Bulls Regain Control Of The Market As Fed Taper Looms

In this 10-15-21 issue of “Bulls Regain Control Of The Market As Fed Taper Looms.”

  • Market Rallies As Earnings Season Kicks Off
  • FOMC Minutes Confirm Fed Taper Coming
  • Navigating Uncertainty
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Rallies As Earnings Season Kicks Off

Two weeks ago, we laid out the case for why we started increasing our equity exposure in portfolios.

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

Chart updated through Friday.

While the market started the week a bit sloppily, the bulls charged back on Thursday as earnings season officially got underway. With the market crossing above significant resistance at the 50-dma and turning both seasonal “buy signals” confirmed, it appears a push for previous highs is possible.

Correction Is Over For Now

After nearly a month of selling pressure, the rally over the last couple of days came on cue and supported our recommendation to increase exposure to equities. As noted by Barron’s:

“Market sentiment is getting more buoyant. Thursday, the S&P 500 saw its largest gain since March 5, according to Instinet. The percent of stocks on the index that rose, 95%, was the highest since June 21. Friday, about 90% of components were positive. Instinet sees a high likelihood that the index will reach 4.570 fairly soon, for a more than 2% gain.” 

Two factors are driving the rebound. Earnings, so far, are coming in above estimates. Such isn’t surprising as analysts suppressed estimates going into reporting season. Secondly, bond yields declined.

However, there are still reasons to remain cautious near term. As shown below, the internals of the market, while improved slightly, remain negatively diverged. The number of stocks above respective 50- and 200-dma remains low, the bullish percent index remains weak, and relative strength declines.

Furthermore, most companies haven’t reported earnings yet, and macroeconomic challenges still exist. So far, large banks beat estimates on reduced loan loss reserves, but they don’t deal with supply-chain limitations. We are about to see earnings from companies directly impacted by, and don’t benefit from, higher inflation, labor costs, and supply line disruptions.

Technically, If the current rally is going to push back to all-time highs, the market’s underlying strength must begin to improve markedly over the next couple of weeks. If not, the current rally will likely fail sooner than later. Furthermore, the odds of a correction increase as the Fed begins to reduce monetary accommodation.


FOMC Minutes Confirms Taper Is Coming

In the most recent release of the Federal Reserve’s FOMC minutes, the much anticipated “taper” of bond-buying programs got confirmed. To wit:

The illustrative tapering path was designed to be simple to communicate and entailed a gradual reduction in the pace of net asset purchases that, if begun later this year, would lead the Federal Reserve to end purchases around the middle of next year.

The path featured monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS). Participants generally commented that the illustrative path provided a straightforward and appropriate template that policymakers might follow, and a couple of participants observed that giving advance notice to the general public of a plan along these lines may reduce the risk of an adverse market reaction to a moderation in asset purchases.

While the Fed did not explicitly discuss rate hikes, as noted in our Daily Commentary, the futures market has already priced in two rate hikes next year.

Between reducing bond purchases and lifting overnight rates, the risk to investors is more than evident. As we noted in “3-Things That Will Trigger The Next Bear Market:”

“The risk of a market correction rises further when the Fed is both tapering its balance sheet and increasing the overnight lending rate.

What we now know, after more than a decade of experience, is that when the Fed starts to slow or drain its monetary liquidity, the clock starts ticking to the next corrective cycle.”

Next Bear Market, When Is The Next Bear Market? 3-Things Will Tell You

The problem for the Fed is that while they suggest they will “adjust” based on incoming data, they may well get trapped between surging inflation and a recessionary economy.

Inflation: Transient Or Persistant

As noted, the risk to the Fed is getting trapped by inflation. The hope has been that current inflationary pressures from the economic shutdown would be “temporary” or “transient” and resolved as the economy reopened. However, nearly 18-months later, with the economy booming, employment running hot, and more job openings than unemployed persons, the disruptions remain. Notably, prices are surging, particularly in the areas that affect households the most.

If inflation is running ‘hot” and employment is full, the Fed should remove monetary accommodation and hike interest rates. However, with economic growth weak, financial stability dependent on monetary interventions, and record numbers of near-bankrupt companies dependent on low-interest-rate debt, a reversal of accommodation could be disastrous.

The hope was inflation would be transient and monetary accommodations could continue unfettered. Now, as noted by St. Louis President James Bullard, this year’s surge in inflation may well persist amid a strong U.S. economy and tight labor market.

While I do think there is some probability that this will naturally dissipate over the next six months, I wouldn’t say that’s such a strong case that we can count on it,” Bullard said Thursday during a virtual discussion hosted by the Euro 50 Group.

“I would put 50% probability on the dissipation story and 50% probability on the persistent story.”

As Michael Lebowitz noted this week:

“If demand stays high, and supply lines and production remain fractured, inflation will continue to run hot. If such occurs, CEOs may decide not to invest in new production facilities where ‘persistent’ inflation becomes more likely.   

Primarily, ‘persistent’ is not ‘transitory.’ Nor is persistent in the Fed’s forecast. Persistent inflation requires the Fed to take detrimental actions to investors.

Given the oddities of the current environment, and our fiscal leaders’ carelessness, it is something we must consider.” 


In Case You Missed It


Both Bulls And Bears Have Valid Views

Given the potential for a “policy mistake” and our cautionary views, the following email question currently sums up many investors’ views.

“I really am not sure what to do. Should I raise more cash and be defensive with inflationary pressures rising, and the Fed set to taper. Or, should I just stay invested given the market seems to be doing okay?”

For investors, they have gotten caught between logical views.

From the bullish perspective:

  • The market just completed a much-needed 5% correction.
  • Short-term conditions are oversold.
  • Bullish sentiment is largely negative.
  • Earnings season should be supportive.
  • Stock buybacks are running at a record pace.
  • The seasonally strong period of the year tends to be positive for stocks.

However, those views get countered by the bearish perspective discussed last week.

  • Valuations remain elevated.
  • Inflation is proving to be sticker than expected.
  • The Fed confirmed they will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to wane.
  • Technical underpinnings remain weak.
  • Corporate profit margins will shrink due to inflationary pressures.
  • Earnings estimates will get downwardly revised keeping valuations elevated.
  • Liquidity continues to contract on a global scale
  • Consumer confidence continues to slide.

Given this backdrop, it is understandable why investors are finding reasons “not” to invest. However, as stated previously, avoiding crashes and downturns can be as costly to investment outcomes as the downturn itself.

Navigating Uncertainty In Your Portfolio

As noted above, the market has not done anything technically wrong. Longer-term, the bullish trend remains intact, the recent correction worked off much of the overbought condition, and investor sentiment is negative enough to support a short-term rally.

However, while we think a rally is likely near-term, there is considerable risk to the market as we head into 2022. Such is why we stated last week:

If you didn’t like the recent decline, you have too much risk in your portfolio. We suggest using any rally to the 50-dma next week to reduce risk and rebalance your portfolio accordingly.

So here are some guidelines to follow.

  1. Move slowly. There is no rush in making dramatic changes.
  2. If you are over-weight equities, DO NOT try and fully adjust your portfolio to your target allocation in one move. Think logically above where you want to be and use the rally to adjust to that level.
  3. Begin by selling laggards and losers. 
  4. Add to sectors, or positions, that are performing with, or outperforming the broader market.
  5. Move “stop-loss” levels up to recent lows for each position. Managing a portfolio without “stop-loss” levels is foolish.
  6. Be prepared to sell into the rally and reduce overall portfolio risk. Not every trade will always be a winner. But keeping a loser will make you a loser of both capital and opportunity. 
  7. If none of this makes any sense to you – please consider hiring someone to manage your portfolio for you. It will be worth the additional expense over the long term.

While we remain optimistic about the markets, we are also taking precautionary steps to tighten up stops, add non-correlated assets, raise some cash, and hedge risk opportunistically on any rally.



Portfolio Update

As we head into the heart of earnings seasons, we slightly increased our exposure to technology stocks while maintaining the balance of our allocations. After making additions to equities over the last couple of weeks, we are nearly fully exposed to equities, slightly overweight cash, and a tad underweight target duration in our bond holdings.

While our positioning is bullish, we remain very concerned about the market over several months. Historically, stagflationary environments do not mix well with financial markets. Such is because the combination of inflationary pressures and weaker economic growth erodes profit margins and earnings.

Furthermore, expectations heading into 2022 remain exceptionally optimistic, which leaves much room for disappointment. With liquidity getting drained, the Fed reducing monetary accommodation, and two rate hikes scheduled next year, the risk to investors remains elevated.

So, why aren’t we sitting in cash? Because our job is to take advantage of markets when a reasonable risk/reward opportunity presents itself, like now. However, we do understand there is a significant risk. Or, as Seth Klarman from Baupost Capital once stated:

“Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

We are not in the “prediction business.”

We are in the “risk management business.”

For now, we are giving the market the benefit of the doubt. However, we are keeping our positioning on a very short leash. With valuations still elevated, the technical deterioration of the market remains a primary concern.

Have a great weekend.

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” are oversold. The current reading is 68.13 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “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 70.8 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

As noted last week,

“The markets finally appeared to have bottomed this week as the debt ceiling debate got resolved until December. But, while the pressure was relieved somewhat, there is still risk heading into the end of the year.”

Such remains the case this week. While the market started weakly, it successfully retested and held the 100-dma. Such bolsters our case, with both MACD signals confirming that the “seasonally strong” period has begun. While such does not eradicate any downside risk, it does reduce the risk of a significant correction near-term.

As noted below, we continued adding to our equity exposure this week and are currently carrying nearly full allocations. While such leaves us a little uncomfortable given the Fed, valuations, and a stagflationary environment, we think the short-term benefits offset the risk.

We are watching our positions closely and have moved stops up to recent lows for all positions.

Furthermore, after increasing the duration of our bond portfolio, the recent uptick in rates provides another entry point to lengthen our duration once again. If there is a risk-off event in the market, yields will drop to 1% or less providing a nice bump in appreciation in our bond portfolio. In the meantime, we are collecting a bit of income while holding the hedge.

For now, there seems to be minimal risk in the market. However, don’t be misled. There are numerous risks we are watching that could lead us to reverse course rapidly. Our job remains to protect your capital first and foremost, but we want to capture gains when we can.

Portfolio Changes

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

*** Trading Update – Equity and Sector Models ***

“As we kick off earnings season in earnest we are increasing our technology exposure where we have been underweight previously. In the equity model, we are adding 1% to our current holdings of ADBE and initiating a 2% position in AMD due to its breakout above its recent downtrend.

In the ETF model, we are adding 3% to XLK.” – 10/14/21

Equity Model

  • Add 1% to ADBE bringing the total weight to 2.5%
  • Initiating a 2% position in AMD.

ETF Model

  • Add 3% to XLK bringing total weight to 13.5%

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

As noted last week, the market finally bounced solidly off of support and broke above the overhead resistance at the 100-dma and the 50-dma. The triggering of the underlying MACD “buy signals” suggests we have entered into the seasonally strong period of the year.

However, our weekly signals continue to suggest some caution despite the current short-term bullish improvements. There are currently several essential catalysts that could derail the market rally over the next couple of months, the most prominent of which is the Fed.

In the short term, we suggest maintaining exposures in plan portfolios and putting stored cash back to work in your selected allocation model. While we have not removed international, emerging, small and mid-cap funds from the allocation model, we suggest avoiding these areas for now and moving those allocations to domestic large-cap.

If you are close to retirement or are concerned about a pickup in volatility, there is nothing wrong with being underweight equities. However, there is likely not a lot of upside in markets heading into next year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

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

Or, let us manage it for you automatically.


401k Model Performance Analysis

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.

Have a great week!

Technical Value Scorecard Report – Week Ending 10-15-21

Relative Value Graphs

  • The S&P 500 is 0.9% higher versus last Friday, as the weakness in the first half of this week was relieved by a rally yesterday where the index closed about 1.7% higher. Most cyclical sectors outperformed the index, with energy and materials leading the way. However, financials were left behind as the 10Y Treasury yield fell almost 10 bps from its recent high to 1.54% this morning.
  • The third graph shows the strong excess returns in energy (XLE) and broad relative weakness in most other sectors over the last 35 trading days.
  • Energy moved further into overbought territory as crude oil broke above $82. As we noted last week, on a technical basis, there is little to stop crude from rising to $100, but supply could increase should OPEC deem it appropriate.
  • Small and mid-caps remain the most overbought factors, but their scores are still low enough to provide more upside. Emerging markets had a great week on a relative basis, moving from moderately oversold to slightly overbought. International markets remain oversold relative to the S&P 500 but saw a slight improvement.
  • In the upper right corner in the first graph, note the inflation vs. deflation index moved well into overbought territory. TLT moved into slightly overbought territory versus IEI from deeply oversold as we saw a flattening in the yield curve last week.

Absolute Value Graphs

  • On an absolute basis, the energy sector continues nearing overbought extremes. As we noted last week, there is still more upside, but a healthy consolidation may be in store over the coming weeks. XLV is the most oversold sector on an absolute basis after struggling to find its footing over the past few weeks.
  • Both materials and discretionary saw substantial increases in their absolute scores, while financials and transportation saw some relief from overbought conditions.
  • TIP moved into overbought territory as inflation expectations have ticked up recently, while TLT moved to fair value from moderately oversold, reflecting some relief in the 10Y Treasury yield.
  • Momentum and mid-caps are the most overbought factors, while emerging markets and international markets are the most oversold. Emerging markets saw an improvement last week but remain oversold on an absolute basis.
  • The S&P 500 is still slightly overbought on an absolute basis after an intra-week dip last week.
  • As shown in the fourth graph, all sectors are above their 200dma. Materials are over two standard deviations from its 20dma, and energy is over two standard deviations from its 50dma. Energy moved from 1.3 standard deviations above its 200dma last week to 1.8 standard deviations this week.

Users Guide

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

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

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

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)

Bulls Charge As Earnings Season Gets Underway

Yesterday, the “Bulls” gained control of the ball from the “Bears” as earnings season got underway. After a successful retest of the 100-dma, the bulls charged to the critical 50-dma resistance level. The S&P 500 remains stuck between the 50-dma and the 100-dma over the last month. However, with the “seasonally strong” period of the year underway, the bulls look like they will attempt a run to all-time highs.

There are quite a few headwinds that could still trip up the bulls, so it is worth keeping some risk controls in place. In addition, as we have noted previously, breath and participation remain weak, which historically tends to limit upside in the near term.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Empire Manufacturing, October (25.0 expected, 34.3 during prior month)
  • 8:30 a.m. ET: Retail sales, month-over-month, September (-0.2% expected, 0.7% during prior month)
  • 8:30 a.m. ET: Retail sales excluding autos and gas, month-over-month, September (0.4% expected, 1.8% during prior month)
  • 8:30 a.m. ET: Import price index, month-over-month, September (0.6% expected, -0.3% during prior month)
  • 10:00 a.m. ET: University of Michigan sentiment, October preliminary (73.5 expected, 72.8 during prior month)

Earnings

Pre-market

  • 5:45 a.m. ET: Truist Financial Corp. (TFCis expected to report adjusted earnings of $1.18 per share on revenue of $5.52 billion
  • 6:45 a.m. ET: PNC Financial Services (PNC) is expected to report adjusted earnings of $3.59 per share on revenue of $5.03 billion
  • 8:30 a.m. ET: Goldman Sachs (GS) is expected to report adjusted earnings of $9.92 per share on revenue of $11.60 billion
  • 8:45 a.m. ET: The Charles Schwab Corp. (SCHW) is expected to report adjusted earnings of 81 cents per share on revenue of $4.52 billion

Courtesy Of Yahoo

Markets Sustain Key Support, as Banks Soldier On

A Major Support Of Asset Prices Remains

With companies struggling with slower economic growth, higher input costs, and weaker consumption, the need to manufacture earnings to beat estimates remains a high priority. Therefore, it is not surprising to continue seeing companies utilize their cash hoards to buy back stock at a record pace.

As note previously, it is the corporate insiders who benefit from these activities.

It’s the insiders, of course, as changes in compensation structures since the turn of the century became heavily dependent on stock-based compensation. Insiders regularly liquidate shares that were “given” to them as part of their overall compensation structure to convert them into actual wealth. As the Financial Times recently penned:

‘Corporate executives give several reasons for stock buybacks but none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay and in the short-term buybacks drive up stock prices.

A recent report on a study by the Securities & Exchange Commission found the same:

SEC research found that many corporate executives sell significant amounts of their own shares after their companies announce stock buybacks, Yahoo Finance reports.’

What is clear, is that the misuse and abuse of share buybacks to manipulate earnings and reward insiders has become problematic.”

Jobless Claims and PPI

Initial Jobless Claims had another nice decline and now sits at +293k, the lowest level since the pandemic. The last two weekly claims reports bode well for the upcoming unemployment report. Unlike CPI, PPI was generally weaker than expectations. The headline number rose 0.5% versus +.07% last month. However, the year-over-year number was +8.6%, lower than expectations for +8.7% but above last month’s +8.3%. Core PPI, excluding food and energy, rose 6.8% on an annual basis.

$15 Billion Is The Benchmark

The latest Fed minutes show that tapering of QE purchases is likely to begin in November. It appears they will reduce purchases by $15 billion a month, which should eliminate this round of QE by July 2022. $15 billion now serves as a benchmark. Any changes to that amount will help us gauge if they are becoming more aggressive or conservative. Some members prefer a faster pace. Per the minutes- “Several participants indicated that they preferred to proceed with a more rapid moderation of purchases than described in the illustrative examples.”

Liquidity Remains Very Accommodative

Despite the Fed beginning to “taper” their balance sheet purchases, monetary accommodation remains extremely “accommodative” currently. As discussed previously in 3-Triggers Of The Next Recession,” monetary accommodation is the key to determining the start of the next recession and bear market. As shown, such is not the case currently but will become a more significant concern when the Fed begins to hike rates.

