean. The chart below is the long-term valuation of the S&P 500 going back to 1871.

Stock Market Bubble, Yes, Virginia. There Is A Stock Market Bubble.

Notice that except for only 1929, 2000, and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently.  

Secondly, all market crashes, which resulted from the preceding bubble,  have been the result of things unrelated to valuation levels. Those catalysts have ranged from liquidity issues to government actions, monetary policy mistakes, recessions, or inflationary spikes. Those events were the catalyst, or trigger, that started the “reversion in sentiment” by investors.

There are currently two “pins” that could pop the current market bubble.

The Inflation Pin

To fully explain why the Fed is now trapped, we must start with the inflation premise.

The Federal Reserve has consistently argued that monetary policy is a function of their two mandates: full employment and price stability.

While the Fed has stated they are willing to let “inflation” run hot, their biggest fear is a repeat of the runaway inflation of the 70s. However, the basis of the entire bull market thesis is low rates.

As Oliver Blanchard of the Federal Reserve recently stated concerning Biden’s $1.9 trillion stimulus package:

“How this number translates into an increase in demand this year depends on multipliers. If the average multiplier is 1 (which I think of as a conservative assumption), this implies that demand would increase by 4-times the output gap.

If this increase in demand could be accommodated, it would lead to a level of output at 14% above potential, which would take the unemployment rate very close to zero. 

Such would not be overheating (i.e. inflation), it would be starting a fire.”

Using the money supply as a proxy, we can compare the money supply changes to inflation.

The chart below advances M2 by 9-months as compared to CPI and the Fed Funds rate. If the historical correlation holds, the Federal Reserve will start talking about tapering monetary policy, and hiking interest rates, within the next year.

Of course, the last time the Fed started discussing similar policy changes was in 2017, which lead to the great “Taper Tantrum” of 2018.

The Interest Rate Pin

As noted, the problem with inflation is that if economists do get their wish for higher prices, such also corresponds historically with higher interest rates.

However, as you will note, each time that interest rate has moved up correspondingly with inflation, such never remained the case for long. While much of the media is currently suggesting that interest rates are about to surge higher due to economic growth and inflationary pressure, I disagree.

Economic growth is “governed” by the level of debt and deficits. However, it isn’t just the heavily leveraged government – it is every single facet of the economy.

Debt has exploded.

In 1980, the Federal Reserve became active in monetary policy, believing they could control economic growth and inflationary pressures. Decades of their monetary experiment have succeeded only in reducing economic growth and inflation and increasing economic inequality.

In a heavily indebted economy, increases in rates are problematic for markets whose valuation premise relies on low rates.

Each time rates have “spiked” in the past; it has generally preceded a mild to a severe market correction.

As is often stated, “a crisis happens slowly, then all at once.” 

So, how did the Federal Reserve get themselves into this trap?

“Slowly, and then all at once.”

The Trap

In an economy laden with $85 Trillion in total debt, higher interest rates have an immediate impact on consumption, which is 70% of economic growth. The chart below shows this to be the case, which is the interest service on total credit market debt. (The chart assumes all debt is equivalent to the 10-year Treasury, which is not the case.)

Importantly, note that each time rates have risen substantially from previous lows, there has been a crisis, recession, or a bear market. Currently, with rates at historic lows, consumers are rushing out to buy houses and cars. However, if rates rise to between 1.5 and 2%, economic growth will quickly stall. Such was a point we made in our COT Report:

“Can rates rise in the near-term due to “checks to households” that get spent to pull-forward consumption? Absolutely.

However, the limit of that increase in rates is between 1.56% and 2.19%. At these points, rates will collide with the outstanding debt.”

The Federal Reserve is well aware of the problem. Such is why they have been quick to reduce rates and increase bond purchases, as higher rates spread through the economy like a virus.

The Rate Virus

In an economy that requires roughly $5 of debt to create $1 of economic growth, changes to interest rates have an immediate impact on consumption and growth.

1) An increase in rates curtails growth as rising borrowing costs slow consumption.

2) As of January 21st, the Fed now has $7.38 trillion in liabilities and $39.2 billion in capital. A sharp rise in rates will dramatically impair their balance sheet.

3) Rising interest rates will immediately slow the housing market. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in rates means higher borrowing costs and lower profit margins for corporations.

5) Stock valuations have been elevated due to low rates. Higher rates exacerbate the valuation problem for equities.

6) The negative impact on the massive derivatives market could lead to another credit crisis as rate-spread derivatives go bust.

7) As rates increase, so do the variable rate interest payments on credit cards. With the consumer already impacted by stagnant wages, under-employment, and high living costs, a rise in debt payments would further curtail disposable incomes. 

8) Rising defaults on debt services will negatively impact banks that are still not adequately capitalized and still burdened by massive bad debt levels.

9) The deficit/GDP ratio will surge as borrowing costs rise sharply.

I could go on, but you get the idea.

Since interest rates affect “payments,” increases in rates negatively impact consumption, housing, and investment, which ultimately deters economic growth.

With “expectations” currently “off the charts,” literally, it will ultimately be the level of interest rates that triggers some “credit event” that starts the “great unwinding.”  

It has happened every time in history.

No Way Out

The problem for the market going forward, as noted, is that markets have priced in a speedy recovery back to pre-recession norms, no secondary outbreak of the virus, and a vaccine. If such does turn out to be the case, the Federal Reserve will have a huge problem. 

The “unlimited QE” bazooka is dependent on the Fed needing to monetize the deficit and support economic growth. However, if the goals of full employment and economic growth get quickly reached, the Fed will face a potential “inflation surge.”

Such will put the Fed into a very tight box. The surge in inflation will limit their ability to continue “unlimited QE” without further exacerbating the inflation problem. However, if they don’t “monetize” the deficit through their “QE” program, interest rates will surge, leading to an economic recession.

It’s a no-win situation for the Fed.

As Doug Kass concluded last week:

“To me, there is only one inescapable economic conclusion – inflation and interest rates are heading higher as better economic growth in the last half of 2021 is delivered by the unprecedented stimulus. Unfortunately, the stimulus is in the form of mostly transfer payments and not in expansion of productivity or capacity.  

The economic boom will be a sugar-based high and there is an almost inevitable bust cycle emerging by or in 2023 when the heady fiscal stimulus ends.      

Today’s record stock prices belie a likely hard economic landing that may lie ahead.”

Of course, this has always been the case historically. Just as the “Coyote” still wound up going over the cliff when chasing the “Roadrunner,” excessive bullish optimism is always eventually met with disappointment.

Technical Value Scorecard Report For The Week of 2-19-21

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

Commentary 2-19-21

  • Communications remain the most overbought sector this week, however, the banking, transportation, and energy sectors rose to nearly equally overbought levels versus the S&P 500. All four sectors are trading near or above their respective 200-day ma, so caution is advised.
  • Materials remain relatively weak, having underperformed the S&P 500 over the last 5, 10, 20, and 35 day periods. This is a little surprising as inflationary sectors have outperformed, as we will discuss, and implied inflation rates rose through those periods.
  • We added a new Inflation indicator to the Sector analysis in the Fixed income section of the first set of graphs. The indicator is based on the ratio of our inflationary index to our deflationary index. The index sector constituents are listed in the Users Guide at the bottom of the article. The third graph below compares the two indexes over the past year as well as their differential. Since early November the inflation index has outperformed the deflation index by over 20%. Not surprisingly, the score and sigma for the index, (inflation index relative to deflation index) shown below point to relative overbought conditions in the inflationary indexes. As long as the Fed ignores higher yields and the government talks up massive amounts of stimulus, this condition may persist.
  • Small caps, momentum, technology, and emerging markets remain the most overbought index/factors on a relative basis.
  • On an absolute basis, the S&P 500 is back to strongly overbought levels. This indicator along with other technical signals and our proprietary models indicates some weakness or consolidation is near. Similarly, the hot sectors mentioned above are near extreme overbought levels on an absolute basis. The deflationary sectors, staples, utilities, and healthcare are fairly valued. Nothing is oversold on an absolute basis. This condition also applies to every factor/index.