#FedGrammarMatters

We often note how the Fed uses language at times to complicate matters. Their word choice often puts their policies and forecasts beyond the grasp of many non-economics or finance professionals. Fed members use vague terminology, allowing them to be technically correct through a wide range of outcomes.

In our latest article, What Causes “Transitory” Inflation to Become “Persistent,” we write:

“Transitory is a vague term. It can mean minutes or hours. Or, it can infer years or decades. Over 400 economics Ph. D.s can not be dumb. They likely chose the word because it has no clear-cut definition.

The Fed itself supports our notion of the high-level language they use. For example, in a recent article, the Fed states:

Hernández-Murillo and Shell (2014) showed that the complexity of the language used in the FOMC statement increased towards the end of Bernanke’s tenure to a reading grade level of 20 to 21, equivalent to a least a doctoral degree level of education. The circles in Figure 2 illustrate that since then the Flesch-Kincaid grade level for the FOMC statement language gradually declined under Yellen and has averaged between grades 16-17 thus far under Chair Powell, equivalent to a bachelor’s or master’s degree level of education.

The following graph accompanies the article. In short, Fed communications remain technical. In normal times, such may not matter. However, with inflation running hot and the word stagflation used regularly, the Fed may want to simplify their language. Otherwise, they risk creating even more confusion, fear, and behaviors that foster even more inflation.

Traders Are Pushing Oil, Rates & The Dollar. Are They Right?

With inflation fears getting stoked by the mainstream media, traders are pushing oil, interest rates, and the dollar higher. Are they right? Or, are they about to get smacked by a slower economy and deflationary headwinds?

Once a quarter, I dig into the Commitment of Traders data to see where speculators are making their bets. Such is an excellent metric to watch from a contrarian view. Generally, when traders are positioned either very long or short in a particular area, it is often a good bet something will reverse.

Positioning Review

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

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

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

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

Therefore, as shown in the charts below, we can look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

Since 2012, the favorite trade of bullish speculators has been to “short the VIX.” Shorting the volatility index (VIX) remains an extraordinarily bullish and profitable trade due to the inherent leverage in options. Leverage is one of those things that works great until it doesn’t.

Currently, net shorts on the VIX are still very elevated but reduced from 2020 levels. However, speculators have once again started to increase their net short-positioning over the last several weeks as the market declined.

The current positioning is large enough to fuel a more substantial correction if markets fail current support levels. Moreover, as noted on Tuesday, weekly signals suggest that downside risk is present. To wit:

“The recent decline triggered both weekly signals for the first time since the March 2020 correction. (The chart below is the same model we use to manage 401k allocations. You can see the related models and analysis here)

Given that volatility has remained compressed during the entirety of the September correction, a break below recent support will trigger short-covering of VIX options. Such would also be coincident with a more significant decline in the index.

Crude Oil Extreme

Crude oil has gotten a lot more interesting as of late. After a brutal 2020, the price of oil futures going negative at one point, oil is now pushing above $80/bbl. Given current views of “inflation” from the massive liquidity infusions and supply chain disruptions, the focus on speculative positioning is not surprising.

As shown in the monthly chart below, the price advance in crude oil is now back to historical extremes that have previously denoted tops in oil prices. As a result, the current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

The speculative long-positioning is driving the dichotomy in crude oil by NCTs. While levels fell from previous 2018 highs during a series of oil price crashes, they remain elevated at 398,307 net-long contracts and rising quickly.

The good news is that oil did finally break above the long-term downtrend. However, it is too soon to know if these prices will “stick.” 

Furthermore, the deflationary push and the dollar rally will likely derail oil prices if it continues.

U.S. Dollar Rally Is Here

As I stated earlier this year:

“There are two significant risks to the entire ‘bull market’ thesis: interest rates and the dollar. For the bulls, the underlying rationalization for high valuations has been low inflation and rates. In February, we stated:

Given an economy that is pushing $87 trillion in debt, higher rates and inflation will have immediate and adverse effects:

  1. The Federal Reserve gets forced to begin talking tapering QE, and reducing accommodation; and,
  2. The consumer will begin to contract consumption as higher costs pass through from producers. 

Given that personal consumption expenditures comprise roughly 70% of economic growth, higher inflation and rates will quickly curtail the ‘reflation’ story.

A few months later, the Fed started to talk about tapering their balance sheet purchases.

With the market currently priced for perfection, the disappointment of economic growth caused by the rising dollar, interest rates, and a contraction in consumer spending is a significant risk to the market. As shown, the rally in the dollar is already starting to weaken the inflationary impact of higher import prices and suggests a peak in CPI.

The one thing that always trips the market is what 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. 

As noted previously,

“Whatever causes the dollar to reverse will likely bring the equity market down with it.”

The dollar has been rising very quietly, and traders are becoming more aggressively long the dollar trade.

Interest Rate Conundrum

Over the latest several years, I have repeatedly addressed why financial market “experts” remain confounded by rates failing to rise. In March 2019, I wrote: “The Bond Bull Market,” which followed our earlier calls for a sharp drop in rates as the economy slowed.

At that time, the call was a function of the extreme “net-short positioning” in bonds, which suggested a counter-trend rally was likely. Then, in March 2020, unsurprisingly, rates fell to the lowest levels in history as economic growth collapsed. Notably, while the Federal Reserve turned back on the “liquidity pumps,” juicing markets to all-time highs, bonds continue to attract money for “safety” over “risk.” 

Recently, “bond bears” have again returned, suggesting rates must rise because of inflationary concerns. However, again, such is unlikely as economic growth is quickly stalling as liquidity runs dry.

Currently, traders are more aggressively long contracts suggesting rates could still rise a bit further. However, while there is upside to rates, it is likely limited to less than 2% before economic growth gets impacted.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

Conclusion

The markets are oversold enough on a short-term basis to rally. However, numerous headwinds are mounting from higher rates, inflation, oil prices, and the dollar. So while traders are piling into inflationary trade, they are likely going to be disappointed.

While the markets can undoubtedly discount these headwinds short-term, they won’t be able to do it indefinitely. Such is why we remain concerned over the weekly and monthly “sell signals,” which are suggestive of increasing risk.

The biggest problem is that technical indicators do not distinguish between a consolidation, a correction, or an outright bear market. As such, if you ignore the signals as they occur, by the time you realize it’s a deep correction, it is too late to do much about it.

I suggest that with our “sell signals” triggered, taking some action could be beneficial. 

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

There is minimal risk in “risk management.” In the long term, the results of avoiding periods of severe capital loss will outweigh missed short-term gains.

The Fed’s FOMC Minutes Suggests Taper Will Start In November

The Fed’s FOMC minutes from the September meeting suggest the Fed will taper its asset purchases by $15 trillion a month starting in November. At that pace, the current $120 trillion of QE will get zeroed out by July. Currently, there was no timeline to raise interest rates, but over the last few weeks, Fed Funds futures have priced in greater odds of rate hikes in 2022.

For instance, the June 2022 contract now implies a 25% chance of a tightening by June. The odds were near zero in mid-September. The December 2022 contract suggests a 100% chance of a 25bps rate hike and a 50% chance of a second hike by the end of the year.

With more certainty around the Fed’s next steps, the markets are entering a new regime. Is your portfolio ready?

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Initial jobless claimsweek ended Oct. 9 (320,000 expected, 326,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Oct. 2 (2.670 million expected, 2.714 million during prior week)
  • 8:30 a.m. ET: Producer price index, month-over-month, September (0.6% expected, 0.7% during prior month)
  • 8:30 a.m. ET: PPI excluding food and energy, month-over-month, September (0.5% expected, 0.6% during prior month)
  • 8:30 a.m. ET: PPI, year-over-year, September (8.7% expected, 8.3% during prior month)
  • 8:30 a.m. ET: PPI excluding food and energy, year-over-year. September (7.1% expected, 6.7% during prior month)

Earnings

Pre-market

  • 5:55 a.m. ET: UnitedHealth Group (UNH) to report adjusted earnings of $4.39 per share on revenue of $71.13 billion
  • 6:45 a.m. ET: Bank of America (BACto report adjusted earnings of 71 cents per share on revenue of $31.74 billion
  • 6:45 a.m. ET: US Bancorp (USBto report adjusted earnings of $1.15 per share on revenue of $5.76 billion
  • 7:00 a.m. ET: Walgreens Boots Alliance (WBA) to report adjusted earnings of $1.00 per share on revenue of $33.07 billion 
  • 8:00 a.m. ET: Wells Fargo (WFCto report adjusted earnings of 97 cents per share on revenue of $18.40 billion
  • 8:10 a.m. ET: The Progressive Corp. (PGR) to report adjusted earnings of 21 cents per share on revenue of $11.96 billion
  • 7:30 a.m. ET: Morgan Stanley (MS) to report adjusted earnings of $1.69 per share on revenue. of $13.92 billion
  • 7:30 a.m. ET: Domino’s Pizza (DPZ) to report adjusted earnings of $3.11 per share on revenue of $1.04 billion
  • 8:00 a.m. ET: Citigroup (C) to report adjusted earnings of $1.79 per share on revenue of $16.93 billion 

Post-market

  • 4:10 p.m. ET: Alcoa (AA) to report adjusted earnings of $1.71 per share on revenue of $2.93 billion

Courtesy of Yahoo

Market Testing Overhead Resistance

Yesterday, the market rallied back to the 100-dma, which now acts as resistance to higher prices. However, while the market tried to climb above it during the trading day, it failed to do so. This morning, futures are pointing higher which will push the index above both the 100-dma and 20-dma. If the rally holds, such will set up an advance to the important 50-dma.

With Friday being options expiration, the volatility seen this week is not surprising. However, the good news is that the overall decline has been very orderly, with no real signs of panic. Such suggests that once the current consolidation period is behind us, we will see a modest advance into year-end.

On a longer-term basis, valuations, internal deterioration, reduction in liquidity, and slower economic growth pose serious challenges to the markets in 2022. As such, we continue to suggest a modicum of risk management currently, with a more deliberate approach to protecting capital as the calendar changes.

Will The Fed Taper Sooner and Harder?

How Do Stocks Perform Under Stagflation?

Goldman Sachs recently published some analysis showing how stocks perform under various inflationary and economic environments. The most notable is the relative performance of stocks in a “slow growth and high inflation” environment. Or, rather what is more commonly known as “stagflation.”

Everything You Need To Know On “Net Zero”

Over the next couple of decades it is expected that global governments will pursue $150 Trillion in spending (mostly derived from debt) to achieve a victory over climate change. While this is great for wealthy, the poor and middle classes will ultimately pay the price through slower economic growth and inflationary pressures. BofA produced the following graphic on where the money will go and, by extension, who will benefit.

CPI Hotter than Expected

CPI came in slightly higher than expectations. The monthly rate of price increases is 0.4%, 0.1% higher than last month. The year-over-year rate, at 5.4%, is also a tad above expectations. The core monthly and annual rates, excluding food and energy, are in line with consensus.

It is important to note that some inflation resulted from deflation or lower prices this time last year. While “base effects” are rapidly lessening, they are still in play. Per Ben Casselman of the N.Y. Times- “Base effects” — the impact of the drop in prices earlier in the pandemic — are still playing some role in lifting year-over-year inflation. If prices had kept rising at their pre-Covid rate last year, September inflation would have been 5% instead of 5.4%.”

Chaikin is Providing a Warning

The graph below shows the S&P 500 with the Chaikin Money Flow indicator below it. The indicator looks back over 20 days and multiplies the daily volume with the market closing within each day’s trading range. The multiplier is positive when the S&P closes in the upper half of a day’s trading range. Likewise, where the market closes in relation to the high or low is multiplied by the volume. Thus, high volume and a close at the high or low for the day will produce a strong signal.

Technical analysts use the indicator to help determine if institutions are accumulating or distributing. A green reading (above zero) signals accumulation as it is believed institutions tend to buy late in days. Conversely, the strength of the recent string of red days signals early strength gets followed by late-day weakness. Such is a sign of institutional distribution (selling). The Chaikin indicator has not been this profoundly negative since 2018.

“Broadening, Not Transitory”

Atlanta Fed President Bostic went where no Fed member has gone since the pandemic. He stated, “U.S. inflation is broadening, not transitory.” Such appears to be the first time a Fed member voiced concern that higher inflation is no longer transitory. If other Fed members join him in this view, it might speed up the tapering process and bring forward the date of the first rate hike.

Humorously, he started his speech with disdain for the use of “transitory” to describe the recent bout of inflation. To wit: “You’ll notice I brought a prop to the lectern. It’s a jar with the word “transitory” written on it. This has become a swear word to my staff and me over the past few months. Say “transitory,” and you have to put a dollar in the jar.”

Inflation Is On Today’s Docket As Fed Gears For Taper

Today we will get the latest reading on inflation as the Fed tapering QE in November seems to be a foregone conclusion by the markets. At this point, today’s CPI report, tomorrow’s PPI release, and other inflation data, along with continuing improvement in the labor markets are key factors for investors to watch. It is these economic stats that will help guide the Fed’s pace of reducing QE. JOLTS information, discussed below, provides more evidence the labor market is healing nicely.

Daily Market Commnetary

What To Watch Today

Economy

  • 7:00 a.m. ET: MBA Mortgage Applications, week ended Oct. 8 (-6.9% during prior week)
  • 8:30 a.m. ET: Consumer price index, month-over-month, September (0.3% expected, 0.3% during prior month)
  • 8:30 a.m. ET: CPI excluding food and energy, month-over-month, September (0.2% expected, 0.1% during prior month)
  • 8:30 a.m. ET: CPI year-over-year, September (5.3% expected, 5.3% during prior month)
  • 8:30 a.m. ET: CPI excluding food and energy, year-over-year, September (4.0% expected, 4.0% during prior month) 
  • 8:30 a.m. ET: Real Average Hourly earnings, year-over-year, September (-1.1% during prior month)
  • 8:30 a.m. ET: Real Average Weekly earnings, year-over-year, September (-1.4% during prior month)
  • 2:00 p.m. ET: FOMC meeting minutes

Earnings

  • 6:15 a.m. ET: BlackRock (BLK) is expected to report adjusted earnings of $9.39 per share on revenue of $4.84 billion
  • 7:00 a.m. ET: JPMorgan Chase (JPM) is expected to report adjusted earnings of $2.97 per share on revenue of $29.86 billion
  • 7:00 a.m. ET: First Republic Bank (FRCis expected to report adjusted earnings of $1.84 per share on revenue of $1.27 billion 
  • 8:25 a.m. ET: Delta Air Lines (DALis expected to report adjusted earnings of 17 cents per share on revenue of $8.45 billion 

Market Loses Support Yesterday On Weak Trading

Yesterday, the market traded sloppily all day eventually losing the support at the 100-dma. Such keeps the market at risk of a retest of recent lows. As noted yesterday, with weekly and monthly “sell signals” in place, a longer, and potentially deeper, correction period is possible.

If the market is going to maintain its bullish bias, it needs to hold support at the recent lows and rally back above current resistance by next week. A failure to do so, and we will likely see the recent lows taken out and a test of the 200-dma becomes a high probability event.

Some caution is advised until we get through “options expiration” this Friday.

JOLTs

Per the JOLTs report, the number of job openings fell for the first time since April. The number of openings in August was 10.43 million versus expectations of over 11 million. This may be a signal the labor market is getting better, or at least less bad, at matching workers with openings. The quits rate rose to a record 2.9% of the workforce. Typically workers quit jobs when they have confidence in finding a better, higher-paying job. Prior to Covid, the quit rate was around 2.2%.

As shown below the number of openings is still well above normal levels. The second graph below, the Beveridge Curve, highlights the anomaly. At the current unemployment rate of 5.2%, we should expect a job openings rate of about half of what it is. The million-dollar question is whether employers truly have as many job openings as advertised or are there too many unemployed workers either not trained for certain jobs or not willing to accept offered wages.

Can Markets Maintain Support?

Is The 50DMA Trying To Tell Us Something?

As we show below circled in red, the 50dma is turning lower for only the second time since the market rebounded in April of 2020. In late October and early November of last year, the 50dma turned lower for six days on a relatively steep 7.5% decline. The current market decline causing the 50dma to fall is only a 4% decline but its duration is almost twice as long as the prior one.

Used Car Prices En Fuego

After a brief rest bit, used car prices rose again in September back to all-time highs as shown in the Manheim Used Vehicle Value Index below. The accompanying report notes: “According to Cox Automotive estimates, total used vehicle sales were down 13% year-over-year in September.”  Prices rising with sales falling clearly points to a lack of supply.

Per the report: “Using a rolling seven-day estimate of used retail days’ supply based on vAuto data, we see that used retail supply peaked at 114 days on April 8, 2020. Normal used retail supply is about 44 days’ supply. It ended September at 37 days, which is below normal levels. We estimate that wholesale supply peaked at 149 days on April 9, 2020, when normal supply is 23. It ended September at 18 days.”

What Causes “Transitory” Inflation to Become “Persistent”?

What Causes “Transitory” Inflation to Become “Persistent”?

You are the CEO of Acme Widget Factory. Among your many duties is overseeing production and profit margins related to your core product, widgets. Competition in your industry is stiff, with over a half dozen widget producers.

The pandemic and recovery are throwing the widget industry for quite a loop. In the spring of 2020, there was no demand for widgets. You laid-off employees and limited production while focusing on survival. During the summer of 2020, fiscal stimulus was percolating through the economy, and demand soared. It continues at a robust pace.

Acme’s future is brighter, but as CEO, you face a new set of problems. Your factories are running at full force, as are your competitors, but demand appears insatiable. At the same time, the prices of the materials needed to make widgets keep rising. Further, new and existing workers are demanding higher wages.