Graphs (Click on the graphs to expand)


Users Guide

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

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma 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.

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

The ETFs used in the model are as follows:

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

#WhatYouMissed On RIA This Week: 2-19-21

What You Missed On RIA This Week Ending 2-19-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 2-19-21

Due to the blackouts in Texas, we were unable to record new shows this week. We will return next week.


What You Missed: Video Of The Week

Due to the blackouts in Texas, we were unable to record new shows this week. We will return next week.



Our Best Tweets For The Week: 2-19-21

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

See you next week!

Eric Hickman: 4th-Wave Of COVID-19 Will Push Rates To Zero

Eric Hickman discusses why we should beware of the 4th-Wave of Covid-19.

I know everyone is tired of hearing about the virus. Some think it is overblown by the media, many want to focus on the positives, and others have had their lives upended and want to forget.

There are reasons for optimism. It is a new year with longer days and warmer temperatures. People continue to get inoculated with increasing speed. The approval of new vaccines continues as new cases, deaths, and hospitalizations from the third wave fall (see below). The 1918 Spanish Flu had three waves over about a year; the COVID-19 pandemic has had three over a year as well.

Indeed, this is about over, right?

Tuned Out?

It isn’t over, and financial markets don’t accept that yet. I realize suggesting anything negative about the virus is misanthropic, but the truth matters, and the optics are misleading.

New cases decrease in the third wave because we are past the holidays, not because of vaccinations. It is a common misconception the decrease we’ve seen in the virus is due to vaccinations. The two aren’t related, at least yet.

“The decline in cases is likely a natural drop after record travel followed by indoor holiday gatherings triggered a surge in infections.”Dr. Sarita Shah, associate professor at Emory University’s Rollins School of Public Health.

“We’ve seen these rises and falls in the COVID case counts now a few times, and they seem to really track along holidays or people’s movements,” Shah said.

To Early

“COVID-19 symptoms take between two to 14 days to appear after exposure, and cases peaked precisely two weeks after the Christmas holidays.” – Brittany Baker, undergraduate program coordinator and clinical assistant professor at North Carolina Central University.

Dr. Wafaa El-Sadr, professor of epidemiology and medicine at Columbia University’s Mailman School of Public Health, said the falling case numbers couldn’t get attributed to the COVID-19 vaccine. Not even a tenth of the population has gotten vaccinated, according to the CDC.

“We’re vaccinating our most vulnerable populations right now, but once we start to move into the broad population, the population that’s driving the numbers. That’s when we’ll start to see an impact on the overall numbers,” Shah said.

She said Americans might start to see the vaccine’s influence on case numbers as early as the summer, but it will be more evident in the fall.

U.S.A Today, 02/06/2021, “Coronavirus cases are falling in the U.S., but experts say it’s not from the COVID-19 vaccine yet.”

New Sars-CoV-2 variants

As with all replicating biological entities, viruses change over time with random mutations to their genetic code (genome) when reproducing. Most mutations do not affect or are detrimental. Still, every once in a while, a random change (or series of changes) will alter a trait that increases its biological fitness – its competitive advantage in its environment. Beneficial mutations get carried forward to new generations, which crowd out the inferior older genome. Such is natural selection.

The process happens at a glacial pace in the life-forms we are most familiar with (say mammals) because reproduction takes years. Viruses replicate in a matter of hours to days, and more specifically, single-strand RNA viruses (of which the coronavirus, SARS-CoV-2, is one) replicate faster than other viruses.

Viruses that encode their genome in RNA, such as SARS-CoV-2, HIV and influenza, tend to pick up mutations quickly as they get copied inside their hosts, because enzymes that copy RNA are prone to making errors.

Nature.com, 09/08/2020, “The coronavirus is mutating – does it matter?”

The concerning new Sars-CoV-2 variants emerging from the U.K., South Africa, and Brazil have yet to become dominant in the U.S. On February 7, a study reported that the more transmissible U.K. variant is now “spreading rapidly in the U.S.” It could become the dominant strain by late March. Italy’s health ministry said on February 12 that the U.K. variant makes up 17.8% of cases and will likely become prevalent in the coming months. The vaccine-weakening South African and Brazilian variants got detected in the U.S. in January. There are now several cases dotted around the U.S. They will presumably gain traction as they did in their original countries. This process takes months.

New Variants

The variants detected recently in the U.K. and South Africa have several novel changes in their spike-protein genes.

Scientists think one mutation these variants share could help the virus attach to and enter cells. The recently detected variant from Brazil shares a key spike-protein mutation with the one from South Africa.

“What we’re seeing is exactly what we expect to see. The surface proteins of the virus are under tremendous pressure to change.” – Sean Whelan, a virologist at Washington University in St. Louis.

“All the virus really cares about is multiplying. If it can get into the cells of the [host] and avoid the immune system of that host, it will multiply. Whether it causes the disease is a different question.”

Some scientists worry that South Africa’s variant could be better at evading antibodies produced in response to natural infection and vaccination. Preliminary estimates suggest the variant from the U.K. is 50%–70% more transmissible than earlier versions of the virus. And U.K. scientists said recently that early data suggested it could also be deadlier.

The variants found in the U.K. and South Africa have become the dominant types in countries where they were first detected.

Chart Source: Wall Street Journal

Parallel Evolution

The variant from the U.K. has spread widely abroad. As of late January, it had been reported in 70 countries and territories. The variant from South Africa has been reported in more than 30, while the U.K. variant was detected in more than two dozen U.S. states through late January. The Centers for Disease Control and Prevention projected it could become the dominant domestic strain by mid- to late March unless steps are taken to slow it. Variants first found in South Africa and Brazil have also been detected in the U.S.

WSJ, 01/30/2021, “How Coronavirus Mutations Are Taking Over”

Restricting travel between continents may prevent these variants from getting around, but there is another wrinkle to this. In biology, convergent or parallel evolution is a common yet counter-intuitive phenomenon. Independent lineages of a biological entity can arrive at similar evolutionary fitness solutions without any interaction between them. The similarity between the sugar glider (marsupial from Australia) and the flying squirrel (mammal from North America) is an example of this (image below).

Image Source: Getty/Encyclopedia Brittanica/UIG

Mutants

The same phenomenon is happening with Sars-CoV-2 mutations. Critical mutations from the U.K. variant (N501Y) and the one shared by the South African and Brazilian variants (E484K) emerged independently in a now-deceased Boston COVID-19 patient with a prolonged continuous infection. There are quotes from a National Public Radio story below. But for those interested, it is an interesting read (or listen) found at the link below:

Li and his colleagues published their findings in The New England Journal of Medicine in early November 2020 with little fanfare. Then about a month later, the pandemic took a surprising turn – and this peculiar case in Boston took on a new importance.

Scientists in the U.K. and South Africa announced they had detected new variants of the coronavirus. These variants were causing huge surges of COVID-19 in these countries.