The problem facing Acme’s CEO is occurring in executive suites across America. Their decisions about how to navigate through 2022 and beyond in this unprecedented period illuminates a potential source for “persistent” inflation. 

Acme Widgets

The price of widgets is up 20% in just the last year. However, demand weakens with each recent price increase. In economic speak, demand for widgets is elastic. Consumers demand fewer widgets as prices rise.  

Even with the slight reduction in demand, the industry cannot produce enough widgets. The good news is profit margins are higher than average as widget prices are rising faster than expenses.

As the CEO of Acme, you have a tough decision to make. Do you keep production capabilities as is or boost production with a new factory and more employees?

The CEO’s Transitory Dilemma

The biggest unknown you, the CEO, face in making the decision above is forecasting the future. In particular, the following questions:

  • How will widget sales be in 2023 and beyond?
  • Will input prices continue to rise?
  • Can you pass on rising costs to consumers?
  • Assuming inflation remains hot, will employees demand higher wages and more benefits?
  • If needed, can I even hire more capable employees?  

Most CEOs closely track economic activity and forecasts. Unless they are hiding under a rock, they recognize recent economic strength is primarily driven by the pandemic – specifically, the government’s massive spending and benefits programs.

CEOs, aiming to make the right decisions, must appreciate the economy’s heavy reliance on Washington in their strategic plans.

The President and Democrats are trying to keep money flowing through the economy. They are currently proposing massive spending bills. Blocking their plans is the upcoming 2022 midterm elections. Political games will make it much trickier to pass spending bills than in 2020. Democrats in office realize weak economic growth is not a winning ticket. Those Republicans, wanting their seats, also understand that.

 As CEO, we are beholden to our lobbyists to help us make decisions about Widget production. A strong economy typically results in better widget sales. As the economy continues to re-open and consumer behaviors normalize, personal consumption is likely to revert to longer-term averages unless Uncle Sam continues to be very generous to consumers.

As the CEO, we must determine if continued massive fiscal spending is likely or a one-time pandemic action.

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The Fed’s Opinion

CEOs also need to decipher what the Fed thinks of future economic growth and how they may steer policy.

Per the Fed- “The Federal Reserve Board employs just over 400 Ph.D. economists, who represent an exceptionally diverse range of interests and specific areas of expertise.”

The Fed has the greatest army of economists in the world. What they say and their economic forecasts should have a profound impact on our decisions. Unlike guessing about how Washington plans on spending money, the Fed is easier to decipher.  

Transitory

Via official policy statements and minutes, the Fed describes the recent bout of strong economic growth and inflation as “transitory.” By this, they suggest economic growth will moderate, and swelling inflation will revert to norms.

According to Merriam-Webster’s dictionary, transitory implies a short period.

Transitory is a vague term. It can mean minutes or hours or infer years or even decades. 400+ economics Ph. D.s are not dumb. They likely chose the word because it has no clear-cut definition.

Had they defined the period of excessive price and economic growth with a specific range of months, they risk being wrong. They will be technically correct with the current phrasing if inflation and growth normalize tomorrow or in two years.

The graph below from Google Trends shows the search term “transitory inflation” is popular after being largely non-searched.

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Fed Forecasts

Since the Fed is not defining transitory in terms of a specific time, we need another way to quantify their vagueness.  Fortunately, the Fed’s FOMC members periodically put out expectations for growth, inflation, and unemployment. While the results are based on the forecasts of FOMC board members, we have little doubt they represent the work of the Ph.D. army.

The three charts below show their expectations for the remainder of this year as well as 2022, 2023, and 2024. We also include their “long-run” forecast and the average from 2017-2019 for historical context.

The first graph points to economic growth normalizing in 2023. After that, they expect GDP growth to be weaker than pre-pandemic levels.

Inflation will return to near normal but run a little hotter than before the pandemic.

Fed members expect the unemployment rate to fall below the pre-pandemic average in 2022 and remain there for at least two more years.

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Transitory vs. Persistent

With our fiscal policy expectations and the opinions of over 400 Ph. D.s, we, as CEO, have a tough decision to make. Should we construct a new factory, hire workers, and boost production to meet current demand?

If the Fed is correct, the recent boost in widget sales is transitory. Further, per their expectations, future economic growth, ergo widget sales, may be weaker than pre-pandemic levels. Adding a new factory and more workers may be profitable while the boom lasts. However, doing so may result in excess capacity and too many workers in the long run. If the industry adds production capability, supply will certainly outstrip demand and reduce prices down the road.

In addition to weaker expected economic growth, we must also consider expectations for a lower unemployment rate and higher prices than were normal pre-pandemic. In theory, those conditions should result in higher wages and production costs in a few years.

As CEO, we must think in terms of at least 5-10 years. While the current outlook is good, it may also be transitory. Per the Fed forecasts, our sales and margins are likely to shrink. Boosting capacity into such an environment seems foolish.

Taking permanent steps to cure short-term needs can be a costly trap. Unless runaway fiscal spending becomes the norm.

Conclusion

As COVID spread around the globe, economies were shuttered. At the same time, governments around the world flooded consumers and some companies with unprecedented amounts of cash.

As a result of limited production and strong demand, prices soared. This is the source of current inflation.

If demand stays high, in part due to more fiscal spending and supply lines and production remain fractured, inflation will continue to run hot. If such a scenario plays out as many CEOs decide not to invest in new production facilities, “persistent” inflation becomes much more likely.  

We strip you of the CEO title. As an investor with CEO insight, you have a lot to consider. Primarily, “persistent” is not “transitory.” Nor is persistent in the Fed’s forecast. Persistent inflation requires the Fed to take detrimental actions to investors.

This is not our outlook but given the oddities of the current environment and our fiscal leaders’ carelessness, it’s one we must consider. 

Market Sell-Off Sets Up Critical Test Of Support

The market’s sell-off yesterday sets up a critical test of support at the 100-dma. Last week, the market was able to regain the 100-dma as stocks rallied off lower support. The decline yesterday left stocks touching the running moving average. It is a critical technical juncture for stocks. If stocks can hold the 100-dma, it will provide a support level stocks can build off of for a push higher to the 50-dma. A failure of that support will lead to a retest of recent lows or potentially more. With a lot of economic news and earnings releases this week, it is hard to guess where markets will head to next.

Daily Market Commnetary

What To Watch Today

Economy

  • 6:00 a.m. ET: NFIB Small Business Optimism, September (99.5 expected, 100.1 during prior month)
  • 10:00 a.m. ET: JOLTS Job Openings, August (10.954 million expected, 10.934 million during prior month)

Earnings

  • No notable reports scheduled for release

Politics

Courtesy of Yahoo

Pain In The Supply Chain

(By @marketoonist)

Oil Prices May Peak Here Soon

Crude oil has gotten a lot more interesting as of late. After a brutal 2020, the price of oil futures going negative at one point, oil is now pushing above $80/bbl. Given current views of “inflation” from the massive liquidity infusions and supply chain disruptions, the focus on speculative positioning is not surprising.

As shown in the monthly chart below, the price advance in crude oil is now back to historical extremes that have previously denoted tops in oil prices. The current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

The speculative long-positioning is driving the dichotomy in crude oil by NCTs. While levels fell from previous 2018 highs during a series of oil price crashes, they remain elevated at 398,307 net-long contracts and rising quickly.

The good news is that oil did finally break above the long-term downtrend. However, it is too soon to know if these prices will “stick,” or as the economy decelerates towards the end of the year, oil prices will decline.

Furthermore, the deflationary push and the dollar rally will likely derail oil prices if it continues.

Earnings Will Begin To Slow

As we kick off the Q3 earnings season, expectations are still for a very robust earnings season. However, given much tougher year-over-year comparisons, rising inflationary pressures, ongoing supply chain disruptions, and declining consumer confidence, there is risk to those outlooks. We expect forward estimates will start to ratchet down sharply over the next couple of quarters as slower economic growth drags on margins.

Staples Getting Historically Cheap

In last Friday’s Technical Value Scorecard in RIA Pro we discussed how cheap the consumer staples sector was getting. To wit: “However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days.

SentimentTrader follows up our work with a much longer-term view. As shown below, staples, at about 6% of the S&P 500, have the lowest weighting in the S&P 500 since the tech boom in late 1999. In the year 2000 when that bubble popped, staples (XLP) ended the year up 42%. The S&P was down 10% and the technology sector (XLK) was down over 40%.

The Real Impact of $80 Oil

A Big Week Ahead

Buckle up!  This is a big week for key economic data. The JOLTs report on Tuesday will provide more color on the labor market and specifically if job openings continue to at record levels. Wednesday features CPI and the Fed minutes from their September meeting. Given the importance of inflation to the Fed, CPI will help them further hone in on how to taper QE, in regards to amounts and timing. More inflation data follows Thursday with PPI. Retail Sales and the University of Michigan Consumer Sentiment Survey come out on Friday.

Also on tap are the 10 and 30-year Treasury auctions on Tuesday and Wednesday respectively. It will be interesting to see if demand is strong given the recent backup in yields.

If you crave more information, have no fear, earnings for the major banks start on Wednesday with JPM. Many of the largest banks follow them on Thursday. Most other companies will release earnings over the coming six weeks. Beyond earnings and revenues, investors will be paying close attention to forward guidance, in particular how inflation is affecting their bottom line.

Dividends Over Oil Production

Last Friday we wrote how oil rig counts were rising slower than is typical considering the current price of oil. Another consideration is the transition to cleaner forms of energy. As Reuters writes below, companies like Occidental are not clamoring to increase production.

(Reuters) – U.S. oil and gas producer Occidental (OXY.N) wants to raise margins and re-establish dividend payments for its shareholders rather than focus on growing its production volumes, Chief Executive Vicki A. Hollub said on Thursday.

Oil companies can best contribute to the energy transition by producing just enough oil to meet demand in a way that is more efficient and produces fewer emissions, the CEO said.

“We don’t see that in 2022 and beyond that we need to grow significantly,” Hollub said at an online event by the Energy Intelligence Forum.

“Our growth in the period, and maybe over the next ten years, will more be to reestablish dividend and grow that dividend”.

Technically Speaking: Is The Risk Of A Bigger Correction Over?

Is the risk of a more significant correction over now that the expected 5% decline is complete? That was a hotly debated question after this past weekend’s newsletter supporting the idea of a reflexive rally into year-end. As I stated:

“After a harrowing 5% decline, sentiment is now highly negative, supporting a counter-trend rally in the markets. Thus, we think there is a tradeable opportunity between now and the end of the year. But, as we will discuss below, significant headwinds continue to accrue, suggesting higher volatility in the future.

That comment sparked numerous debates over market outlooks through year-end. To wit:

So, who is right? A hard rally into the end of the year, or a major low?

While we certainly hope for the former, some risks support a further correction on both a fundamental and technical basis.

Fundamental Warnings

In Andrew’s comment, he suggests that economic growth will accelerate through the end of the year. If such is the case, that will support a pick up in earnings growth and outlooks that would bolster higher asset prices.

The problem with that view is two-fold.

In Q2 of this year, G.D.P. estimates started that quarter at 13.5% and ended at 6.5%. The third quarter started at 6% and is now tracking at 1.3%, as shown below.

As we discussed in “The Coming Reversion To The Mean,” the “second derivative” effect of economic growth is manifesting itself. To wit:

“We are at that point in the recovery cycle. Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.09/24/21

Reversion Economic Growth, The Coming “Reversion To The Mean” Of Economic Growth

When writing that blog, our estimates were for a cut in growth to 3.9%. We are currently closer to 1%.

Secondly, fourth-quarter growth will also remain under significant pressure for several reasons:

  1. Year-over-year comparisions remain challenging.
  2. Manufacturing surveys look to slow in a challenging enviroment.
  3. Employment continues to quickly revert to long-term norms.
  4. Liquidity continues to turn negative.

The last point is the most problematic. The massive surge in economic growth in 2020 was a direct function of the massive direct fiscal injections into households. With that support gone, economic growth will revert to normality, particularly in an environment where wage growth does not keep up with inflation.

Given that earnings and revenue are a function of economic growth, the most considerable risk to Andrew’s fundamental view is slower growth and valuations.

Confirmed Weekly Warnings

When discussing the market, distinguishing time frames becomes critically important. As noted in the newsletter, we suggested the market got oversold enough short-term to elicit a rally.

The rally above the 100-dma and the trigger of both M.A.C.D. “buy signals” (lower panels) are supportive of a short-term rally over the next few days to weeks.

However, the sell-off yesterday is retesting that 100-dma and will turn it into important support if it holds through the end of the week. If not, we are going to challenge the recent lows.

It is not uncommon to see such counter-trend rallies, even powerful ones, during a longer-term corrective process. Such is an important consideration given the weekly “sell signals.”

The recent decline triggered both signals for the first time since the March 2020 correction. (The chart below is the same model we use to manage 401k allocations. You can see the related models and analysis here)

Since 2006, when we developed and started publishing this “risk management model” each week, the signals continue to signal critical periods for investors to watch. Market returns have a very high correlation to the confirmed “buy” or “sell” triggers.

There are also two other important points. First, the current signals are occurring at elevations we have never witnessed previously. Secondly, the confirmed signals are happening with the market at the top of its long-term bullish trend from the 2009 lows. Thus, a correction to the bottom of that long-term bullish trend channel will encompass a nearly 30% decline without violating the bullish uptrend.

Daily Market Commnetary

Longer-Term Signals Suggest Caution

Again, even with the broader macro issues facing the market, we can not dismiss the possibility of a near-term reflexive rally. However, the monthly signals are also confirming the weekly alerts.

Monthly “sell signals” are more rate and tend to align with market corrections and bear markets. However, like the confirmed weekly signals above, the monthly “sell signal” was triggered for the first time since March 2020.

While the longer-term M.A.C.D. has not yet confirmed that monthly signal, it is worth paying close attention to. Historically, the monthly signals have proven helpful in navigating correction periods and bear markets.

Let me reiterate these longer-term signals do not negate the possibility of a counter-trend bull rally. As noted, in the short term, the market is oversold enough for such to occur.

Bullfights And Matadors

On the surface, it seems like “bull markets” are extremely difficult to kill as they keep rising despite the increasing number of warnings suggesting differently.

If you have ever witnessed a bullfight, the bull will keep charging the matador even though it has been continually impaled. However, even though the bull keeps trying to get his antagonist, it begins to slow from exhaustion and blood loss until the final blow gets dealt.

Bull markets are much the same. The advance will continue until it becomes exhausted, which is why it seems like bull markets end “slowly and then all at once.”

Currently, numerous internal technical and fundamental measures are providing warnings that investors are currently ignoring because the “bull is continuing to charge the matador.”

Such is why it is essential to align time frames with your portfolio management process.

If you are trading your portfolio with a relatively short holding period, you want to focus on hourly to daily charts. Currently, those suggest a near-term rally is possible.

However, if you employ a longer-term “buy and hold” type philosophy, you will want to pay attention to the longer-term charts. Those suggest the risk of a more substantial correction is increasing.

These longer-term signals suggest investors should be using such rallies to rebalance portfolio risks, raising some cash, adding hedges, and reducing overall portfolio volatility. Our best guess is that we are still in the midst of a short-term, sentiment (F.O.M.O.) driven bull market.

While it is entirely possible we could see the market rally back towards its previous highs before year-end, you need to decide if you want to be the “bull or the “matador” when it comes to your portfolio.

The “matador” walks out of the arena more often than not while the “bull” gets carried out.

Viking Analytics: Weekly Gamma Band Update 10/11/2021

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

Gamma Band Update

The S&P 500 (SPX) had a strong rally last Thursday and closed the week just under our calculated gamma flip level. This Friday, we have the October monthly option expiration in stocks, which has seen volatility and a pullback in and around this day over the last several months.  The gamma band model began the week with an allocation of 30% to SPX and 70% cash.   

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can conceptually be viewed as a risk along with other tools. When the daily price closes below Gamma Flip level (currently near 4,400), the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,260), the model will reduce the SPX allocation to zero. The range between Gamma Flip and the lower gamma has tightened because risk is higher.

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

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

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

 

Disclaimer

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

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

Authors

Erik Lytikainen, the founder of Viking Analytics, 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 BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. 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 5000-Year View Of Rates & The Economic Consequences

The fact we have the lowest interest rates in 5000-years is indicative of the economic challenges we face. Such was a note brought to my attention by my colleague Jeffrey Marcus of TPA Analytics:

“BofA wants you to know that ‘Interest rates haven’t been this low in 5,000-years.‘ That’s right, 5000 years. ‘In the next 5,000 years, rates will rise, but no fear on Wall Street this happens anytime soon,’ said David Jones, director of global investment strategy at Bank of America. This should not come as a shock to anyone who has been watching, given that the FED’s balance sheet is now an astonishing $8.5 trillion and that fiscal spending has caused the U.S. debt to balloon to over $28 trillion (For reference, the U.S. GDP is $22 trillion).

All of this really means that the FED and the U.S are in a tough spot. They need a lot of growth to dig out from mountains of debt, but they cannot afford for rates to move too high or debt service will become an issue.

Yes, rates will probably rise at some point in the next 5000-years. However, currently, the primary argument is that rates must increase because they are so low.

That argument fails in understanding that low rates are emblematic of weak economic growth rates, deflationary pressures, and demographic trends. 

Short-Term Rate Rise Can’t Last

In recent weeks, interest rates rose sharply over concerns of a debt-ceiling default and inflationary fears. But, as Mish Shedlock noted, five factors are spooking the bond market.

  1. Debt Ceiling Battle: Short Term, Low Impact
  2. Supply Chain Disruptions: Medium Term, Medium Impact
  3. Trade Deficit: Long Term, Low-to-Medium Impact
  4. Biden’s Build Back Better Spending Plans: Long Term, High Impact
  5. Wage Spiral: Long Term, High Impact

“I said early on that if Progressives get their way on spending plans, especially their demands to have 80% clean energy by 2030 it would set off a bout of stagflation. The rise in bond yields and a slowing economy are now linked.” – Mish Shedlock

He is correct. The problem, however, between today, and the 1970s, is the massive debt and leverage levels in the U.S. economy. Thus, any significant rise in rates almost immediately leads to recessionary spats in the economy.

A Long History Of Rates & Economic Growth

The chart below shows a VERY long view of interest rates in the U.S. (equivalent rates to the Federal Funds Rate and 10-year Treasury) since 1854.

Interest rates are a function of the general trend of economic growth and inflation. More robust rates of growth and inflation allow for higher borrowing costs to be charged within the economy. Such is why bonds can’t be overvalued. To wit:

“Unlike stocks, bonds have a finite value. At maturity, the principal gets returned to the lender along with the final interest payment. Therefore, bond buyers are very aware of the price they pay today for the return they will get tomorrow. As opposed to an equity buyer taking on investment risk, a bond buyer is loaning money to another entity for a specific period. Therefore, the interest rate takes into account several substantial risks:”

  • Default risk
  • Rate risk
  • Inflation risk
  • Opportunity risk
  • Economic growth risk

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.) “

What Caused Rates To Rise Previously

Interest rates rose during three previous periods in history. During the economic/inflationary spike in the early 1860s and again during the “Golden Age” from 1900-1929. The most recent period was during the prolonged manufacturing cycle in the 1950s and 60s. That cycle followed the end of WWII where the U.S. was the global manufacturing epicenter.

However, notice that while interest rates fell during the depression era, economic growth and inflationary pressures remained robust. Such was due to the very lopsided nature of the economy at that time. Much like the current economic cycle, the wealthy prospered while the middle class suffered. Therefore, money did not flow through the system leading to a decline in monetary velocity.

Currently, the economy once again is bifurcated. The upper 10% of the economy is doing well, while the lower 90% remain affected by high joblessness, stagnant wage growth, and low demand for credit. Moreover, for only the second time in history, short-term rates are at zero, and monetary velocity is non-existent.

The difference is that during the “Great Depression,” economic growth and inflationary pressures were at some of the highest levels in history. Today, the economy struggles at a 2% growth rate with inflationary pressures detracting from consumptive spending. 

Low Rates Can Last A Long Time

Interest rates are ultimately a reflection of economic growth, inflation, and monetary velocity. Therefore, given the globe is awash in deflation, caused by weak economic output and exceedingly low levels of monetary velocity, there is no pressure to push rates sustainably higher. The dashed black line is the median interest rate during the entire period.

(Note: Notice that a period of sustained low interest rates below the long-term median averaged roughly 40 years during both previous periods. We are only currently 10-years into the current secular period of sub-median interest rates.)

The following chart overlays the 10-year average economic growth rate. As you will notice, and as discussed above, rates rise in conjunction with more substantial levels of economic growth. Such is because more substantial growth leads to higher wages and inflation causing rates to rise accordingly.

Today, the U.S. is no longer the manufacturing epicenter of the world.  Labor and capital flow to the lowest cost providers to effectively export inflation from the U.S., and deflation gets imported. Technology and productivity gains ultimately suppress labor and wage growth rates over time. The chart below shows this dynamic change which began in 1980. A surge in debt was the offset between lower economic growth rates and incomes to maintain the “American lifestyle.”

A Demographic Challenge

The chart below shows both the long-view of real, inflation-adjusted, annual GDP growth and on a per-capita basis. I have also included the annual growth rates of the U.S. population. [Data Source: MeasuringWorth.com]

There are some interesting differences between the “Great Depression” and the “Great Recession.” During the depression, the economy grew at 13% and 18% on an annualized basis. Today, the current economic cycle of 2.5% and 2.7%. What plagued the economic system during the depression was the actual loss of wealth following the “Crash of 1929” as a rash of banks went bankrupt, leaving depositors penniless, unemployment soaring, and consumption drained. While the government tried to assist, it was too little, too late. The real depression, however, was not a statistical economic event but rather an absolute disaster for “Main Street.”

During the current period, real economic growth remains lackluster. In addition, real unemployment remains high, with millions of individuals simply no longer counted or resorting to part-time work to make ends meet. Finally, with more than 100-million Americans on some form of government assistance, the pressure on “Main Street” remains.

One crucial difference is the rate of population growth which, as opposed to the depression era, has been on a steady and consistent decline since the 1950s. This decline in population growth and fertility rates will potentially lead to further economic complications as the “baby boomer” generation migrates into retirement and becomes a net drag on financial infrastructure.

Today, despite trillions of dollars of interventions, zero interest rates, and numerous bailouts, the economy has yet to gain any real traction, particularly on “Main Street.” 

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

The End Of The Bond Bubble

The problem with most forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American’s participation in the domestic economy. Interest rates, however, are an entirely different matter.

While there is not much downside left for interest rates to fall in the current environment, there is not a tremendous amount of room for increases. Moreover, since interest rates affect “payments,” increases in rates quickly negatively impact consumption, housing, and investment.

Will the “bond bull” market eventually come to an end?  Yes, eventually. However, the catalysts needed to create the economic growth required to drive interest rates substantially higher, as we saw previous to 1980, are not available today. Such will be the case for decades to come. The Fed has yet to conclude we are caught in a “liquidity trap” along with the bulk of developed countries.

Over the following 5000-years, rates will eventually rise. But for now, I am long bonds and continue to buy more whenever someone claims the “Great Bond Bull Market Is Dead.”

Market Futures Sink As Oil Breaks Above $80

This morning market futures are pointing lower as oil breaks above $80 and bond yields rise. Furthermore, investors need to fasten their seat belts, for a busy week full of economic data, Fed minutes, and corporate earnings. The market gets a rest from data today due to the Columbus day holiday. Between CPI, PPI, Retail Sales, and JOLTs, all set for release this week, the Fed will have a new round of data to guide their tapering decision. Expect more tug of war in the markets as investors deal with new data.

Daily Market Commnetary

What To Watch Today

Economy

  • No notable reports scheduled for release

Earnings

  • No notable reports scheduled for release

Politics

  • The U.S. House of Representatives and Senate are both out of session until Oct. 18.
  • The World Bank Group and the International Monetary Fund (IMF) kick off their annual meetings in Washington D.C. They will release the World Economic Outlook tomorrow morning.

Courtesy of Yahoo

Oil Breaks Above Key Resistance

This morning oil futures are pointing significantly higher with oil breaking above key resistance levels going back to 2009. While oil is very overbought, and a very overcrowded trade, at the moment, such does not mean prices can’t surge higher given the bottlenecks in the system. There is a good bit of overhead resistance as oil prices move into the $90-$100 range, and the bigger issue becomes the inflationary backlash of higher prices on consumption and economic growth.

Stock Futures Are Lower To Start The Week

“Stock futures were slightly lower on Monday to start the week as traders eyed surging energy prices and the start of earnings season around the corner.

Dow Jones Industrial average futures fell 107 points, 0.3%. S&P 500 futures lost 0.5% and Nasdaq 100 futures shed 0.7%. The Dow is coming off its best week since June.” – CNBC

As noted in “Is The Great Bear Market Of 2021 Over?” We need to see some follow through buying this week in markets to confirm the break above resistance last week. If we fall back below the 100-dma, stocks will retest recent lows. The risk is that continued failures to advance will lead to a break of support and a deeper correction will ensue.

Great Bear Market 10-08-21, Is The Great “Bear Market” Of 2021 Finally Over? 10-08-21

GDP Revised Down As Expected.

Futures also took a hit as Goldman Sachs cut its economic growth forecast. Goldman cut its 2022 growth estimate to 4% from 4.4% and took its 2021 estimate down a tick to 5.6% from 5.7%. The firm cited the expiration of fiscal support from Congress and a slower-than-expected recovery consumer spending, specifically services.” – CNBC

Such is not a surprise and is a function of the “second derivative” effect we have discussed since the beginning of this year.

In Q2 of this year, G.D.P. estimates started that quarter at 13.5% and ended at 6.5%. The third quarter started at 6% and is now tracking at 1.3%, as shown below.

As we discussed in “The Coming Reversion To The Mean,” the “second derivative” effect of economic growth is manifesting itself. To wit:

“We are at that point in the recovery cycle. Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.09/24/21

Reversion Economic Growth, The Coming “Reversion To The Mean” Of Economic Growth

When writing that blog, our estimates were for a cut in growth to 3.9%. We are currently closer to 1%.

Secondly, fourth-quarter growth will also remain under significant pressure for several reasons:

  1. Year-over-year comparisions remain challenging.
  2. Manufacturing surveys look to slow in a challenging enviroment.
  3. Employment continues to quickly revert to long-term norms.
  4. Liquidity continues to turn negative.

The last point is the most problematic. The massive surge in economic growth in 2020 was a direct function of the massive direct fiscal injections into households. With that support gone, economic growth will revert to normality, particularly in an environment where wage growth does not keep up with inflation.

Payrolls Report

The BLS Jobs report was weaker than expected, with job growth of 194k. Expectations were for a gain of between 475k and 500k jobs. The BLS revised the prior month higher to 366k from 235k. The unemployment rate did fall from 5.1 to 4.8%, however, it was in part due to people dropping out of the workforce. 183k people left the workforce causing the participation rate to fall from 61.7 to 61.6%. With the number of job openings so high and jobless benefits ending we find it surprising people are leaving the workforce. Also interesting was temporary help fell slightly. With so many job openings one would expect many companies to hire temporary workers to fill gaps until they can hire permanent workers. The graph below from True Insights shows payroll growth is starting to fall back in line with pre-pandemic rates of 150-200k per month.

The Danger of Fighting the “Last War”

Bill Dudley, President of the New York Fed from 2009 to 2018, in a Bloomberg editorial, voices concern the Fed is too worried about deflation, or as he says, the “last war.”  He argues the Fed should be concerned inflationary pressures are more than transitory. He prefers the Fed take on a more hawkish tack sooner rather than later. Per Dudley:

This dovishness increases the risk of a major policy error. If the economic outlook evolves in unexpected ways, Fed officials will almost certainly be slow to respond. Hence, if inflation proves more persistent than anticipated and even accelerates as the economy pushes beyond full employment, they’ll have to tighten much more aggressively than they expect.

A faster pace of tightening would come as a shock for financial markets and could risk tipping the economy back into recession. That’s the danger of fighting the wrong war.

Oil Prices and Rig Counts

The graph below compares oil prices to rig counts. After falling to recent lows, rig counts are rising. However, they are still well less than should be expected given current oil prices. Why are oil producers not adding rigs and producing more oil to take advantage of higher prices? There are a few reasons.

First, OPEC is increasing production and will get more aggressive if prices keep rising. Second, oil producers realize the current economic boom and spike in economic activity, and demand for oil is temporary. It is the result of short-term fiscal stimulus and economic normalization. Lastly, President Biden is threatening to release oil from the strategic oil reserves. If the government indiscriminately caps the price of oil via rhetoric and action, the incentive to produce and add rigs is lessened.

Is The Great “Bear Market” Of 2021 Finally Over?

In this 10-08-21 issue of “Is The Great ‘Bear Market’ Of 2021 Finally Over.?

  • Is The “Great Bear Market” Finally Over?
  • Debt Ceiling Resolution Is Only Temporary
  • Odds Are We’ve Seen The Highs For The Year
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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


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Schedule your “FREE” portfolio review today.


Is The Great “Bear Market” Finally Over?

In last week’s newsletter, we stated:

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

Chart updated through Friday

Notably, the very short-term moving average convergence divergence (MACD) indicator (lower panel) did trigger this past week. With markets not yet back to extremely overbought territory, and sentiment still very negative, the bulls are trying to reclaim the 50-dma.

Our seasonal MACD indicator (next to the bottom panel) also triggered, but just barely. We need to see some follow-through buying action next week.

Money Flow Buy Signal Also Positive

The RIAPRO Money Flow indicator also triggered a buy signal, becoming more robust support for a short-term rally this past week.

So, do all these signals mean the “Great Bear Market Of 2021” is behind us?

After a harrowing 5% decline, sentiment is now highly negative, supporting a counter-trend rally in the markets. Thus, we think there is a tradeable opportunity between now and the end of the year. But, as we will discuss below, significant headwinds continue to accrue, suggesting higher volatility in the future.

I want to reiterate our conclusion from last week:

If you didn’t like the recent decline, you have too much risk in your portfolio. We suggest using any rally to the 50-dma next week to reduce risk and rebalance your portfolio accordingly.

While the end of the year tends to be stronger, there is no guarantee such will be the case. Once the market “proves” it is back on a bullish trend, you can always increase exposures as needed. If it fails, you won’t get forced into selling.

That advice remains apropos this week as well. The biggest mistake investors make is allowing emotion to dominate their investment decision-making process. Such is why “buy and hold” investing is appealing during a bull market because it removes decisions from portfolio management.

However, as we discussed this past week in “The Best Way To Invest.”

“Buy and hold” strategies are the “best way” to invest until they aren’t.



The Debt Ceiling Non-Crisis

As discussed in the “Debt Ceiling Non-Crisis,” the hyperbole surrounding the debt limit was on full display, culminating with this tweet from Bernie Sanders:

While “Ole’ Bernie” is trying to coerce his counterparts to raise the debt limit, his statement is full of misinformation to scare individuals. As noted in our article:

“In 1980, that all changed, and seven administrations and four decades later, Government debt surged, deficits exploded, and the debt ceiling rose 78 times. (49 times under Republicans and 29 times under Democrats.)

As Congress lifts the debt ceiling for the 79th time, the runaway spending and deficit increases continue to accelerate. The consequence of increasing debts and deficits is evident in the declining economic growth rates over the past 40-years.”

Debt Ceiling Rates, The Debt Ceiling Non-Crisis & Why Rates Will Fall.

In other words, this isn’t about paying bills from the Trump Administration, but also every President before him back to Ronald Reagan. For each year that we amass more enormous debts and deficits, the interest payments increase along with the growing burden of “mandatory spending.”

The problem today, as discussed in the “Insecurity Of Social Security,”

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

Social Security Insecurity, #MacroView: The Insecurity Of Social Security

In 2019, 75% of all expenditures went to social welfare and interest on the debt. Those payments required $3.3 Trillion of the $3.5 Trillion (or 95%) of the total revenue collected. Given the decline in economic activity during 2020, those numbers become markedly worse. For the first time in U.S. history, the Federal Government will have to issue debt to cover the mandatory spending.

Only A Temporary Fix

Think about that for a moment. In 2021, we will spend more on our “mandatory spending” than “revenue” will cover. Such means the Government will continue to go further into debt every year just to run the country. On top of the required spending, our politicians now want to add another $5 trillion in debt for “infrastructure.”

See the problem here.

The “debt ceiling” was always a “non-crisis.” It was just political brinksmanship playing out on national television. The resolution, as expected, came last week with Senate Minority Leader, Mitch McConnell, proposing a debt limit ceiling lift to $29 trillion. Such will fund the government through December.

“Senate leaders reached a bipartisan agreement Wednesday to defuse the impending debt limit crisis by allowing for a short-term increase in the statutory borrowing cap while lawmakers negotiate a longer-term solution.

Democrats said they would agree to an offer from Minority Leader Mitch McConnell that would pave the way for an increase in the debt limit into December. But the two parties still disagreed on any long-term strategy.” – Roll Call

While raising the debt ceiling may look like a victory for the Democrats, it may not be.

“While raising the debt ceiling just once is proving to be a challenge, the only thing worse would be having to vote to raise it twice

From a political perspective, the only thing less attractive than voting to raise the debt limit to $31 trillion is voting to raise it to $29 trillion and then voting a second time to raise it to $31 trillion’” – Zerohedge


In Case You Missed It


Odds Increasing We’ve Seen The Highs For This Year

There are reasons to be optimistic as we head into the seasonally strong period of the year. However, while the seasonal and technical backdrop is improving short term, we should not dismiss the numerous headwinds.

  • Valuations remain elevated.
  • Inflation is proving to be sticker than expected.
  • The Fed will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to wane.
  • Corporate profit margins will shrink due to inflationary pressures.
  • Earnings estimates will get downwardly revised keeping valuations elevated.
  • Liquidity continues to contract on a global scale
  • Consumer confidence continues to slide.

While none of these independently suggest a significant correction is imminent, they will limit the market’s advance making new highs less attainable. Furthermore, given the “debt crisis” will return in December, the risk of volatility remains elevated.

Much of the mainstream media overlooks the rapid decline in liquidity that supported the market over the last year. While the “human infrastructure” bill will provide some support, the difference is the spending is spread out over 10-years versus the “checks to households” in 2020.

Furthermore, that liquidity drain is rapidly deteriorating the outlook for economic growth. Here is the latest report from the Atlanta Federal Reserve:

“The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2021 is 1.3 percent on October 5, down from 2.3 percent on October 1.

As BCA Research shows, as we head into the last quarter of the year and 2022, the slower economic growth rates will coincide with corporations’ weaker revenue and earnings growth.

As noted, with valuations already elevated, a reversal in earnings growth will likely limit a stronger advance.



Portfolio Update

We discussed last week that after taking profits in August and raising cash, we slowly started adding back into our equity holdings. The recent spike in bond yields also allowed us to increase the duration of our bond portfolio this week.

We continued that process early this week, adding additional exposures and rebalancing portfolio risk by reducing laggards.

We are now at target weight in our equities, slightly overweight in cash, and our duration is somewhat shorter than our benchmark. As noted above, while we are looking for a market recovery through year-end, we are keeping a slightly cautious positioning bias to our models. If we are wrong and the market breaks vital support levels, we will reverse our positioning.