When researchers looked at the genes of these variants, guess what they found? A cluster of mutations that looked remarkably similar to the mutations found in the virus from the Boston patient. The sets of mutations weren’t exactly identical, but they shared important characteristics. They both had about 20 mutations, and they shared several key ones, including a mutation (N501Y) known to help the virus bind more tightly to human cells and another mutation (E484K) known to help the virus evade antibody detection.

National Public Radio, 2/5/2021, “Extraordinary Patient Offers Surprising Clues to Origins of Coronavirus Variants”

The virus may optimize itself to known mutations without spreading geographically, weakening the power of travel restrictions.

New Variants Will Emerge

The virus is just a little over one-year-old on its new metaphorical planet of “humans” and is still trying to find an evolutionary best fit. A safe assumption is that more variants will emerge.

“Look, there is going to be a whole cascade of these new variants. The virus moved between species. It migrated from the back end of a pangolin and to humans. And it’s got to adapt to humans. What we see now is it is getting better and better and more efficient at living in humans. And that we can see a set of other mutations coming down the line. So, I think we mustn’t say ‘ahh, well we now know what the mutations are going to look like.’ We don’t. There’s gonna be a set of other ones.”

U.K. Channel 4 news, 01/24/2021, Interview with Prominent Virologist Sir John Bell

Even though vaccination plans for developed-world adults are firming up, the developing world and children are less clear. As long as the virus circulates in humans anywhere, it will find new optimizations that will likely require vaccine alterations.

The more widespread infections remain globally, the more mutations will occur. A lingering pool of cases in poorer countries risks giving birth to resistant strains that force richer economies to lock down and start vaccinating all over again.

Financial Times, 02/05/2021, “The global race between vaccines and mutations”

Taken together, it is probable that the world will have at least one more severe wave of infections this spring and summer – a fourth wave – before the inoculated and previously infected can crowd out those with no protection. Re-vaccination (booster shots) for new variants add to this timeline.

Rates Will Fall Dramatically

Such isn’t doomsday, but at a minimum, it elongates the time until battered industries (hospitality, entertainment) will have a chance to recover. So far, markets continue to believe the pandemic is a net benefit to bigger businesses globally (all-time highs in public companies, see below).

The explanation for this is that it is only the small, non-public companies that are struggling.

That is far-fetched.

The pandemic will cost the world’s public companies in aggregate at some point. I wrote nine months ago that “COVID-19 Defies Hyperbole.” Even though risk-on markets had gone up when I suggested they would go down, I stand by my prediction. Apt fiscal and monetary injections forestalled a deeper contraction. Still, it is a delusion to think we will get out of this for free – especially in a world economy that was overdue for a retraction anyways.

Even without a fourth COVID-19 wave, the negative impact on jobs, rents, consumer demand, tax revenue, and entire economy segments (hospitality, entertainment) has yet to be considered seriously. As they become so, risk-on markets (stocks, commodities, crypto-currencies, houses, and non-G-7 currencies) will drop, and long-term U.S. Treasury yields will fall dramatically.   


Eric Hickman is president of Kessler Investment Advisors, Inc., an advisory firm located in Denver, Colorado, specializing in U.S. Treasury bonds.

Bye Bye Brokers, Hello Blockchain Technology

Bye Bye Brokers

The Game Stop (GME) shenanigans are another reminder of the systematic risks lurking in the financial markets. Equally important, the incident highlights how certain players prevent markets from running more efficiently. The inherent dangers and market inefficiencies are not only borne by market participants but by every citizen.

This article discusses a technological advancement, allowing financial markets to operate more efficiently. In particular, we discuss the tokenizing of assets and show how blockchain technology can make our markets and, therefore, the economy more efficient.

We thank Charlie McGarraugh and commend his ability to explain a complex topic in plain English. For more on tokenizing assets, we highly recommend listening to his recent appearance on Smarter Markets.

A Dirty Piston in Capitalism’s Engine

The United States went from a sleepy backwater colonial outpost to an economic superpower on the back of capitalism. America and western civilization show that capitalism raises living standards for all. Capitalism is not perfect, but the more a country adheres to its core tenets, rule of law, private property, competition, free markets, and freedom, the greater its benefits to all citizens.

When any of capitalism’s tenets are encumbered, it impairs the natural dynamism that fosters prosperity. Today’s brand of capitalism, dare we say corporatism, leaves much to be desired. Multi-decade trends of weakening economic growth, massive leverage, declining productivity growth, and widening financial inequality serve as evidence.

Financial markets are constrained, manipulated, and made more costly to transact in due to intermediaries. These players limit the benefits of capitalism to the detriment of a majority of citizens. Free markets are not as free as they can be.

The recession of 2007-2009 reminds us these problems do not just result in higher transaction costs and reduced capital flows. They also carry immense layered and hidden systematic risks that burden the entire population. Consider the fact that very few people knew what a sub-prime mortgage or CDO-squared was before the great financial crisis. Even the PhDs at the Fed underestimated those risks.

To tune up capitalism’s engine and provide more to the many, we must find a more efficient way to operate financial markets.

Bye Bye Brokers

What if instead of routing trades through the choke point of a few banks and brokers, we could trade directly with any investor?

In the past, such an idea was not feasible. Banks and brokers historically provided valuable intermediary services. They not only found and matched buyers and sellers to make markets more liquid but they also became buyers and sellers in times of illiquidity. Equally important, they took on any risks associated with the settlement and custodian of assets.

Despite their fees, markups, risks, and other costs, markets ran more efficiently with intermediaries.

Blockchain technology, however, presents a better alternative for tomorrow.

Tokenizing Markets

Tokenizing assets is the act of digitally representing securities, commodities, collateral, future deliveries, and almost everything else on to the blockchain database. Transaction details on these assets reside in a public database for all to see.

Tokenized assets do not require intermediaries to trade or settle securities. Banks and brokers can still play a central role in introducing buyers and sellers and making markets when needed. But the system is not beholden to them.

For example, if I want to buy 100 shares of tokenized Ford stock, and you want to sell it, we agree on a price. We then use our unique electronic keys to instantaneously settle our security and cash exchange.

In the example, there is no bid/offer spread or broker fees although we might incur a small fee if an exchange introduced us.  The settlement does not take two days or carry the risk a broker fails. Bids and offers are shown worldwide without being limited to one broker, exchange, or time zone.

Tokenization is not just about better pricing, risk reduction, and trading efficiencies. When intermediaries playing less of a role, systematic risk lessens.

In a tokenized world, the Lehman default might have been avoided with real-time collateral management and pricing. Scams like Madoff are impossible to perpetrate as regulators can more easily see if there are actual “assets.”

Risks to Tokenization

As appealing as this technology is, one should consider its drawbacks. First, how would an investor access their portfolio and execute trading in the event of a power failure, or if they lost their key? Second, hacking is now ubiquitous in the on-line and electronic world. Despite safeguards, we cannot rule it out. Third, who provides regulatory oversight for such a system?

The expansion of the electronic payments infrastructure build-out over the past 20 years addresses some of these issues. We believe the market and technological innovation will overcome the risks in time.

However, there is another impediment to tokenization.

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

The Road Block

Standing in the way of progress are the well-connected banks and brokers with a lot to lose.

Note the highlighted words from Charlie’s quote below.