For now, we are giving the market the benefit of the doubt. However, we are keeping our positioning on a very short leash. With valuations still elevated, the technical deterioration of the market remains a primary concern. Such was a point we made in our Daily Market Commentary this week:

On RIAPRO, we provide the sentiment and technical measures we follow. The number of oversold stocks is back towards extremes, which supports the idea of a short-term rally.”

manic monday, Will Stocks Bounce After a Manic Monday

“However, the overall “breadth” and “participation” of the market remains highly bearish. Thus, to avoid a deeper correction, breadth must improve.

manic monday, Will Stocks Bounce After a Manic Monday

We are watching these technical measures very closely as they will dictate our next course of action.

Have a great weekend.

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” are oversold. The current reading is 51.27 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “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 64.2 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

The markets finally appeared to have bottomed this week as the debt ceiling debate got resolved until December. But, while the pressure was relieved somewhat, there is still risk heading into the end of the year.

Nonetheless, our job is to make money when we can while maintaining our discipline of risk controls. As noted below, we made a couple of minor additions to our portfolios this week and reduced areas that broke through technical supports and our stop levels.

We are now at target weight in our equities, slightly overweight in cash, and our duration is somewhat shorter than our benchmark. As noted above, while we are looking for a market recovery through year-end, we are keeping a slightly cautious positioning bias to our models. If we are wrong and the market breaks vital support levels, we will reverse our positioning.

We continue to be mindful of the risk exposure the portfolio has currently, but we are also entering into the seasonally strong period of the year. With a much-needed correction now behind us, we don’t want to get too conservative just yet, particularly as global money flows remain exceptionally strong currently. Furthermore, as we head into Q3 earnings season, corporations are now on a “buyback spree” that supports stocks.

We continue to monitor our portfolios closely. However, if you have any questions, do not hesitate to contact us.

Portfolio Changes

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

*** Trading Update – Equity and Sector Models ***

“This morning we added 1% to COST and PG. We also bought a new 1% position in WM.  WM allows us to increase exposure to industrials without taking on China’s risk, as many industrials have.” – 10-07-21

Equity Model

  • Add 1% to COST bringing the total weight to 2.5% of the portfolio.
  • Adding 1% to PG bringing the total weight to 2% of the portfolio.
  • Initiating a 1% position in WM.

We just reduced our exposure in both portfolios slightly in part because of recent volatility and what we view as a poor risk/reward skew.

In the Equity model, we sold the entire position in UPS. It broke through key technical support and is trading poorly. FDX recently had poor earnings and UPS will likely follow suit when they report on October 26th. We also sold the entire stake of IYT in the ETF model as well.

We also cut JNJ to 1.5% from 2.5%. It has also broken through key technical support, but we like the fundamental story longer-term. We will look for an opportunity to add back into the position once it strengthens technically.” – 10-06-21

Equity Model

  • Sell 100% of UPS
  • Reduce JNJ from 2.5% to 1.5% of the portfolio.

ETF Model

  • Sell 100% of IYT

“We added 1% of XLP to the sector model. It is turning up on a buy signal from a very oversold condition. The inflationary impulse is likely to fade or at least take a break, arguing for sectors like staples, technology, and healthcare should begin to perform better.” – 10-08-21

ETF Model

  • Add 1% of the portfolio to XLP increasing weight to 5% of the portfolio.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

This past week, the markets finally bounced solidly off of support and above the 100-dma. With the markets approaching the “seasonally strong” period of the year, we are looking for our MACD signals to confirm our current positioning. As noted in this week’s newsletter, we may have seen the highs for this year, and 2022 may well see an increase in volatility.

As noted last week:

“With the correction complete, and markets very oversold short-term, portfolio allocations can remain at current levels. Cash that accumulated over the past few weeks can now get deployed to allocations. Also, rebalance your bonds back to weightings after the recent rise in rates.”

That remains the case again this week. Importantly, continue to remain overweight large-cap domestic stocks and vastly underweight international, emerging markets, small and mid-capitalization stocks. Inflationary pressures will hit those areas the hardest in the future.

There is no need to be aggressive here. There is likely not a lot of upside between now and the end of the year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

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

Or, let us manage it for you automatically.


401k Model Performance Analysis

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.

Have a great week!

Technical Value Scorecard Report – Week Ending 10-08-21

Relative Value Graphs

  • The S&P 500 is about 1% higher versus last Friday, as the selloffs from earlier in the week were bought vigorously over the previous two days. Energy continues to lead the way, beating the S&P by nearly 1%. Other cyclical sectors outperformed as well, including Industrials, materials, and financials. Transportations stocks were the odd sector out as higher energy prices and poor earnings from FedEx held the sector back.
  • The third graph shows the strong excess returns in energy (XLE) and broad relative weakness in most other sectors over the last 35 trading days.
  • Energy and financials are overbought but still have some room to run, as we noted last week. Crude oil is close to breaking above $80 a barrel. On a technical basis, there is little above $80 to stop it from rising to $100. However, OPEC may increase production and/or Biden release strategic reserves if higher prices occur.
  • Small and mid-caps are among the most overbought sectors but still at scores low enough to provide more upside. International markets, developed and emerging, maintain oversold scores. Given recent dollar strength, the trends may continue.
  • In the upper right corner in the first graph, note the inflation vs. deflation index and TIPs vs. TLT are both overbought. This corresponds with the leading sectors benefiting from another inflationary impulse.

Absolute Value Graphs

  • On an absolute basis, the energy sector is nearing overbought extremes. As we noted earlier, there is still more upside, but a healthy consolidation may be in store over the coming weeks. Staples have the worst absolute score. This sector is feeling the pressure of rising prices, and at this point, it is not clear if they can pass them on to consumers.
  • Discretionary, financials, industrials, and materials all had big jumps in their absolute scores. In the case of industrials and materials, they are now at fair value.
  • All bonds are oversold but not quite to the degree that would warn a rally is in store. Similar theme as we discussed earlier, bond yields are rising, prices falling due to a renewed inflationary scare.
  • Most factors are near fair value. RSP, the equal-weighted S&P 500, is the most overbought, and the NASDAQ is the most oversold. Quite the reversal from a few weeks ago!
  • The S&P 500 is back to slightly overbought but still well below its average score from the prior year.
  • As shown in the fourth graph, all sectors are above their 200dma, except for staples, which is slightly below it. However, staples are nearly three standard deviations below its 50dma, arguing for a bounce in the coming days. Conversely, energy is over two standard deviations above its 50dma, but only 1.3 above its 200dma. As we noted earlier, a consolidation is likely, but more upside would not be surprising. The NASDAQ is two standard deviations below its 50dma, arguing for a bounce, similar to staples.

Users Guide

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

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

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

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)

The Bulls Have The Ball And Are Running For The 50-dma

After Wednesday’s impressive rebound the bulls are regaining confidence and attempted a run for the 50-dma yesterday. With control back in their hands, the first big test will be getting the ball past the 50-dma for an attempt at the “end zone” of all-time highs. The bears will likely set us a strong defensive front at the 50-dma, leading to a battle royale for market control in the coming days. Today’s BLS unemployment report may play a big role in picking the winner of this battle.

This morning futures are flattish (at the time of this writing) as we await the employment report at 7:30 am this morning. Will the report be strong enough to cement the Fed’s “taper” decision in November? Or, will a weak report potentially put a pause on the reduction of liquidity? For the markets, this could be bad news is good news if a poor jobs report keeps the “punch bowl” full.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Change in non-farm payrolls, September (500,000 expected, 235,000 in August)
  • 8:30 a.m. ET: Unemployment rate, September (5.1% expected, 5.2% in August)
  • 8:30 a.m. ET: Average hourly earnings, month-over-month, September (0.4% expected, 0.6% in August)
  • 8:30 a.m. ET: Average hourly earnings, year-over-year, September (4.6% expected, 4.3% in August)
  • 8:30 a.m. ET: Labor force participation rate, September (61.7% in August)
  • 10:00 a.m. ET: Wholesale inventories, month-over-month, August final (1.2% expected, 1.2% in prior estimate)

Earnings

  • No notable reports scheduled for release

Politics

Courtesy of Yahoo

A Run For The 50-dma

As noted, the market cleared the all-important hurdle of the 100-dma resistance level yesterday and made an initial attempt at the 50-dma. However, such proved to be “too far, too fast” for the bulls. The key is with the markets not yet overbought, and the MACD signal still on a sell signal, but improving, that the 100-dma holds and becomes support.

With earnings season approaching, the bulls have their work cut out for them. Risk is elevated, so we still consider this rally a counter-trend bounce until the 50-dma is taken out.

The concerns over the next several months are several.

  1. Economic growth is slowing fast.
  2. Earnings and revenue are tied to economic growth which puts equities at risk.
  3. The fiscal drag is become much more prevalent.

“Inflation” is Coming Next Week

The graph below, courtesy of the Market Ear, shows how mentions of inflation are a hot topic for earnings calls. As we gear up for another round of earnings releases starting in earnest next week, there is little doubt the number of “inflation” mentions will increase further. The question facing shareholders is how well can companies deal with inflation? Can they take advantage of higher prices or will they negatively impact profit margins? Each company and industry has different factors to consider that will help answer those questions.

From a macro perspective, we will also learn a  good deal about expectations for continued inflation in the coming quarters. The Fed speaks with executives at many large companies, so this information will also help us better assess our outlook on the potential pace at which the Fed tapers QE.

Jobless Claims

Following yesterday’s strong ADP report, the labor market showed more improvement.  Weekly Initial Jobless Claims fell back toward a post-covid low of 326K. This was below expectations of 348k and well below last week’s 364k.

Market Rise On Debt Ceiling Increase

St. Louis Fed Expects an Ugly Jobs Report While JPM is Optimistic

Per Market News (MNI), the St. Louis Federal Reserve expects to see an 818k decline in tomorrow’s BLS payrolls report. St. Louis Fed economist Max Dvorkin states: “There’s still “a lot of uncertainty around these figures,” but the model has tracked actual CPS employment “quite well” through the summer, he said.” He blames the recent uptick in Covid cases and the impact on global supply lines. The current forecast is for a gain of 410k jobs. If the Fed’s forecast is proven correct the Fed might delay what appears to be a tapering announcement in early November.

On the other hand, JP Morgan is optimistic “we are looking for a 575,000 gain in jobs and a drop in the US unemployment rate to 5%. The driver for an above-consensus forecast is the expected rebound in the leisure and hospitality sectors.”

Our expectations are roughly in line with JPM in that we will see a seasonal adjustment boost to the employment report which could make it look stronger than reality.

Retail Inventories are Low

Price pressures, especially on retail goods, will likely continue into the holiday season. The graph below shows the ratio of Retailers’ inventories to sales is at a 25+ year low and well below pre-pandemic levels. Given there appears to be little let-up in supply line problems, it’s becoming increasingly probably that many retailers will not be able to fully stock their shelves to meet the heavy demand for Christmas presents. With, the limited inventory we suspect many stores, both online and brick and mortar, will be able to raise prices over the next few months.

Why We Aren’t Repeating The Roaring 20’s Analog

No. We are not repeating the “Roaring 20’s” analog. Ben Carlson had a recent post asking if the “Roaring 20’s” are already here? As his chart shows below, there are certainly some similarities between 1920 and 2020 given the recent “pandemic shutdown” driven recession.

However, what Ben missed were the differences both economically and fundamentally between the two periods. 

Let me preface this article by stating that I don’t like market analogies, particularly when they are with early market eras like the ’20s. The population of the country was vastly smaller, the financial markets were rudimentary at best, there were few big players in the markets, and the flow of information was slow.

1920 Was The Bottom

Ben makes an important observation to start his post.

“Yet coming out of that awful period, America experienced an unprecedented boom time the likes of which this country had never seen before.  

The 1920s ushered in the automobile, the airplane, the radio, the assembly line, the refrigerator, electric razor, washing machine, jukebox, television and more. There was a massive stock market boom and explosion of spending by consumers the likes of which were unrivaled at the time. After the immense pressure of the Great War, many people simply wanted to have fun and spend money.”

Ben is correct, the ’20s marked the start of a period of marvel and rapid change. However, his chart above misses some important events starting in 1900 leading to 20-years of negative returns.

  • Panic of 1907
  • Recession in 1910-1911
  • Recession in 1913-1914
  • Bank Crash of 1914
  • World War I ran from 1914-1918
  • Spanish Flu Pandemic 1918-1919
  • Economic Depression in 1920-1921

The market “melt-up” was undoubtedly driven by an economic recovery, a surge in innovation, etc. but was supported by historically low valuations. (Current valuations align with 1929 more than 1920.)

The innovations in the early 1900s put increasing numbers of people to work. The increases in jobs led to higher wages and more robust economic growth. Today, companies are spending money on innovation and technology to increase productivity, reduce employment, and suppress wage pressures.

The history of the economy and related events shows the difference between then and now.

As Ben notes:

“But that’s why people in the 1920s were so joyous — they went to hell and back before the boom times.”

Yes, the U.S. certainly went through a tough year in 2020. But such is far different than what was experienced in the early 1900s. There are also fundamental challenges that exist today.

Daily Market Commnetary

Valuations Do Matter

“Frederick Lewis Allen once wrote, ‘Prosperity is more than an economic condition: it is a state of mind.’ Yet the current boom isn’t just a happiness survey. The numbers back me up here.

The S&P 500 has now hit 58 new all-times since the pandemic bear market ended in March 2020. Housing prices are at all-time highs. People have more equity in their homes than ever before. Wages are rising at the fastest pace in years. Economic growth is going to be at the highest level in decades in 2021.

Add it all up and the net worth of all American households is at all-time highs. But this time it’s not just the top 1% who is benefitting.” – Ben Carlson

Again, Ben is correct, however comparing the recent liquidity-driven stock market mania to that of the 1920s is not exactly apples to apples. 

In the short term, a period of one year or less, political, fundamental, and economic data has very little influence over the market.

In other words, in the very short term, “price is the only thing that matters.” 

Price measures the current “psychology” of the “herd” and is the clearest representation of the behavioral dynamics of the living organism we call “the market.”

But in the long-term, fundamentals are the only thing that matters. Both charts below compare 10- and 20-year forward total real returns to the margin-adjusted CAPE ratio.

Both charts suggest that forward returns over the next one to two decades will be somewhere between 0-3%.

There are two crucial things you should take away from the chart above with respect to the 1920’s analogy:

  1. Market returns are best when coming from periods of low valuations; and,
  2. Markets have a strong tendency to revert to their average performance over time.

Wash, Rinse, & Repeat

As noted, the flood of liquidity, and accommodative actions, from global Central Banks, has lulled investors into a state of complacency rarely seen historically. However, while market analysts continue to come up with a variety of rationalizations to justify high valuations, none of them hold up under real scrutiny. The problem is the Central Bank interventions boost asset prices in the short-term; in the long-term, there is an inherently negative impact on economic growth. As such, it leads to the repetitive cycle of monetary policy.

  1. Using monetary policy to drag forward future consumption leaves a larger void in the future that must be continuously refilled.
  2. Monetary policy does not create self-sustaining economic growth and therefore requires ever-larger amounts of monetary policy to maintain the same level of activity.
  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, wealth effect diminishes, and real wealth is 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.

The stock market has returned more than 198% since the 2007 peak, which is more than 3.9x the growth in corporate sales and 8x more than GDP.

Monetary Policy Expansionary, #MacroView: Monetary Policy Is Not Expansionary.

Unfortunately, the “wealth effect” impact has only benefited a relatively small percentage of the overall economy. While Ben notes that even the bottom 50% have benefitted, such is a bit of an exaggerated claim. The bottom 50% of the population has the same net worth as prior to the “Financial Crisis.” Such hardly suggests an economy benefitting all. 

A Quick Note On Technology

Ben is correct when he discusses the advances in technology in the ’20s.

However, there is a fundamental difference between the impacts of technology in the 1920s and today.

The rise of automation and the automobile’s development had vast implications for an economy shifting from agriculture to manufacturing. Henry Ford’s innovations changed the economy’s landscape, allowing people to produce more, expand their markets, and increase access to customers.

In the ’20s, technological advances led to increased demand, creating more jobs needed to produce goods and services to reach those consumers.

Today, technology reduces the demand for physical labor by increasing workers’ efficiencies. Since the turn of the century, technology has continued to suppress productivity, wages, and, subsequently, the rate of economic growth. Such was a point we made in “The Rescues Are Ruining Capitalism.”

“However, these policies have all but failed to this point. From ‘cash for clunkers’  to  ‘Quantitative Easing,’ economic prosperity worsened. Pulling forward future consumption, or inflating asset markets, exacerbated an artificial wealth effect. Such led to decreased savings rather than productive investments.”

The critical distinction between the technology of the ’20s and today is stark.

When technology increases productivity and output while simultaneously increasing demand by increasing “reach,” it is beneficial.

However, when technology improves efficiencies to offset weaker demand and reduce labor and costs, it is not.

Given the maturity of the U.S. economy and the ongoing drive for profitability by corporations, technology will continue to provide a headwind to economic prosperity.

Conclusion

Ben and I do agree that this is very much like the 20s. However, where we differ is that while he believes we may starting that period, we suggest we are likely closer to the end.

In 1920, banks were lending money to individuals to invest in the securities they were bringing to market (IPO’s). Interest rates were falling, economic growth was rising, and valuations grew faster than underlying earnings and profits.

There was no perceived danger in the markets and little concern of financial risk as “stocks had reached a permanently high plateau.” 

It all ended rather abruptly.

Today, while stock prices can be lofted higher by further monetary tinkering, the underlying fundamentals are inverted. The larger problem remains the economic variables’ inability to “replay the tape” of the ’20s, the ’50s, or the ’80s. At some point, the markets and the economy will have to process a “reset” to rebalance the financial equation.

In all likelihood, it is precisely that reversion that will create the “set up” necessary to begin the “next great secular bull market.” Unfortunately, as was seen at the bottom of the market in 1974, there will be few individual investors left to enjoy the beginning of that ride.

The Fed Must End Its Love Affair With The Markets.

The Fed must end its long-running love affair with the markets. It needs to be over, and here are several reasons why the Fed needs to end it.

In 1977, the band Fleetwood Mac released one of its most successful albums – Rumours. The song Chains was a big hit for the group. It was a mish-mosh of band riffs. You sort of can tell near the end that it was one big old jam session. In the beginning, the baseline, the lyrics are clean.

Confidentially, it’s one of my favorite tunes, but halfway through, I’ve had enough of hearing it, and I’m ready to move on. Allegedly, the inspiration for the lyrics was the drawn-out breakup between Stevie Nicks and Lindsey Buckingham.

The Fed’s easy-money tune has been a rich melody for risk assets, but I’m at the point where the notes are clashing, and it’s time for them to prepare to exit the stage. Furthermore, this coupling is more drawn out than Hallmark Channel’s holiday movie lineup.

Here are several reasons why the Fed needs to break the chain with stock markets.

Inflation Isn’t Transitory. It’s Permatory.

A new Fed mandate must be drawn-out and creative definitions because the word transitory has stretched, morphed, pulverized into something I don’t recognize. So, I took it upon myself to create a new word. Permatory. The kind of inflation that never goes away yet is still considered ‘transitory’ by the Fed, a price point that’s painful and not so temporary. But, listen, just like the central bankers and the Executive branch of government, I can hold my own when it comes to tossing a word salad. The exercise was fun. Until I shopped for groceries and noticed the prices, I realized that permatory would be painful for most Americans.

I mean, if the dictionary means anything anymore, here’s the current definition (without the intervention of Jerome Powell), of transitory per Miriam-Webster:

Definition Of Transitory

1: brief durationTEMPORARY the transitory nature of earthly joy 2: tending to pass awaynot persistent.

So, transitory means temporary.

I guess earthly joy is temporary. Life is fleeting. So, I think the Fed’s definition of transitory realistically can last a lifetime. Good for them, not so good for consumers. Frankly, I don’t expect inflation to be as horrific as the 1970s when a top-of-the-line stereo system costs $600. However, it will make us squirm in the wallet, more than we’ve squirmed in a long time.

The Atlanta Fed’s inflation project is an ongoing initiative. The theory behind sticky price inflation is that specific consumer prices change infrequently; thus, they incorporate expectations about future inflation more effectively than prices that change frequently.

Per The Atlanta Fed:

While some economists wrestle with the question of what, exactly, causes prices to be sticky, others have taken on the tedious task of documenting the speed at which prices adjust. The most comprehensive investigation into how quickly prices change that we know of was published a few years ago by economists Mark Bils and Peter Klenow.

Bils and Klenow dug through the raw data for the 350 detailed spending categories used to construct the CPI. They found that half of these categories changed their prices at least every 4.3 months. Some categories changed their prices much more frequently; price changes for tomatoes, for example, occurred every three weeks. And some goods, like coin-operated laundries, changed prices on average only every 6½ years or so.

As of September 14, 2021, the sticky-price consumer index increased 2.6% (on an annualized basis) in August. However, consumers know that prices for many goods and services have increased at least twice that percentage. As a result, consumer price hikes have inundated business headlines. Kimberly-Clark, Unilever, Chipolte, Proctor & Gamble. Name the company, and I’ll show you sticker shock!

Even Subway is in on it!

Sticky-price items include personal care products and services, food away from home, rents, water, trash collection services, medical care services, recreation, motor vehicle maintenance, and repair. Flexible price items (not sticky) include fuel, car rental, meat, poultry, fish, eggs, fruits, vegetables, new and used vehicles, cereals, and bakery products.

Will Flex Become Sticky? It’s A Possibility.

Candidly, I believe several flex-price inflation categories are at risk of becoming sticky, including fuel and food products. Longer-term political initiatives to ‘motivate’ consumers to go green will lead to sustained higher prices for meat, poultry, fish, and eggs. Ostensibly, real wage growth (adjusted for inflation) will remain stubbornly negative, thus distressing lower and middle-class household budgets.

Structural issues, including political headwinds coupled with a growing need for energy, will keep oil and gas prices moving higher. However, don’t expect OPEC to cooperate either. Instead, they’ll maintain their output steady in the face of rising demand, ostensibly keeping prices uncomfortable for all of us.

Per www.apartmentlists.com’s National Rent Report for October, the national MEDIAN rent has increased by an astounding 16.4% since January. As rents are considered sticky, I wouldn’t expect prices to contract much. Also, the Federal Reserve Bank of New York does a good job mapping changes to regional and national home prices. Year-over-year, as of July, median home prices are higher by an eye-popping 23% when wages are higher by roughly 3%.

For example, in Houston’s Harris County, home prices rose close to 11% through the same period. Estimates are for prices to moderate or pull back modestly. However, not enough to provide inflationary relief. Currently, the Federal Reserve Bank of Atlanta estimates that the median U.S. household needs 32% of its income to cover mortgage payments, the highest percentage since 2008!

RIA’S Financial Guardrails Take The Emotion Out Of Home Purchases.

By the way, one of our financial tenets at RIA is that a mortgage payment should not breach 20% of net household income. We’re not budging on the guardrail or the advice. It’s discouraging for those who want to purchase a primary residence. However, our goal is to make sure consumers are not house and cash flow poor. We suggest most clients and their children who come to us for guidance postpone their purchase until they can increase their down payments and prices cool off. It takes discipline to wait. Discipline builds wealth.

Also, the outlook for 2022 wages is far from rosy. Per SHRM. Org: pay raises in the U.S. are returning to pre-pandemic levels, but rising prices mean higher salaries aren’t likely to keep pace with inflation. The median total U.S. salary increase budgets for 2021 are three percent, on par with the previous ten years, and projections for 2022 are also 3 percent.

Fiscal Stimulus Is Coming.

No, it’s not Paul Revere! Instead, here’s the second of three reasons why the Fed must break the chain with stock markets.

Regardless of supply chain disruptions, which may be temporary, there is a renewed focus on fiscal stimulus and robust benefits to households, including aggressive child tax credits. I wouldn’t be surprised if a universal basic income benefit arrives on our shores within the next decade.

The monetary stimulus in the form of quantitative easing especially is not inflationary. However, long-term fiscal stimulus will raise the Fed’s overall baseline inflation, which means they will need to increase short-term rates in the face of sustained higher unemployment and lower economic growth. Stagflation anyone?

It’s time for the Fed to break the chain with markets because inflation due to fiscal stimulus is indeed a sustained threat. Consumers’ real wages (adjusted for inflation) will remain negative, thus welcoming additional fiscal relief. A balancing act is imminent as perhaps the Fed can adjust rates accordingly as the fiscal side takes over for them.

Candidly, this chain is going to be captivating to monitor as Powell sweats to sever it. After all, the Fed has morphed into some underground social justice enterprise graced with unspoken mandates to combat racism and wealth inequality. But, of course, one can say the Fed is the reason for wealth inequality in the first place since its policies fuel stock prices.

Conversely, lower rates have helped the majority of households take on more debt, purchase larger homes, and allow them to live above their means. So how will rising rates affect those families? If the federal government sends them checks, probably not much!

Market Valuations Must Adjust To Economic Reality

Here’s the last of the reasons why the Fed must break the chain with stock markets.

Personally, I’m sort of tired of 20-year-old market pundits telling me that bear markets are a thing of the past. Perhaps they’re correct. However, they’ll be a point where buy the dip because the Fed will bail us out is not going to work, and today is as good a day as any. The Fed has allowed speculation to run rampant. Price distortion plagues every asset class. Investors are buying up virtual land and invisible artworks. It’s time for the insanity to stop. The reward-with-no-risk chain that permeates markets must be severed.

The Federal Reserve must halt emergency action. However, in the face of sustained inflation and the greater probability of additional fiscal stimulus, they’ll have little choice but to move quickly to increase short-term interest rates too. If Powell has the political will to do so, that is. Even the mention of imminent short-term rate increases will adjust risk asset prices accordingly.

Bond markets have been foretelling about the future state of global economic growth. But, as much as financial pundits who suffer from chronic Recency Bias lament how GDP will indefinitely trend above average, bond yields and the nation’s debt burden tell a different story.

Debt To GDP Is Rising

Germany’s Ifo economic institute recently cut its growth forecast to 2.5% for 2021 due to supply bottlenecks lasting longer than expected. Carmen M. Reinhart and Kenneth Rogoff, who in their seminal tome This Time Is Different and various studies, including Growth in a Time of Debt from 2010, provide evidence that over the past two centuries, debt above 90 percent gets typically associated with a mean growth of 1.7 percent versus 3.7 percent when debt is low (under 30 percent of GDP). Readers should know that since then, Rogoff has changed his tune. Debt is now a good thing. He references the effects of the pandemic as a reason for the change of heart. However, the numbers are the numbers; the research remains valid.

Keep in mind; the United States stands at roughly 128% national debt to GDP. The bond market has been indicating all along that once the pandemic growth spurt concludes, GDP would return to sluggish moderation. We are on the way. The Federal Reserve Bank of Atlanta’s GDP Now forecast has collapsed to 1.3% as of October 5.

It’s time for the Fed to break the chain with risk assets. This love affair is strained. They have overstayed their welcome, but the damage is done. As a result, the Fed has trained an entire generation of new stock investors to be overconfident and oblivious to risk. Overall, it sends the wrong message and could be a recipe for disaster.

At RIA, we estimate formidable headwinds to future market performance. We estimate future returns to be more in line with GDP. Interestingly, Bank of America believes future long-term market returns will be harmful for the first time since 1999. Although we’re not as dire with our estimates, we do think future returns will be challenging to say the least.

What Are Investors To Do?

What should an investor do in the face of why the Fed must break the chain with stock markets? Here are three ideas:

1) Manage Expectations.

A 5% pullback feels like 10%. A 10% correction feels like a bear market. Volatility is the price of admission to participate on the ride of risk assets. Stock investors must reassess their risk attitude with a fresh perspective. A perspective that includes the Federal Reserve no longer there to bail us out. Underneath the surface, the Fed’s mandates appear to be broadening. Central banks are being reshaped to become social justice warriors that don’t bode well for stock investors.

Consequently, Powell is too old school. A progressive new chair will likely replace him: A central banker who is not subservient to stock markets. Listen, it could happen. Regardless, based on stock performance this year, it’s best to rebalance, take some risk off the table, reallocate to growth AND value stocks.

2) Establish A PRR: Personal Rate of Return.

Looking to beat an index such as the S&P 500 is a mindless goal, especially when investors do not comprehend the risk they may be taking to do it. Don’t fulfill your ego. Instead, focus on financial milestones such as college savings and retirement. Meeting or exceeding these goals takes awareness and understanding of a personal rate of return or a PRR. A PRR is a return YOU and YOUR family require to meet goals. How do you establish a PRR? By completing a comprehensive financial plan – One that examines the rate of return needed to hit your financial benchmarks. Then, it’s best to compare annual portfolio returns to a PRR, not some market index that has nothing to do with your life or legacies.

3) Speculate Wisely.

Want crypto? Great. Seek metals? OK! How about land in the Twilight Zone? Well, that’s fine, I guess. However, investors should define boundaries when considering speculative ventures. For example, we partner with clients who participate in speculative investing only with money they’re willing to lose.

I know investing on a risk-adjusted basis sounds a lot like “eat your vegetables.” I know that sometimes we want dessert, and we want it before the main course. Anything in life is acceptable in moderation and when rules are applied. But, hey, I’m human. Sometimes I take chocolate over broccoli too!

Intuitively, with the emphasis on additional fiscal stimulus and the heat of inflation, some of which I believe is structural now, it feels like the Fed will have no choice but to become more aggressive about exiting easy monetary policy.

As a result, we should brace for the repricing of stocks.

The political demonization of the Fed along with reduced liquidity should make for an interesting 2022.

Fleetwood Mac’s famous tune is about a turbulent breakup. The severing of the chain between the Fed and markets will be volatile, unsettling, and fraught with drama. Just like a song but not as enjoyable.

I think I’ll write my song to describe next year. I’m no Stevie Nicks, but I think my working title is coming along nicely: Buckle In.

Futures Higher On Short-Term Debt Ceiling Resolution

Futures are rising again this morning after a short-term resolution to the debt-ceiling got offered by Senate Minority Leader, Mitch McConnell. Investors have been on a roller coaster since last Friday with the market swinging between support and the 100-dma. The wild-ride on Wednesday, not only retested recent support level lows, but took out the 100-dma by the close. A follow-through rally today could put the market on track to retest the 50-dma.

If the market can muster a couple of days of a rally, and clear the 50-dma, we will likely trigger the all-important MACD “seasonal buy” signal. Such would confirm the official start of the seasonally strong period. While it is very possible we have seen the highs for this year, the markets are oversold enough now for a 3-4% rally into the end of the year.

Daily Market Commnetary

What To Watch Today

Economy

  • 7:30 a.m. ET: Challenger Job Cuts, year-over-year, September (-86.4% in August)
  • 8:30 a.m. ET: Initial jobless claims, week ended October 2 (348,000 expected, 362,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended September 25 (2.802 million during prior week)
  • 3:00 p.m. ET: Consumer credit, August ($17.500 billion expected, $17.004 billion in July)

Earnings

  • 7:00 a.m. ET: Tilray (TLRYis expected to report adjusted losses of 6 cents per share on revenue of $173.58 million
  • 7:30 a.m. ET: Conagra Brands (CAG) is expected to report adjusted earnings of 49 cents per share on revenue of $2.54 billion

Politics

Looking For Opportunities To Buy

If markets can hold the 100-dma through Friday, we will start looking to increase exposure to our equity portfolios. This morning, I ran a quick scan on the stocks with the strongest relative strength to start finding some candidates.

Delaying the Debt Cap Limit

As we stated all week, it was only a function of time until the debt ceiling got raised. Yesterday, Senator McConnell told a closed-door meeting of Senate Republicans that he would offer a short-term debt ceiling extension today. Stocks recovered from their morning losses on the rumor.

“Senate leaders reached a bipartisan agreement Wednesday to defuse the impending debt limit crisis by allowing for a short-term increase in the statutory borrowing cap while lawmakers negotiate a longer-term solution.

Democrats said they would agree to an offer from Minority Leader Mitch McConnell that would pave the way for an increase in the debt limit into December. But the two parties still disagreed on any long-term strategy.” – Roll Call

While raising the debt ceiling may look like a victory for the Democrats, it may not be.

“While raising the debt ceiling just once is proving to be a challenge, the only thing worse would be having to vote to raise it twice

From a political perspective, the only thing less attractive than voting to raise the debt limit to $31 trillion is voting to raise it to $29 trillion and then voting a second time to raise it to $31 trillion’” – Zerohedge

However, as we stated would happen, yields dropped on the news.

ADP Jobs Report

The ADP Employment report shows strength in the jobs market during September. Per ADP, there was a net pick-up of 568k jobs in September versus 374k in August. The services sector accounted for about 80% of the gains with leisure/hospitality accounting for 226k jobs.

“Leisure and hospitality remain one of the biggest beneficiaries to the recovery, yet hiring is still heavily impacted by the trajectory of the pandemic, especially for small firms. Current bottlenecks in hiring should fade as the
health conditions tied to the COVID-19 variant continue to improve, setting the stage for solid job gains in
the coming months.” – Nela Richardson, chief economist, ADP.

Markets Rocky Start to Q4

Atlanta Fed GDPNow Tumbles, Again

The Atlanta Fed’s forecast for Q3 GDP growth fell again from 2.3% to 1.3%. The forecast was over 5% in early September. The worsening trade deficit and weaker than expected ISM Services Index are to blame for the latest revision.

Volatility Is Not Living Up To Hype

Watch a few minutes of CNBC and you would think recent daily market gyrations are extreme. In prior commentaries, we note that volatility and the put/call ratio are not signaling much concern. The reason is that the roller coaster the market has been on over the last week or two or is not that daunting. Dare we say it’s a kiddie ride. The graph below charts the absolute daily price change of the S&P 500. As circled, daily changes are running above 1% a day. While above-average, there is nothing too unusual about it.

Utilities vs. Energy

The bar chart below, courtesy of Charles Schwab, shows 100% of energy stocks in the S&P Energy sector are above their 50dma. Conversely, not one utility is above its 50dma. XLU, the utility sector ETF, is sitting on its 200dma while XLE (energy) is about 15% above its 200dma. The second graph shows XLU is resting on important support in both the 200dma (red) and a support line (lime) going back to June 2020. We added utilities to both RIA Pro portfolios over the last week, as we believe support will hold and a bounce is probable. However, caution is warranted as higher natural gas and coal prices may weigh on the sector, forcing it to break support.

Bonds: Hold ‘Em, Fold’ Em, Walk Away, or Run?

Bonds: Hold ‘Em, Fold’ Em, Walk Away, or Run?

“You got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run”  

Kenny Rogers- The Gambler

So how do we know when to hold or fold ’em bonds?

If you ask bond traders, you are likely to get many different answers. Some will say it depends on future inflation rates. Over the last ten years, the Fed has become a popular response. Economic growth rates, demographics, and the dollar are also likely replies.

According to our Twitter followers, over half think the Fed is the most significant determinant of bond yields.

In this article, we explore a few essential factors that tend to dictate bond yields. We aim to assess whether the recent increase in yields is a buying opportunity or foreshadows even higher rates.

This article is not just for bond investors. Given the importance of low yields to justify extreme equity valuations, rising yields will not only dampen earnings multiples but weigh on earnings.

Federal Reserve Monetary Policy

The Fed is the runaway winner in our Twitter Poll. It is not surprising, given it purchases $120 billion per month of U.S. Treasuries (UST) and MBS (mortgage-backed securities). These outsized purchases directly impact treasury and mortgage yields. Other assets also benefit from the excess liquidity and lower rates, such as equities, crypto, and some commodities.