It’s different because we can build a system based on assets rather than a system built on institutions.” – Charlie McGarraugh

The current trading environment is entirely dependent on institutions such as JP Morgan, Goldman Sachs, Citadel, and others. These institutions take on risk, provide liquidity, and profit handsomely as intermediaries.

They have enormous corporate profits and generous wages to protect. There is no doubt these firms will use their strong lobbies and overwhelming support from the Fed and U.S. Treasury to slow down efforts to tokenize assets.

15 Billion Reasons to Stop Technology

To help you appreciate why intermediaries will try to block the economic benefits of tokenization, consider Ken Griffin. His equity trading firm, Citadel, handled about a quarter of all trading volume in U.S. equity markets last year.

Per Bloomberg: “The trading operation, which is separate from Griffin’s hedge fund business, generated $3.84 billion of revenue in just six months, more than the $3.26 billion for all of 2019, according to a presentation to investors. Net income was $2.36 billion in the first six months of 2020, compared with $982 million for the same period a year earlier.”

The enormous profits from Citadel’s equity trading operations are almost entirely risk-free!

Forbes estimates Mr. Griffin’s net worth to be around $15 billion. What do you think the odds are that Ken Griffin and his competitors walk away from such easy money?

Tokenizing Game Stop

During the GME fiasco, Robin Hood (RH) reportedly required emergency funding to cover collateral requirements. Without funding, RH may have failed at costs to its clients. Additionally, RH and other large brokerages restricted trading, causing angst and losses for many retail GME investors.

RH’s largest source of revenue comes from Citadel. Citadel pays RH to execute its client’s trades. While Citadel was “acting on behalf of RH’s clients”, they also had exposure to GME through Melvin Capital, a hedge fund in which they hold a principal interest. In fact, they provided $2 billion in funding to Melvin to keep it afloat.

Citadel is conflicted. Based on public evidence, they favored their bottom line over RH clients.

With the GME/RH situation in mind, let’s consider the GME episode in a tokenized realm. Short interest in GME exceeded 100%, meaning more shares were held by investors than existed. Under the current system, a broker can lend its clients’ shares without the client knowing. When such occurs, two investors own the shares, and one investor is short the shares. The transactions net out but they introduce risk if the broker fails.

With tokenized shares, the risks and rewards of lending securities are only taken by those willing and wanting to accept the risk. They are also paid for taking the risk. Further, trade settlements happen immediately, eliminating counterparty risk.  Lastly, retail investors do not have to depend on a conflicted intermediary or insolvent broker.

Had the problem escalated, there is little doubt the Federal Reserve would have bailed out Citadel and RH, at the public’s expense.

Summary

Monetary incentives explain why capitalism is effective. It certainly has flaws, but history attests that no other system has improved the standard of living for the masses to the extent capitalism has.

The more freely and uninhibited money can flow throughout an economic system, the more the economy benefits all of its people. Intermediaries, by definition, present an impediment to the flow of money.  The purposes they serve comes at a cost to society. Before blockchain, one could argue the benefits outweighed the costs. Today that is not true.

As market participants and citizens, we can only hope the self-interests of a few do not impede on the benefits to all of us. 

Technically Speaking: Howard Marks On Speculative Manias

One of my favorite investing legends is Oaktree Management’s Howard Marks. His investing wisdom and in-depth knowledge of investor psychology and market dynamics are unparalleled. Given the “speculative mania” we continue to watch in the market, I thought a review of some of his previous thoughts is appropriate.

Over the weekend, I re-read some previous research and ran across an interview between Goldman Sach’s Hugo-Scott Gall and Howard Marks. The talk ranged from investment decisions to behavioral dynamics. While the interview occurred in 2013, it is just as relevant as if he said it yesterday.

I have annotated some of the points for clarity.

Investor Psychology

Hugo Scott-Gall: How can we understand investor psychology and use it to make investment decisions?

Howard Marks: It’s the swings of psychology that get people into the biggest trouble, especially since investors’ emotions invariably swing in the wrong direction at the wrong time. When things are going well people become greedy and enthusiastic, and when times are troubled, people become fearful and reticent. That’s just the wrong thing to do. It’s important to control fear and greed.

Another mistake that people often make is to compare themselves with others who are making more money than they are. They mistakenly conclude they should emulate the others’ actions after they’ve worked. This is the source of the herd behavior that so often gets them into trouble. We’re all human and so we’re subject to these influences, but we mustn’t succumb. This is why the best investors are quite cold-blooded in their professional activities.

We can infer psychology from investor behavior. That allows us to understand how risky the market is, even though the direction in which it will head can never be known for certain. By understanding what’s going on, we can infer the “temperature” of the market. 

We need to remember to buy more when attitudes toward the market are cool and less when they’re heated. For example, the ability to do inherently unsafe deals in quantity suggests a dearth of skepticism of investors. Likewise, when every new fund is oversubscribed, you know there’s eagerness. 

Too little skepticism and too much eagerness in an up-market – just like too much resistance and pessimism in a down-market – can be very bad for investment results.

On Prudence

Warren Buffett once said,

“The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.”

I agree thoroughly. In order to understand how much prudence others are applying, we need to observe investor behavior and the kinds of deals getting done. In 2006 and 2007, just before the onset of the financial crisis, many deals got done that left me scratching my head. That indicated low levels of risk aversion and prudence. We can’t measure prudence through a quantitative process. Therefore, we have to infer it by observing the behavior of market participants.

The fundamental building block of investment theory is the assumption that investors are risk averse. But, in reality, they are sometimes very risk averse and miss a lot of buying opportunities. Sometimes they are very risk tolerant and buy when they shouldn’t. Risk aversion isn’t constant or dependable. That’s what Buffett means when he says that when other people apply less, you should apply more.

Repeating Mistakes

Hugo Scott-Gall: Why do behavior patterns and mistakes recur despite the plethora of information available now? Are we doomed to repeat our mistakes?

Howard Marks: Information and knowledge are two different things. We can have a lot of information without much knowledge, and we can have a lot of knowledge without much wisdom. In fact, sometimes too much data keeps us from seeing the big picture; we can “miss the forest for the trees.”

It’s extremely important to know history, but the trouble is that the big events in financial history occur only once every few generations. In the investment environment, memory and the resultant prudence regularly do battle with greed, and greed tends to win out.

Prudence is particularly dismissed when risky investments have paid off for a span of years. John Kenneth Galbraith wrote that the outstanding characteristics of financial markets are shortness of memory and ignorance of history.

History Often Rhymes

In hot times, the few who do remember the past are dismissed as relics of the old, lacking the ability to imagine the new. But it invariably turns out that there’s nothing new in terms of investor behavior. Mark Twain said that “history does not repeat itself but it does rhyme,” and what rhymes are the important themes.

The bottom line is that even though knowing financial history is important, requiring people to study it won’t make a big difference, because they’ll ignore its lessons. There’s a very strong tendency for people to believe in things which, if true, would make them rich. Demosthenes said,

“For that a man wishes, he generally believes to be true”

Just like in the movies, where they show a person in a dilemma to have an angel on one side and a devil on the other, in the case of investing, investors have prudence and memory on one shoulder and greed on the other. Most of the time greed wins. As long as human nature is part of the investment environment, which it always will be, we’ll experience bubbles and crashes.

Being Overconfident

Hugo Scott-Gall: Success in our industry often leads to overconfidence. How do good investors avoid that?

Howard Marks: Mark Twain once said,

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

One of the chapters in my book is about the importance of knowing what you don’t know. People who are smart often overestimate what they know, and this tendency can grow, particularly if they are financially successful. And eventually, you get to the master of the universe problem that Tom Wolfe identified in “The Bonfires of the Vanities.”