The Fed now owns nearly 25% of all public U.S. Treasury debt outstanding, as shown below. Since 2020, the Fed has bought more than half of the debt issued by the Treasury. Further, the Fed owns another $3.25 trillion of mortgages and other assets that also influence yields.

The Fed is the dominant “investor” and marginal price setter of Treasury yields. Their role is even more prominent considering a good percentage of Treasury debt is “put away.” These are bonds held to maturity that will likely never be sold. Foreign nations, pension funds, insurance companies, and other investors are such holders. As a result, the float, or amount of bonds available for purchase, is well less than the total supply.

Given the Fed’s enormous footprint, how does QE influence bond yields? In Taper Is Coming Got Bonds? we compare bond yield changes to the size of the Fed’s balance sheet.

The article’s results are not intuitive. One would think yields would fall as the Fed buys bonds and vice versa. Quite the opposite occurs. To wit: “Ten-year yields tend to rise about 1% from the start of QE to peak yield levels during QE. Equally important, yields tend to fall toward the end of QE.”

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As shown in the graph and table below, yields rise during QE. Equally important, yields decline after periods of QE.

With the Fed set to taper in November and finish in the second quarter, this metric argues for lower yields.

Economic Activity and Inflation

Bond traders, old enough to remember a time before 2008 when the Fed was not the dominant price setter of U.S. obligations, may claim economic activity and inflation matter most for bond yields.

Economic Activity

The chart below compares quarterly instances of real ten-year trailing economic growth rates versus the yield on the 10-year UST. The correlation is statistically significant at .71. 

Given the strong correlation, we can confidently form a reliable forecast for ten-year yields if we can reasonably forecast future economic growth.

The graph below helps us. Following each of the last three recessions, the trend real growth rate declines. This is a consequence of increasingly larger amounts of unproductive government spending during and after each recession. Given the massive amount of unproductive debt issued over the last year and a half, we suspect another step down in the growth rate is coming.   

We forecast real economic growth to average between 1.50% and 2.50% over the next ten years. The Fed’s “longer run” projection of 1.90% falls right in the middle of this range. The table below uses the scatter plot to determine where 10-year UST yields should be in three growth scenarios. Based on the current yield of 1.50, yields seem fair given growth forecasts.

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Inflation and Inflation Expectations

In theory, investors should demand a yield greater to or equal to the expected inflation rate and credit losses. Such a sufficient yield ensures purchasing power is, at a minimum, preserved by the investment. Treasuries are supposedly risk-free; therefore, UST yields should equal or exceed expected inflation.

Theory and reality are often two different things, as is the case today. The expected rate of five-year inflation is approximately 2.50%. The current 10-year bond yield is almost half of that. There are many reasons for such inefficiency. Chief among them is the Fed’s large footprint and strong demand for high-grade collateral to back derivatives. The Fed’s now trillion dollars plus reverse repurchase program is evidence of collateral needs. More on that in another article.

The two plots below show the relationship between yields and inflation, and inflation expectations.

While not as strong as the relationship between prior GDP and yields, there is a decent correlation between inflation and yields. If inflation rates and inflation expectations revert to pre-pandemic norms of 1.50-2.00%, we should expect yields in a range of 2.00 to 4.00%. It’s a wide range but consider the low end of the forecast is a good amount higher than current yields. Given the profile of expected future debt issuance, we suspect the Fed will do everything in its power to prevent a yield north of 2.50% or even less.

Other Forecasts

The graph below, courtesy of Ed Yardeni, shows the strong correlation between the Citi Economic Surprise Index and ten-year UST yield changes. The Citi index measures economists’ consensus economic data estimates versus actual readings.

Over time the index oscillates as economists tend to overestimate economic activity then underestimate it. As shown below in red, economists are now overly optimistic as their forecasts are recently better than actual data. The index is likely reaching a point where economists start under-forecasting economic data. If true and the correlation in the graph holds, yields are likely to rise over the coming months.

The Institute for Supply Management (ISM) publishes a closely followed survey of manufacturing conditions. The survey has a strong relationship with economic growth and, therefore, yields. Like the graph above, the survey results tend to oscillate up and down, albeit much less frequently.

The ISM Index is currently just below 35-year highs. Due to the nature of the survey questions and the range of possible answers, it is difficult for the index to rise or even stay at current levels. Even if the index defies gravity and remains near multidecade highs over the next few months, the index’s year-over change will fall to near zero. Normalization to pre-pandemic levels will result in a 5-to-15-point year-over-year decline. A similar move in yields could result in yields at or near 0.00%.

The Citi Index argues for higher yields in the next few months. Conversely, the ISM survey points to lower yields.

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Summary

What would Kenny Rogers do?

As investors, we must read the table and figure out our odds of success. With yields so low, and as a result, the cushion for error minimal, this has never been so important.

Short-term traders are dealing with a period of indecision in the bond market. Some investors are nervous as inflation is running hot, and they wonder who will shoulder the heavy supply of Treasuries if the Fed tapers. Conversely, as we have seen, when the Fed steps away from bond purchases, yields tend to fall.

We believe economic growth will continue to slow, and long-standing deflationary pressures will re-exert themselves. Purely based on economic growth, bonds are reasonably priced.

Recent inflation rates and current inflation expectations argue for higher yields. The Citi Surprise Index points to a bump in yields in the coming months, while the ISM Index favors lower yields.

So, what to do? We think the answer goes beyond history and statistics. The economic threshold for higher yields is minimal. An outbreak higher is likely to result in weaker economic growth and deflation ultimately.

The Fed understands the debt trap our economy is in and will do everything in its power to avoid yields high enough to break the economy.

As our Twitter followers, we think the Fed matters most for bond yields. If they can manage inflation, we must assume they can control yields.

Our advice- hold ‘em.

Market Set To Drop After Rebound Over Debt Ceiling Woes

The market is set to drop after yesterday’s rebound as debt ceiling woes continue. From a frenzied Friday to manic Monday, a rebound on Tuesday, it has been a rocky start to October. However, don’t believe the media hype that recent market gyrations are abnormal. They are not. In fact, since 2019, the S&P 500 changes by .87% a day on average. Over each of the last four days, it has moved on average by only 1.28% per day- not much more than average. Ignore the media hype and focus on the technicals. With yesterday’s gains, we are not out of the woods but there are not many signs of significant trouble ahead either.

Daily Market Commnetary

What To Watch Today

The Debt Ceiling – It’s Bad Either Way

“With just under two weeks to go before the pivotal Oct. 18 deadline, Treasury Secretary Janet Yellen told CNBC on Tuesday the U.S. economy could spiral into a full-fledged downturn if Congress doesn’t raise the government’s statutory deficit limit.

In a nutshell, frequent fights over the debt ceiling have become a Catch 22 between paying bills the government has already incurred — or continuing to spend money it doesn’t actually have.

Trump articulated that idea when he told Yahoo Finance that ‘we’re in trouble no matter what … if you raise it, bad and if you don’t raise it, bad. It’s a bad situation to be in.'”

Market Rallies To Resistance

The market rallied off support yesterday and back to the 100-dma. While the market did breach above resistance, it failed to hold above it into the close. This morning, futures are lower again over concerns of the debt ceiling which is pushing yields higher. We are going to look to retest support again, which needs to hold. A failure at current support will lead to a test of the 200-dma, so it is worth remaining cautious near term. Any rallies should be used to reduce risk and rebalance holdings accordingly.

Sentiment Getting Very Bearish

Investor sentiment both from professionals and individuals is getting extremely bearish. Such is usually a decent contrarian indicator for a short-term rally. Given volatility did not spike and short-term technical indicators are getting stretched, such bodes well for a short-term reflexive rally.

However, as shown, with our measure of liquidity declining rapidly, the risk of a deeper correction as we head into 2022 is rising.

ISM Services Weakening

The services sector is not showing nearly as much strength as manufacturing. Last week we noted the ISM Manufacturing Index rose to 61.1, which, while off recent highs, is still at levels commensurate with prior peaks over the last 20 years. ISM Services on the other hand fell to 54.9 today and is 15 points below recent highs of 5 months ago. It is now normalized with pre-pandemic levels.

Put/Call Ratio Is Not Fearful

In Monday’s commentary, we showed the VIX is higher but not rocketing to levels that would cause more concern.  The put/call ratio, another indicator of investor stress, is elevated, but like the VIX, not at concerning levels. As shown, the ratio is still below levels seen in prior 2-5% declines over the last year. The current instance pales in comparison to the surge in March 2020.

Can Markets Rally Post Manic Monday?

Perspective

The graph below, courtesy of Bianco Research, helps put the recent 7% sell-off in the NASDAQ into perspective. As shown, there have been four other declines which have been greater than the current one in just the last year. While recent price action may be concerning, the markets have not done anything overly concerning. That said, valuations are sky high and the Fed is about to embark on tapering QE, so we want to manage our risk closely.

Energy Defying The Market

Despite the S&P 500 falling by about 1.50% yesterday, the energy sector (XLE) rose by a similar 1.50%. As we have shown previously, crude oil ($77.70) is bumping up against long-time resistance of $76-78. A break above resistance could lead to a substantial rise in oil prices. Crude was up over 2% yesterday as rumors spread that OPEC will follow its plan and increase production by 400,000 barrels in November. Some traders were expecting a larger increase in an attempt to limit higher oil prices. Further helping many of the oil companies is a surge in the price of natural gas. Yesterday it rose over 2% to $5.75, more than double its price from spring.

Gamma Matters

In yesterday’s Gamma Band Update Erik Lytikainen wrote: “There have been three straight weeks that the SPX has failed to overtake the Gamma Flip level, which is currently near 4,440. Our risk-avoiding model currently has an allocation of 30% to SPX and 70% cash. If the market closes below what we call the “lower gamma level” (currently near 4,285), the model will reduce the SPX allocation to zero.”

Erik’s model is reducing exposure because options gamma has flipped negative. Simply, it is at a point where further moves lower in the S&P 500 result in increasingly more selling by options dealers. When prices are above the gamma flip traders need to buy to hedge their books. The graph below from Tier1 Alpha confirms his analysis, showing the Gamma Flip level just north of 4400. Given how large options volume has become this year and general market illiquidity, options hedging is a significant cause of price change and may result in more volatility.

Will Stocks Bounce After a Manic Monday

The equity markets took it on the chin on a manic Monday following frenzied buying on Friday. As the saying goes “volatility begets volatility,” and such is the market environment we are now in. Interestingly, however, implied volatility (VIX) is rising but not at rates that should leave us concerned, at least not yet.

While seasonality is coming into favor, sentiment is getting to more bearish extremes which tends to be a good contrarian indicator.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Trade balance, August (-$70.8 billion expected, -$70.1 billion in July)
  • 9:45 a.m. ET: Markit U.S. services PMI, September final (54.4 expected, 54.4 in prior print)
  • 9:45 a.m. ET: Markit U.S. composite PMI, September final (54.5 in prior print)
  • 10:00 a.m. ET: ISM Services index, September (59.9 expected, 61.7 in August)

Earnings

  • 6:00 a.m. ET: PepsiCo (PEPis expected to report adjusted earnings of $1.74 per share on revenue of $19.38 billion

Courtesy Of Yahoo!

Despite Sell-Off, Volume Improved

Despite the sell-off yesterday, volume improved. One of the hallmarks of declines this year is sharp spikes in selling volume. While the market was down sharply at the open yesterday morning, volume declined and there was more buying than selling underneath the surface.

With sell-signals in place, there is certainly still risk in the market currently. However, previous bottoms are trying to hold, and support from July remains intact.

Winners and Losers

The graphs below from RIA Pro show a good number of yesterday’s winners were energy stocks. Conversely, technology and communications led the way lower.

Breadth Remains Weak, Markets Oversold

As noted in today’s “Technically Speaking” report:

While short-term indicators got oversold, longer-term indicators did not. The dichotomy of these different indicators supports the idea of a rally short-term (days to a couple of weeks) but a more significant correction ahead.

On RIAPRO (Free 30-day trial), we provide the sentiment and technical measures we follow. The number of oversold stocks is back towards extremes, which supports the idea of a short-term rally.”

“However, the overall “breadth” and “participation” of the market remains highly bearish. Thus, to avoid a deeper correction, breadth must improve.

“There are reasons to be hopeful for a short-term rally with markets oversold, and the sentiment very negative. Furthermore, we are entering into the “seasonally strong” period of the year. The month of October has a spotty record, but November and December trend stronger.”

Will The 50DMA Hold For a 12th Time?

The graph below shows how well the 50DMA has supported the market since the swoon of March 2020. The bottom graph shows the difference between the S&P and the moving average. As highlighted it is currently 2-3% below the moving average, similar to dips in October and November of 2020. While the decline may not feel great, it has yet to show us something different from what we have witnessed over the past year and a half. A further breakdown, especially below the 100dma would be concerning. Conversely, if the S&P 500 re-takes the 50dma, it may likely head back to record highs. As we have been saying over the last few weeks, all eyes are on the 50dma.

Where The Buys Are

Week Ahead

This will be a quiet week for economic data, yet one of the most important of the month. ADP comes out Wednesday with expectations for a gain of 415k new jobs added. The BLS will release its payrolls report on Friday. Economists expect 475k new jobs versus a weak 235k last month in that report. If both data points come near or better than estimates we should assume the Fed will announce tapering QE at their next FOMC meeting (11/03).

Speaking of the Fed we expect they will remain quite vocal this week. As we saw last week, we expect them to continue to reflect concern about inflation and promoting taper soon. Vice-Chair Clarida joins other Fed members in being exposed for personal trading prior to important Fed statements. We suspect, as a result, Powell will not be renominated.

Earnings season kicks off this week but there are not any major companies set to report. The banks will effectively lead off Q3 reporting next week.

Banks Are Not Lending

The graph below from Brett Freeze is a very powerful summary showing why monetary velocity is not rising. As we have written, inflation is a function of money supply and monetary velocity. Fading velocity has offset a large chunk of the surge in the money supply. As his graph below shows, banks are investing in secondary securities, mainly U.S. Treasuries instead of lending money. The tradeoff between the two is normal but the current levels are somewhat extreme.

Technically Speaking: Bears Gain Control As Market Fails Resistance

With yesterday’s rout, the “bears” gained control of the narrative as the market failed at resistance.

In this past weekend’s newsletter, we discussed the market reclaiming the 100-dma on Friday. To wit:

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Therefore, any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier, we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

Chart updated through Monday’s close.

The failure to hold the 100-dma is concerning. With the “bears” continuing to maintain control over the market, risks are mounting. With the market pushing well into 2-standard deviations below the 50-dma, we expect a counter-trend rally.

However, for now, those rallies should likely get used to “sell into,” rather than trying to “buy the dip.”

Daily Market Commnetary

Numerous Headwinds To The Bullish Outlook

The selloff in September took our short-term indicators into oversold territory. Such suggests selling pressure is getting exhausted near term.

While short-term indicators got oversold, longer-term indicators did not. The dichotomy of these different indicators supports the idea of a rally short-term (days to a couple of weeks) but a more significant correction ahead.

On RIAPRO (Free 30-day trial), we provide the sentiment and technical measures we follow. The number of oversold stocks is back towards extremes, which supports the idea of a short-term rally.

However, the overall “breadth” and “participation” of the market remains highly bearish. Thus, to avoid a deeper correction, breadth must improve.

There are reasons to be hopeful for a short-term rally with markets oversold, and the sentiment very negative. Furthermore, we are entering into the “seasonally strong” period of the year. The month of October has a spotty record, but November and December trend stronger.

However, don’t ignore the risks. Much like a patient with a weak immune system, the weak market internals leave investors at risk of numerous headwinds.

  • Valuations remain elevated.
  • Inflation is proving to be sticker than expected.
  • The Fed will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to wane.
  • Corporate profit margins will shrink due to inflationary pressures.
  • Earnings estimates will get downwardly revised keeping valuations elevated.
  • Liquidity continues to contract on a global scale
  • Consumer confidence continues to slide.

While none of these independently suggest a significant correction is imminent, they will make justifying valuations difficult. Moreover, with market liquidity already very thin, a reversal in market confidence could lead to a more significant decline than currently expected.

Longer-Term Signals Suggest Caution

Given the broader macro issues facing the market and not dismissing the possibility of a near-term reflexive rally, the weekly and monthly signals suggest caution.

Important Note: Weekly and monthly signals are only valid at the end of the period.

On a weekly basis, the market has triggered sell signals for the first time since April. However, despite the sell signal, the market continues to hold above its weekly moving average support. Furthermore, the market is as oversold today as it was during the selloff earlier this year.

The monthly picture is more concerning. Monthly “sell signals” are rarer and tend to align with more extensive market corrections and bear markets. But, as shown below, it is the first time since March 2020 that this signal has gotten triggered.

While the longer-term MACD has not yet confirmed that monthly signal, it is worth paying close attention to. Historically, the monthly signals have proven useful in navigating correction periods and bear markets.

Let me reiterate these longer-term signals do not negate the possibility of a counter-trend bull rally. As noted, in the short-term the market is oversold enough for such to occur. However, these longer-term signals suggest that investors should be using such rallies to rebalance portfolio risks, raising some cash, adding hedges, and reducing overall portfolio volatility.

My best guess is that we are still in midst of seasonal weakness and could decline a bit further before sellers get exhausted. Such should lead to a stronger rally into the end of the year, however, new highs may be in the rearview mirror for now.

15-Portfolio Management Rules

There is a substantial risk of a bigger correction as we move into 2022. Such does not imply selling everything and moving to cash. However, being aware of the possibility allows for a logical approach to risk management.