I believe there’s a lot we don’t know, and it’s important to acknowledge that. I’m sure I know almost nothing about what the future holds, but a lot of people claim to know exactly what’s going to happen. I consider it very dangerous to listen to them. As John Kenneth Galbraith said,

“There are two kinds of forecasters. Those who don’t know, and those who don’t know they don’t know.”

I’m proud to say I’m a member of the first group. Amos Tversky, who was a great behaviorist at Stanford University, said that,

“It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.

That is particularly true for investing. I’d much rather have my money run by somebody who acknowledges what he doesn’t know than somebody who’s overconfident. As Henry Kaufman, the noted economist pointed out,

“We have two kinds of people who lose a lot of money; those who know nothing and those who know everything.”

Speculative Mania Smoke 02-12-21, Speculative Mania Continues As It &#8220;Goes Up In Smoke&#8221; 02-12-21

Being Emotionally Disciplined

Hugo Scott-Gall: Have you always been, or did you learn to be self-aware and emotionally disciplined?

Howard Marks: I’m inherently unemotional, and I’ve also observed for 45 years that emotions swing in the wrong direction and learned that it’s extremely important to control it. In the market swoon of 1998, I had an employee tell me he was afraid the financial system was going to melt down. I heard him out and then told him to carry on with his work. 

I don’t compare myself or my colleagues to them, but battlefield heroes aren’t people who are unafraid; they’re people who are afraid and do it anyway. And so we must keep investing; in fact, we should invest even more when it is scary, because that’s when prices are low.

Walter Cronkite once said:

“If you’re not confused you don’t understand what’s going on”.

In the fourth quarter of 2008, I paraphrased that to say, “If you’re not afraid you don’t understand what’s going on.” Those were scary times. But even if you’re afraid, you have to push on. In the depths of the crisis in October ’08 I wrote a memo that I’m particularly proud of, called ‘The Limits to Negativism.’ It touched on the importance of skepticism in an investor. 

In good times skepticism means recognizing the things that are too good to be true; that’s something everyone knows. But in bad times, it requires sensing when things are too bad to be true. People have a hard time doing that.

The things that terrify other people will probably terrify you too, but to be successful an investor has to be stalwart. After all, most of the time the world doesn’t end, and if you invest when everyone else thinks it will, you’re apt to get some bargains.

Suppression Of Rates

Hugo Scott-Gall: How do you think about the current very low interest rate regime?

Howard Marks: Yes. The point is that today you can’t make a decent return safely. Six or seven years back, you could buy three to five-year Treasurys and get a return of 6% or so. So you could have both safety and income. But today, investors have to make a difficult choice: safety or income. If investors want complete safety, they can’t get much income, and if they aim for high income, they can’t completely avoid risk. It’s much more challenging today with rates being suppressed by governments.

This is one of the negative consequences of centrally administered economic decisions. People talk about the wisdom of the free market – of the invisible hand – but there’s no free market in money today. Interest rates are not natural. They are where they are because the governments have set them at that level. Free markets optimize the allocation of resources in the long run, and administered markets distort the allocation of resources. This is not a good thing… although it was absolutely necessary four years ago in order to avoid a complete crash and restart the capital markets.

Being Contrarian

Hugo Scott-Gall: Where would you want to be if you were starting your career as a contrarian today?

Howard MarksA market being interesting in the long term and being cheap at the moment are two different things. Credit and debt investing is still very, very attractive and interesting to spend time in, even though it may not be especially rife with great bargains today


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

Viking Analytics: Weekly Gamma Band Update 2/15/2021

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

Gamma Band Update

The Gamma Band model continues to maintain 100% allocation to the S&P 500 (SPX).  When the daily price closes below the Gamma Neutral or “Gamma Flip” level (currently near 3,865), the model will reduce exposure in order to avoid price volatility. If the market closes on a daily basis below 3,630, the model will reduce the SPX allocation to zero.

This kind of model can be appropriate for investors who want upside exposure to the stock market, while protecting against downside tail risk.  It might seem counter-intuitive to increase allocations when the market rises, but this approach can be shown to increase risk-adjusted returns in the back-test.   

This is one of several signals that we publish daily in our SPX Report.  A free sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and price signals.

The Gamma Flip – Background

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

Gamma Band Model – Background

The purpose of the Gamma Band model is to reduce tail risk.  The Gamma Band model has improved risk-adjusted returns by over 70% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

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

Authors

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

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


Powell Is Wrong. More Stimulus Won’t Create Employment

As discussed in Friday’s #Macroview, stimulus, mainly when it comes from debt, does not create organic economic growth. In the second part of this analysis, we delve into why Powell is wrong when he says more stimulus will solve the employment problem.

Let’s start with the two most essential snippets from Fed Chair Jerome Powell’s speech last week:

Correcting this misclassification and counting those who have left the labor force since last February as unemployed would boost the unemployment rate to close to 10 percent in January.”

“It will require a society-wide commitment, with contributions from across government and the private sector.”

I agree with his first point. If you account for those no longer counted as part of the labor force, the real unemployment rate (more commonly known as the U-6 rate) is near 10%.

However, where  I disagree, as we exposed in part one of this discussion, monetary and fiscal supports when they are non-productive, do not create the confidence required for economic growth.

The Confidence Problem

To understand why confidence is necessary, we need to go back to 2010 when then-Fed Chairman Ben Bernanke revealed the Fed’s “Third Mandate.”   To wit:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

For the Fed, “confidence” is the key to economic growth, given the economy is roughly 70% comprised of personal consumption. Unfortunately, the Fed believed inflating asset prices would “trickle-down” to the rest of the economy. Such would lead to more consumption and economic growth.

That didn’t occur.

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

The Rich Got Richer

Confidence is about an individual being able to sustain their standard of living. Unfortunately, as we addressed previously, the differential between incomes and maintaining a standard of living has not been sufficient.

Unless, of course, you are in the top 20% of the economy, where there is plenty of disposable income to invest into the stock market. Given the Fed’s ongoing accommodation over the last decade, the “wealth gap” between the top 10% of the economy owns nearly 90% of the stock market, and the rest has exploded.

Such was a point we noted in our previous report entitled “The Fed’s Only Choice.” 

The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.” – WSJ

, The Fed&#8217;s Only Choice &#8211; Exacerbate The Wealth Gap, Or Else.

“Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A full 33% of that gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.”

, The Fed&#8217;s Only Choice &#8211; Exacerbate The Wealth Gap, Or Else.

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

The Importance Of Consumer Confidence

Importantly, this all circles back to confidence. Economic growth is dependent on confidence.

  • Individuals need confidence that a regular paycheck will allow them to consume as needed to support their families.
  • Businesses, primarily small business owners, need confidence that consumption (i.e., sales) will remain at levels to sustain their business and generate a profit.

These two dependencies are crucial to the economy. If consumers aren’t confident in their income, they cut back on spending. When consumers cut back spending, business owners become concerned about demand. Therefore, they make decisions to curtail employment, wages, production, investment, and capital expenditures.

The risk was well explained by Treasury&Risk previously:

“It is hard to overstate the degree to which psychology drives an economy’s shift to deflation. When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers all change their primary orientation from expansion to conservation.

  • Creditors become more conservative, and slow their lending.
  • Potential debtors become more conservative, and borrow less or not at all.
  • Investors become more conservative, they commit less money to debt investments.
  • Producers become more conservative and reduce expansion plans.
  • Consumers become more conservative, and save more and spend less.

These behaviors reduce the velocity of money, which puts downward pressure on prices. Money velocity has already been slowing for years, a classic warning sign that deflation is impending. Now, thanks to the virus-related lockdowns, money velocity has begun to collapse. As widespread pessimism takes hold, expect it to fall even further.”

Such is why Powell is incorrect in his views on how to “fix” the economy. Such should be apparent after a decade of monetary policy not working. Artificial stimulus payments, and ongoing monetary accommodations that only benefit the wealthy, do not improve confidence.

Jobs do.

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

Consumer Confidence In The Economy Declines

How do we know such is the case? Because after two massive stimulus packages, with a third on the way, consumer confidence in the economy has weakened. A recent Ipsos Poll of Americans showed:

“Fewer Americans this week believe that the economy will pick up quickly once pandemic restrictions are relaxed. The percentage who agree fell 5 points from last week to 51% now.”

“Purchasing confidence for both major items and other household items is still weak relative to the more confident readings of early to mid-January.”

This poll’s importance is that despite stimulus payments, a new Administration, a vaccine, and a surging stock market, confidence has deteriorated.

We also see the same problem in our composite consumer confidence index verse real personal consumption expenditures. (PCE comprises roughly 70% of the GDP calculation.)

Not surprisingly, the lack of confidence is rolling over into small businesses as well.

Small Businesses Are Less Confident As Well

As we discussed in January, the small business survey put out by the National Federation of Independent Business showed a sharp drop in confidence despite a supposedly improving economy, roaring stock market, and low rates.

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

As noted above, if small businesses believe the economy is “actually” improving over the longer term, they would be increasing employment. Given business owners are always optimistic, over-estimating hiring plans is not surprising. However, reality occurs when actual “demand” meets its operating cash flows.

To increase employment, which is the single most considerable cost to any business, you need two things:

  1. Confidence the economy is going to continue to grow in the future, which leads to;
  2. Increased production of goods or services to meet growing demand.

Currently, there is little expectation for a strongly recovering economy. Such is the requirement for increasing employment and expanding capital expenditures.

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

Such also helps you understand the biggest problem with artificial stimulus. Yes, injecting stimulus into the economy will provide a short-term increase in demand for goods and services. When the funds are exhausted, the demand fades. 

Small business owners understand the limited impact of artificial inputs. As such, they will not make long-term hiring decisions, an ongoing cost, against a short-term artificial increase in demand.

Also, given President Biden is focused on more government regulation and higher taxes (which falls squarely on the creators of employment), increased costs will further deter long-term hiring plans.

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Stimulus Doesn’t Replace A Job.

When it comes to the economy and creating organic economic growth, it is the symbiotic relationship between businesses and consumers.

Such is the point that has eluded policymakers at the Fed and in Washington.

More importantly, the evidence is abundantly clear. After a decade of zero interest rates, more than $36 trillion in interventions and monetary accommodation, the economy collapses on the slightest reduction.

These interventions exacerbated the wealth gap and grossly inflated corporate profitability at the expense of worker’s wages.

Furthermore, employment, which is the backbone of consumer confidence, has not increased strong enough to create sustainable economic growth above 2%. Notably, the number of full-time jobs, which are critical to sustaining a family, has continued to decline.

Notably, that number remains skewed due to the “labor force” calculation. Even though the economy may approach “full-employment,” much of that is an illusion created by the labor force’s shrinkage.

While a “stimulus” check may solve a short-term need, consumers are well aware such is a short-term benefit.

What would boost their confidence is a job.

The Wrong Vaccine

Following the CARES Act, many consumers spent their stimulus checks believing their job loss was only temporary. Today, many of those temporary job losses have now become permanent. That realization by consumers may well change how they spend the next round of stimulus payments. Rather than immediate consumption, the focus may well change to paying down debt or catching up on delinquent mortgage payments.

If such does turn out to be the case, the economy’s impact will be substantially less than anticipated, and confidence will likely erode further.

While Powell hopes that more stimulus will create an environment where more companies will hire, they will only do so when demand is growing organically. As noted previously, stimulus payments don’t inspire business owners’ confidence to increase capital expenditures, hire employees, or take on more risk.

If you want business owners to take on long-term risk and put employees to work, you have to allow capitalism to operate efficiently. Such would require letting “Darwinian” processes take root to clear the system.

As with any illness, the “cure” can often be painful at first, but the long-term benefits are often worth it.

Speculative Mania Continues As It “Goes Up In Smoke”


In this issue of “Speculative Mania Continues As It “Goes Up In Smoke.”

  • Market Review And Update
  • Speculative Mania Continues
  • Two Important Threats
  • Portfolio Positioning
  • #MacroView: Why Stimulus Doesn’t Lead To Organic Growth
  • Sector & Market Analysis
  • 401k Plan Manager

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


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

Catch Up On What You Missed Last Week


Market Review And Update

Last week, we discussed how the market successfully retested and held the 50-dma and rallied enough to turn money flows back positive. We addressed this point on Thursday in our daily “3-Minutes” video (subscribe for daily updates),

As previously noted:

“While the money flow ‘buy signal’ will likely trigger next week, the market is already trading 2-standard deviations above the 40-dma. Such suggests that the upside may be more limited over the next couple of weeks.”

As the market struggled to hold gains, as denoted by the two red-dashed lines, that was the case. Notably, the entire week’s gains came in the last hour of trading on Friday.

With the money flow signals still positive, the overall bias to the market remains bullish for now. However, the rally is still at risk currently, given the more extreme overbought and bullish conditions. Speculation remains rampant, and there are many indicators from relative strength to participation that suggest we could see another correction in March or early April.

When our money flow indicators turn lower again, we will suggest reducing risk accordingly. However, the problem with all technical indicators is two-fold:

  1. They don’t distinguish between a 5% correction and a 20% drawdown; and,
  2. Secondly, the corrections often occur so quickly you don’t have much time to decide just how defensive you need to be. 

Speculative Mania Continues

This past week was quite interesting as the “Reddit WallStreetBets” bunch turned their sites away from Gamestop to “Cannabis.” Early in the week, we saw the “mania” re-manifest itself into names like Tilray, Aphria, Cronos, and others.

However, this time it looks like “Reddit” traders learned their lesson to  “get out early” as the trade went “up in smoke” rather quickly.

Nonetheless, the “speculative mania” remains in the market overall as speculators continue to operate without “fear” of a correction.

Currently, retail net bullish call options are piling up on the most shorted stocks.

However, those are the stocks with the worst fundamental factors.

And as investors chase small and mid-cap stocks to record historical deviations from long-term means.

These are also the companies where the quality of fundamentals are deteriorating the most.

But these are just a view of the signs. I did a much more extensive review of the current speculation in “Is This The Biggest Bubble Ever?”

As my colleague Doug Kass noted previously:

“It is growing increasingly clear to me that global stock markets are in the process of making a speculative move (driven by global liquidity) that may even compare to the advances that culminated in the seminal market tops in the Fall of 1987 and in the Spring of 2000.

No longer is the market hostage to the real economy or sales and profit growth – stuff I have spent four decades analyzing. Instead, liquidity is seen as an overriding influence, actually it has become the sine quo non.

As such, historical valuations become increasingly irrelevant, and price momentum is the lodestar.

He is right.

What could go wrong?

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

Two Important Threats

The question of what could wrong is extremely difficult to answer. The reason is that historically, the thing the “goes wrong,” is almost always something no one is talking about. In February 2020, estimates were for a raging bull market, and then the world was shut down by a pandemic.

“Stuff Happens,” and always when we least expect.

There are, however, two threats that could severely limit the market in the months and quarters ahead. Inflation and Interest Rates.

Interest Rates

With an economy pushing $85 trillion in debt, the entire premise of the “consumption function,” as well as “valuation justification” for the stock market, is based on low-interest rates. However, that is rapidly ending as the rise in rates is now approaching a “danger zone” for the markets. As noted by SentimenTrader on Thursday:

“The march higher in the yield on 10-year Treasury notes took a breather in recent days, but it’s mostly been a steady rise for most of the last 6 months. So much so that the 1-year z-score, a measure of how unusual the move is relative to recent history, just reached 1.5 standard deviations for the 4th distinct time in the past decade.”

As discussed in “Dollar & Rates Issue A Warning,” interest rates are rapidly approaching the 1.5% to 2.0% barrier, where higher payments will collide with disposable income. Historically, such has not ended well for markets.

Inflation

The second threat is inflation. as noted by Michael Lebowitz for our RIAPRO Subscribers (30-day free trial.)

“In February 2019 we wrote MMT and its Fictional Discipline

“In 1998, the Bureau of Labor Statistics (BLS) changed the way they calculated real estate prices within CPI. The BLS replaced an index based on actual home prices with what is now called owner’s equivalent rent (OER). OER is a rental equivalence that calculates the price at which an owned house would rent.”

Since 2019, OER has risen 5.12% while the Case-Shiller Home Price Index (CS) is up 13.73%. OER comprises nearly a quarter of the CPI calculation. The graph below replaces OER with the CS Index in the CPI calculation to show how inflation is understated due to the sharp divergence between actual home prices and the BLS flawed methodology to compute home prices. Per the graph, CPI would be 2.62% and rising, versus .96% and trending lower. The low CPI reading provides cover for the Fed to keep printing, but at what cost?”

When it comes to the stock market, there is a decades-long correlation between interest rates and inflation. More importantly, as with debt, consumers may handle higher prices or debt payments, but not both.

While investors may be able to justify higher inflation or rates in the short-term, it is unlikely they can justify both. As inflation and rates slow economic growth due to the absorption of disposable income via higher prices and interest payments, the market will begin to reprice risk quickly.

Such could be a problem sooner than many think.

The Reason To Focus On Risk

During the past week, we made no substantive changes to our portfolios. It seems like a good time to review why we chose to “focus on risk” given the seeming “insanity” in the markets currently.

As investors, our job is to navigate the waters within which we currently sail, not the seas we think we will sail in later. Higher returns are generated from the management of “risks” rather than the attempt to create returns by chasing markets. That philosophy got well defined by Robert Rubin, former Secretary of the Treasury when he said;

“As I think back over the years, I have been guided by four principles for decision making.  First, the only certainty is that there is no certainty.  Second, every decision, as a consequence, is a matter of weighing probabilities.  Third, despite uncertainty, we must decide and we must act.  And lastly, we need to judge decisions not only on the results, but on how they were made.

Most people are in denial about uncertainty. They assume they’re lucky, and that the unpredictable can be reliably forecast. This keeps business brisk for palm readers, psychics, and stockbrokers, but it’s a terrible way to deal with uncertainty. If there are no absolutes, then all decisions become matters of judging the probability of different outcomes, and the costs and benefits of each. Then, on that basis, you can make a good decision.”

A Simple Philosophy

It should be evident that an honest assessment of uncertainty leads to better decisions, but the benefits of Rubin’s approach, and mine, goes beyond that. For starters, although it may seem contradictory, embracing uncertainty reduces risk while denial increases it. Another benefit of acknowledged uncertainty is it keeps you honest.

“A healthy respect for uncertainty and focus on probability drives you never to be satisfied with your conclusions.  It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference.”

We must recognize and be responsive to changes in underlying market dynamics if they change for the worse and be aware of the inherent risks in portfolio allocation models. The reality is that we can’t control outcomes. The most we can do is influence the probability of specific outcomes, which is why the day-to-day management of risks and investing based on probabilities rather than possibilities is essential to capital preservation and investment success.

It is just something to consider.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 90.8 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 94.6 out of a possible 100.


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

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

S&P 500 Growth Screen

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

NEW!  Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

As we noted last week, the rally continued this week, although it is beginning to get a bit more “sloppy” as deviations and overbought conditions are starting to pull on prices.

While we didn’t make any substantive changes this week, we continue to focus on risk and bringing portfolios closer to our benchmark weightings.

With a much shorter bond-duration than our benchmark, we have mostly mitigated the recent rise in interest rates while increasing yield through some of our current portfolio additions.

As always, while not much happened this past week, we are watching our indicators closely. We think this rally may have one or two weeks left, which should coincide with the stimulus bill’s passing. A “buy the rumor, sell the news” outcome would not be surprising.

We will make changes accordingly.

Portfolio Changes

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

** ETF Portfolios – Trade Update ***

Portfolio Managers – Michael Lebowitz/Lance Roberts

We are continuing to work at rebalancing the portfolio closer to the benchmark weightings. With rates pushing higher, we are reducing XLU by 4% and increasing our underweight positioning in XLK up by 4%. This adjustment is simply a swap of holdings and does not increase overall equity allocation.” – 02/08/21

ETF Portfolio

  • Reduce XLU from 5% to 1% of the portfolio  
  • Increase XLK from 9.5% of the portfolio to 13.5%

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

Compare your current 401k allocation to our recommendation for your company-specific plan and our 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 of 2-12-21

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

Commentary 2-12-21

  • Communications beat the S&P 500 by 7.34% over the last four weeks, which helps explain why its relative score and sigma have risen toward extremely overbought territory on the Sector graph. Discretionary continues to move lower from overbought into oversold territory as inflation becomes a growing concern for many of its component companies.
  • Real estate has risen nicely, with a normalized score (sigma) that is now very overbought.
  • As we have mentioned, staples and utilities have been trading weak due to inflation concerns. Interestingly, materials and industrials are now oversold versus the S&P, despite the benefits of inflation to some of the underlying companies. In the same vein, energy is now back to fair value. Energy slightly underperformed the S&P over the last four weeks.
  • Small-cap and Emerging markets continue to be the most overbought indexes on a relative basis, while value versus growth, the Dow Jones Industrial Average, and developed markets the most oversold.
  • Note the scatter plot shows a high r-squared denoting that relative sector performance and scores are well aligned. If you recall, the r-squared last was very weak at .39.
  • On an absolute basis, most sectors and factor/indexes remain overbought, but not egregiously so. Similarly, the S&P graph in the bottom right of the second set of graphs, shows it is only moderately overbought.
  • We haven’t discussed bonds in a while, but it is worth mentioning higher yields are now weighing on high yield and investment-grade corporate bonds. With little ability for their spreads to compress further versus Treasuries, they are increasingly susceptible to higher Treasury yields.
  • The communications sector is now trading over 2 standard deviations above its 50 and 200-day ma. Accordingly, the sector warrants caution as such levels typically signals a consolidation or retracement. SPY and QQQ are also trading at 2 standard deviations above their respective 50-day mas.

Graphs (Click on the graphs to expand)


Users Guide

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

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma 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.

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

The ETFs used in the model are as follows:

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

#MacroView: Why Stimulus Doesn’t Lead To Organic Growth

There is a growing consensus in Washington the only way to fix the worst economic downturn in more than 70 years is by giving out more free money.  From Joe Biden, to Janet Yellen, to most members of Congress, there is a demand for more “stimulus.”  However, the reason the previous programs failed is the stimulus doesn’t lead to organic growth.

Let me explain.

Joseph Carson, the former Chief Economist at Alliance Bernstein, recently noted:

“Suppose Congress passes something close to Biden’s Administration stimulus proposal of $1.9 trillion. In that case, that will lift the cumulative amount of fiscal stimulus in the past 12 months to $5 trillion—three tranches $2.2 trillion, $900 billion, and $1.9 trillion.

In the past year, nominal GDP totaled $21 trillion, so the cumulative injection of fiscal stimulus amounts to almost 25%.

Nothing in modern times comes close, especially during peace times. CBO published a report in 2010 on the military costs of significant wars. The military war costs of World War 1 amounted to 13.6% of GDP and World War 11 35.8%—-so the current spending/stimulus is in the middle of the two World Wars.”

It is an incredible amount of intervention relative to the underlying crisis. As Joseph pointed out, there is a significant difference between today and WWII.

“During World Wars, activity in the private sector is depressed. That’s not the case today. The housing sector is booming, with housing starts at the highest levels in 15 years, and prices are rising double-digit to record levels. At the same time, the manufacturing sector is experiencing a mini-boom in orders and production.”

However, to understand why more stimulus may not create economic growth, we need to review how we got here.

A Brief History

In March, as the economy shut down due to the pandemic, the Federal Reserve leaped into action to flood the system with liquidity. At the same time, Congress passed a massive $2.2 trillion fiscal stimulus bill that expanded Unemployment Benefits and sent checks directly to households. Then in December, the Trump administration hit the economy with another $900 billion. Now, the Biden administration anticipates repeating that with another $1.9 trillion. As shown below, with money pouring into households’ hands, it is not surprising the economy rebounded.

That surge in the third quarter, and surging stock market to boot, directly responded to both the fiscal and monetary stimulus supplied. The chart below adds the percentage change in Federal expenditures to the chart for comparison.

The spike in Q2 in Federal Expenditure was from the initial CARES Act. In Q1-2020, the Government spent $4.9 Trillion in total, which was up $85.3 Billion from Q4-2019. In Q2-2020, it increased sharply due to the passage of the CARES Act. Spending for Q2 jumped to $9.1 Trillion, which is a $4.2 Trillion increase over Q1-2020. In Q3 and Q4, spending was still well above normal levels running at $7.2 and $6.0 trillion. 

Importantly, note that the rate of change in spending is declining along with economic growth rates. That is the “second-derivative” effect of growth.

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

Second Derivative

The next chart shows how the “second derivative” is already undermining both fiscal and monetary stimulus. Using actual data going back to the Q1-2019, Federal Expenditures remained relatively stable through Q1-2020, along with real economic growth. However, from Q2 through Q4-2020, Federal Expenditures surged. However, the economy still hasn’t returned to positive growth.

The chart below shows the inherent problem. While the additional fiscal stimulus did help stave off a more in-depth economic contraction, its impact becomes less over time.

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

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

Stimulus Doesn’t Provide Confidence.

The problem with monetary interventions, like direct checks to households, is that while it may provide a short-term bump in spending, it does not promote confidence. As shown in the chart below, despite a surging recovery in the economy and the stock market, consumer confidence remains mired at recessionary lows.

The reason that stimulus payments didn’t improve consumer confidence is due to the understanding that such payments are a one-time benefit. What increases economic prosperity and confidence are employment and wage growth.

Such is the problem with artificial stimulus. To increase employment and wages, it is the confidence of employers that needs to improve. The chart below replicates how the economy works. Individuals must produce first before they can consume.

While stimulus will bypass the “production” part of the equation creating short-term demand, such does not create the repeatable demand necessary for businesses to increase employment. We saw this in the recent National Federation Of Independent Business (NFIB) survey.

“Small businesses are susceptible to economic downturns and don’t have access to public markets for debt or secondary offerings. As such, they tend to focus heavily on operating efficiencies and profitability.

If businesses were expecting a massive surge in ‘pent up’ demand, they would be doing several things to prepare for it. Such includes planning to increase capital expenditures to meet expected demand. Unfortunately, those expectations peaked in 2018 and are lower again.”

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

“There are important implications to the economy since ‘business investment’ is a GDP calculation component. Small business capital expenditure ‘plans’ have a high correlation with real gross private investment. The plunge in ‘CapEx’ expectations suggests business investment will drop sharply next month.”

NFIB Small-Cap Stocks, NFIB Survey: Sends A Strong Warning About Small-Cap Stocks

The bigger problem with the stimulus is that it is based on increasing debt levels to provide it.

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

You Can’t Use Debt To Create Growth.

The biggest problem with more stimulus is the increase in the debt required to fund it. As discussed previously, there is no historical precedent, anywhere globally, that shows increased debt levels lead to more robust rates of economic growth or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.

We can view the impact of debt on the economy by analyzing the economic growth created. As shown, it takes an increasing amount of debt to generate each dollar of economic growth.

For the 30 years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Such is why the Federal Reserve has found itself in a “liquidity trap.”

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

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

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

However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve engaged in policies that expanded unproductive debt and leverage.

American Debt, #MacroView: CBO &#8211; The &#8220;One-Way Trip&#8221; Of American Debt

Coming out of the 2020 recession, the economic trend of growth will be somewhere between 1.5% and 1.75%. Given the amount of debt added to the overall system, the ongoing debt service will continue to retard economic growth.

A Permanent Loss 

As noted by Zerohedge, the permanent loss in output in the U.S. was shown by BofA previously. The bank laid out the pre-COVID trend growth and compared it to its base case recovery.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Such aligns closely with our analysis shown above. Given the permanent loss in output and rising unproductive debt levels, the recovery will be slower and more protracted than those hoping for a “V-shaped” recovery. The “Nike Swoosh,” while more realistic, might be overly optimistic as well.

However, this is the most critical point.

The U.S. economy will never return to either its long-term linear or exponential growth trends.

Read that again. 

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

A Continuation Of Boom/Bust Cycles

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40-years.

As Joseph Carson, former Chief Economist at Alliance Bernstein concluded:

“Given the scale of fiscal stimulus, one would expect the Fed to be thinking of “leaning against the wind.” But not this Fed–the Fed is using the same playbook from the Great Financial Recession, providing unneeded stimulus to the red-hot housing market.

What’s the economic and financial endgame? It’s hard to see anything but a ‘boom-bust’ scenario playing out with fast growth and rising market interest rates in 2021 and early 2022, followed by a bust in late 2022/23 when the fiscal stimulus/support dries up.

The US experienced mild recessions following the sharp drop in government military spending after the Korean and Vietnam wars—-and back then, the scale of military expenditures amounted between 2% and 4% of GDP. The ‘sugar-high’ today is unprecedented, raising the odds of a harder landing.

While mainstream economists believe more stimulus will create robust economic growth, no evidence supports the claim. 

Yes, we will get a short-term burst of inflation and interest rates, most certainly. However, such will quickly collide headlong into the massive debt levels overhanging the economy.

Such is the trap that will put the Federal Reserve in a box of hiking rates and reducing monetary accommodation at precisely the wrong time.

But that is a topic we will discuss next week.