  1. Cut losers short and let winner’s run
  2. Set goals and be actionable. 
  3. Emotionally driven decisions void the investment process. 
  4. Follow the trend. 
  5. Never let a “trading opportunity” turn into a long-term investment.
  6. An investment discipline does not work if it is not applied.
  7. “Losing money” is part of the investment process. 
  8. The odds of success improve significantly when the technical price action confirms the fundamental analysis. 
  9. Never, under any circumstances, add to a losing position. 
  10. Market are either “bullish” or “bearish.” During a “bull market” be only long or neutral. During a “bear market”be only neutral or short. 
  11. When markets are trading at, or near, extremes do the opposite of the “herd.”
  12. Do more of what works and less of what doesn’t. 
  13. “Buy” and “Sell” signals are only useful if they get implemented. 
  14. Strive to be a .700 “at bat” player. (No strategy works 100% of the time.)
  15. Manage risk and volatility. 

For now, it appears the “bears” have regained control of the market. However, the bullish trend remains intact which suggests we remain long our equity exposure. When there is a dichotomy of conditions, sometimes the best action is “no action” at all.

The “need to do something” is emotionally driven and tends to lead to worse outcomes.

For now, please pay attention, make small changes as needed, reduce risk on rallies, and wait for the market to tell you where its headed next.

Things are getting interesting.

Viking Analytics: Weekly Gamma Band Update 10/04/2021

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

Gamma Band Update

The S&P 500 (SPX) had sharp down days on Tuesday and Thursday, with a recovery rally to close out the week on Friday.  There have been three straight weeks that the SPX has failed to overtake the Gamma Flip level, which is currently near 4,440. Our risk-avoiding model currently has an allocation of 30% to SPX and 70% cash.   

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can conceptually be viewed as a risk along with other tools. When the daily price closes below Gamma Flip level (currently near 4,440), the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,285), the model will reduce the SPX allocation to zero. The range between Gamma Flip and the lower gamma has tightened because risk is higher.

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

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  Our “Smart Money” Indicator signal remains long but may be turning cautionary as we head deeper into the fall months.

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

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

 

Disclaimer

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

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

Authors

Erik Lytikainen, the founder of Viking Analytics, 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 BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. 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.


Is the “Best Way To Invest” Always The Best Way?

Is “buy and hold” always the best way to invest? It is common to see increasing numbers of articles touting the benefits of “armchair” investing during long bull market advances. The last decade has been a boon for the index ETF industry, financial applications, and media websites promoting “buy and hold” investing and diversification strategies.

But is the “best way to invest” during a bull market also the best way to invest during a bear market? Or, do different times call for different strategies?

Such are the questions we will explore.

The Premise Of Buy & Hold Investing

The premise of “buy and hold” investing is sound, particularly for younger investors. Place money into an index fund regularly (dollar cost average), and over a long period, wealth will compound. A look back over the last 120-years clearly shows the value of the thesis.

It is worth noting there are periods where markets fail to grow. As shown, such is due to the impact of valuations on future market returns.

While “buy and hold” does seem to solve the problem of “bear market cycles” by “riding out” the volatility, there are three critical facets often overlooked.

  1. Diversification does not always work,
  2. The destruction of the “power of compounding;” and,
  3. The reduction of time needed to reach financial goals.

Diversification Doesn’t Always Work

The idea of diversification was derived initially from Harry Markowitz’s seminal work on what has become known as “Modern Portfolio Theory.”

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset’s risk and return should not be assessed by itself, but by how it contributes to a portfolio’s overall risk and return. It uses the variance of asset prices as a proxy for risk.”Investopedia

The essential premise is that holding a basket of diversified assets is less “risky” and provides better returns than owning just one asset, such as the S&P 500. The theory worked well during the last century when various asset classes did not maintain a high correlation. However, with advances in technology, transaction speeds, and information flows, correlations rose at the turn of the century. The chart below compares an S&P 500 Index Fund to a Global Asset Allocation fund.

From 2000 through 2007, allocation funds provided comparable performance to just owning an S&P 500 index fund. However, where the test of MPT failed was in 2008. While the allocation fund did lose slightly less than the S&P 500 index, the damage to capital was quite severe. Moreover, the performance gap compounded over the next decade as international and emerging markets markedly underperformed domestic equity and provided a minimal reduction in volatility.

The Promise Of 8% Returns

However, simply comparing the performance between the two funds is misleading. We must also tie back the performance to the returns required, or instead promised, to meet financial goals.

Since 2004, the allocation fund never achieved the promised growth rates of 8% annualized. The S&P 500 index didn’t accomplish that goal until 2017.

Importantly, it took over $43 trillion in financial interventions to create an asset bubble of a size never before witnessed in history. For investors, what has made the difference between reaching their financial goals or not, was a conscious decision to be entirely allocated to domestic equities and leave MPT behind.

The law of change states: 

“Change will occur, and the elements in the environment will adapt or become extinct, and that extinction in and of itself is a consequence of change.

Sometimes the “best way to invest” is to understand that market dynamics change. As investors, it is critically important to understand the causes of changes.

  • Are the change permanent or driven solely by temporary factors?
  • Do the factors driving those changes have other consequences that will affect future returns?
  • Does the influence of these factors, either temporary or permanent, require a change to model allocation design?
  • Can I adequately compensate for these changes using traditional investment assets?
  • How will these changes affect my personal investment time horizon and financial goals.

The problem with MPT, and its use by the financial industry to sell products or services, is that it is not a stagnant, one-size-fits-all solution. Instead, as we should all be aware by now, the financial markets are constantly growing and evolving.

Therefore, logic suggests that our investment approach and allocations must also evolve or become “extinct.”

Time Horizons Matter

As noted, while “buy and hold” investing is the “best way to invest” during a bull market, there is a generally unrecognized problem with it during market declines.

We previously discussed Morningstar’s analysis suggesting market declines don’t matter. One of the critical issues with the analysis was the exclusion of “life expectancy.” When discussing long periods of “no return” from markets, the impact of “time” becomes a critical factor. (The ordinary mortal doesn’t have 120-years to invest.)

To calculate REAL, TOTAL RETURN, we must adjust the total return formula by including “life expectancy.” 

RTR =((1+(Ca + D)/ 1+I)-1)^(Si-Lfe)

Where:

  • Ca = Capital Appreciation
  • D = Dividends
  • I = Inflation
  • Si = Starting Investment Age
  • Lfe = Life Expectancy

We assume that most individuals get serious about saving and investing around the age of 35. (Have graduated college, started a career, bought a home, have kids.) We also consider the holding period for stocks is equal to the life expectancy less the starting age. The chart below shows the calculation of total life expectancy (based on the average of males and females) from 1900-present, the average investment starting age of 35, and the resulting years until death. I have also overlaid the rolling average of the 20-year total, real returns, and valuations.

The Destruction Of Compounding

One of the significant problems with market declines is the destruction of the compounding effect of money.

We will use a simple mathematical example.

Assume an investor wants to compound returns by 10% a year over 5-years.

, The One Chart Every Millennial Should Ignore

The ‘power of compounding’ ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required.” – The One Chart Every Millennial Should Ignore

The stock market does not COMPOUND returns.

When imputing volatility into returns, the differential between what investors were promised (which is a massive flaw in financial planning) and what happens is substantial over long-term time frames.

Average And Actual Returns Are Not The Same

There is a massive difference between AVERAGE and ACTUAL returns on invested capital. Thus, in any given year, the impact of losses destroys the annualized “compounding” effect of money.

The chart below shows the difference between “actual” investment returns and “average” returns over time. See the problem? The purple shaded area and the market price graph show “average” returns of 7% annually. However, the return gap in “actual returns,” due to periods of capital destruction, is quite significant.

In the chart box below, I have taken a $1000 investment for each period and assumed the total return holding period until death. There are no withdrawals made. (Note: the periods from 1983 forward are still running as the investable life expectancy span is 40-plus years.)

The orange sloping line is the “promise” of 6% annualized compound returns. The black line represents what happened with invested capital from 35 years of age until death. At the bottom of each holding period, the bar chart shows the surplus, or shortfall, of the 6% annualized return goal.

At the point of death, the invested capital is short of the promised goal in every case except the current cycle starting in 2009. However, that cycle is yet to be complete, and the next significant downturn will likely reverse most, in not all, of those gains. Such is why using “compounded,” or “average” rates of return in financial planning often leads to disappointment.

Buy And Hold Works, Until It Doesn’t.

As stated, “buy and hold” investing works well during strongly trending market advances. Given enough time, the strategy will endure the eventual market downturn. However, three key considerations must get considered when endeavoring into such a strategy.

  1. Time horizon (retirement age less starting age.)
  2. Valuations at the beginning of the investment period.
  3. Rate of return required to acheive investment goals.

Suppose valuations are high at the beginning of the investment journey. In that case, the time horizon is too short, or the required rate of return is too high, the outcome of a “buy and hold” strategy will most likely disappoint expectations.

Mean reverting events expose the fallacies of “buy-and-hold” investment strategies. The “stock market” is NOT the same as a “high yield savings account,” and losses devastate retirement plans. (Ask any “boomer” who went through the dot.com crash or the financial crisis.”)

Therefore, during periods of excessively high valuations, investors should consider opting for more “active” strategies with a goal of capital preservation.

Important Points All Investment Strategies Should Consider

Before engaging in a “buy and hold” investment strategy, the analysis reveals essential points to consider:

  • Investors should downwardly adjust expectations for future returns and withdrawal rates due to current valuation levels.
  • The potential for front-loaded returns in the future is unlikely.
  • Your life expectancy plays a huge role in future outcomes. 
  • Investors must consider the impact of taxation, inflation, and current savings rates.
  • In a world where markets are highly correlated, MPT is likely not effective in portfolio allocation strategies.
  • Drawdowns from portfolios during declining market environments accelerate principal destruction. Plans should be made during up years to “safe harbor” capital for reduced portfolio withdrawals during adverse market conditions.
  • Over the last 12-years, the yield chase and the low rate environment have created a hazardous environment for investors. Investment strategies should accommodate for rising volatility and lower returns.
  • Investors MUST dismiss expectations for compounded annual return rates in place of variable rates of return based on current valuation levels.

There is no “one best way to invest.”

Every investor must account for the myriad of variables that will impact their investment returns and financial goals over time. Most importantly, investors must realize that surviving the eventual bear market is more important than chasing the bull market.

The “best way to invest” is the process of navigating the entire market cycle between when you start investing and when you need your capital.

“Buy and hold” strategies are the “best way” to invest until they aren’t.

Just make sure you know where you are within a given market cycle to increase your odds of success.

Is The Great September “Bear Market” Over?

Can we call the September “bear market” over? The bull market regained its strut with Friday’s surge above the 100-dma, which improves the odds of a resumption of the upward trend. It’s too early to tell if the last two weeks were just a bump in the road or something more serious.

However, as discussed in this past weekend’s newsletter:

“It is worth noting there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier, we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

We are cautious on the market momentarily However, if the MACD buy signal gets triggered later this month, such would suggest that the “seasonally strong period” is in play.

Stocks Win Streak 10-01-21, As Expected, Stocks Snap 6-Month Win Streak 10-01-21
Daily Market Commnetary

What To Watch Today

Economy

  • 10:00 a.m. ET: Factory orders, August (1.0% expected, 0.4% in July)
  • 10:00 a.m. ET: Durable goods orders, August final (1.8% in prior print)
  • 10:00 a.m. ET: Durable goods orders, excluding transportation, August final (0.2% in prior print)
  • 10:00 a.m. ET: Non-defense capital goods orders, excluding aircraft, August final (0.5% in prior print)
  • 10:00 a.m. ET: Non-defense capital goods orders, excluding aircraft, August final (0.7% in prior print)

Earnings

  • No notable reports scheduled for release

Politics

  • While Washington avoided a shutdown last week, the debt ceiling, bipartisan infrastructure deal, and reconciliation package all remain unsolved. President Biden is scheduled to give a speech at 11:15 a.m. ET.
  • Today marks the deadline for Facebook to respond to an amended complaint by the Federal Trade Commission (FTC) about the tech giant’s monopolistic tactics. A Facebook spokesman has called the FTC lawsuit “meritless.”
  • Also, the Supreme Court is back in session today. It’s already being called a “blockbuster term” with multiple landmark rulings possible in the months ahead. The court — featuring six Republican appointees to just three Democrats — could even decide to overturn Roe v. Wade.

Courtesy of Yahoo

Is Technology About To Make A Comeback

Technology shares were under a good bit of pressure over the last three weeks as interest rates rose ahead of the “debt ceiling/government shutdown” standoff. However, with that pressure now relieved with the short-term funding bill, interest rates retreated on Friday pushing Technology shares higher.

A quick chart from RIAPRO shows the S&P Technology Sector Spider (XLK) holding support at the 100-dma and oversold on a short-term basis. The last two occasions that sported a similar setup led to decent short-term trades over the next few weeks.

If we run a scan for the stocks with the “buy-rated” fundamentals, have a RIAPRO rank of “Buy” or “Strong Buy,” and are in a powerful technical trend, we find 10-candidates from the S&P 500 index. Nvidia (NVDA) and Paycom Software (PAYC) are interesting candidates from the Technology sector.

Atlanta Fed GDPNow

Today’s release of the Atlanta Fed’s GDP forecast took another big tick lower. As shown below, it now stands at 2.3% for the third quarter, down from 3.2%.

Farrell’s Rule #5 Continued

Yesterday we shared Bob Farrell’s rule #5- “The public buys the most at the top and the least at the bottom.”

Today we follow it up with evidence from Jim Colquitt at Armor Index ETFs. Jim’s graph below compares the average investor allocation to equities to S&P 500 future 10-year returns. As we see, the data is very well correlated lending credence to rule #5. Note the correlation statistics at the top left of the graph.

More importantly, current allocations to equities are more than two standard deviations above the norm. Per Jim- “Since 1952, we’ve only had 4 quarterly observations above the two standard deviation line. Each of which resulted in negative returns (CAGR) for the subsequent 10 years. We now have a 5th.”

Daily Market Commentary

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ISM Better Than Expected

The ISM national manufacturing survey was better than expected despite declines in many regional surveys. ISM Manufacturing rose to 61.1 versus estimates of 59.5 and 59.9 in the prior month.  Employment bounced back into economic expansionary territory and inventories rose, hopefully signaling the supply side shortfalls may be getting better. Prices continue to reside at very high levels. The prices subcomponent is 81.2, up from 79.4.

Higher Prices, Weaker Income, and Strong Consumption

Friday’s Personal Income and Outlays report was not welcome news for consumers. Personal Income only rose 0.2% versus 1.1% last month. The burst to personal incomes from the $5 trillion in Government stimulus has now completely reversed.

Personal Consumption Expenditures (PCE) which is a direct feed into GDP, was +0.8%, much better than last month’s revised -0.1%. Also, the price and core price indices were 0.1% above expectations and in line with last month. The PCE price index rising to 4.3% is the largest annual change since 1991. The PCE price index serves as the price deflator to calculate real GDP. The Fed’s term “Transitory” to describe the recent surge in inflation is starting to get long in the tooth!

While we still see pricing pressures in the economy due to supply change disruptions, the major economic indices are all returning to norms after the stimulus-infused spikes post-shutdown.

Global Monetary Tightening is Beginning

The chart below, from MacroMarkets Daily, shows there are now 8 of 35 central banks increasing interest rates.

Bill Farrell Rule #5

The graph below, courtesy of the Daily Shot, serves as a good reminder of Bill Farrell’s rule #5. “The public buys the most at the top and the least at the bottom.”

Inflation Greater than 3%

The graph below, courtesy of Brett Freeze, shows the Minneapolis Federal Reserve’s implied probability for inflation running greater than 3% for the next five years. The probability is derived from derivative markets. Currently, the Fed puts the odds at approximately a one-third chance inflation runs at 3% or greater. The Fed’s long-term goal is 2%. Interestingly the President of the Minneapolis Fed, Neel Kashkari, remains the most dovish member on the board. Based on those comments, he expects inflation to run well below 3%.

S&P 500 Monthly Valuation & Analysis Review – 09-30-21

S&P 500 Monthly Valuation & Analysis Review: 08-31-21

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

Daily Market Commnetary


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.

As Expected, Stocks Snap 6-Month Win Streak

In this 10-01-21 issue of” ‘As Expected, Stocks Snap 6-Month Win Streak.

  • Stocks Snap 6-Month Win Streak, What’s Next?
  • Why We Are Buying Bonds
  • Not Out Of The Woods Just Yet
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Is It Time To Get Help With Your Investing Strategy?

Whether it is complete financial, insurance, and estate planning, to a risk-managed portfolio management strategy to grow and protect your savings, whatever your needs are, we are here to help.

Schedule your “FREE” portfolio review today.


Stocks Snap The 6-Month Win Streak. What Happens Next?

In mid-August, we discussed the rarity of markets churning out 6-positive months of returns in a row. To wit:

“Using Dr. Robert Shiller’s long-term nominal stock market data, I calculated positive monthly returns and then highlighted periods of 6-positive market months or more.”

Market Months, Technically Speaking: 6-Positive Market Months. What Happens Next?

Importantly, all periods of consecutive performance eventually end. (While such seems obvious, it is something investors tend to forget about during long bullish stretches.)

The data shows that nearly 40% of the time, two months of positive performance gets followed by at least one month of negative performance. Since 1871, there have only been 12-occurrences of 6-month or greater stretches of positive returns before a negative month appeared.

For September, the S&P turned in a negative 4.89% return. While the decline was average for a market correction period, the financial media made it sound like the market just “crashed.”

These types of headlines tend to drive investors to make emotional decisions. However, while it appears the market won’t quit declining, the correction was much needed.

Daily Market Commnetary

Seasonally Strong Period Approaches

With the market now pushing into 3-standard deviation territory below the 50-dma and oversold technically on other measures, the reflexive rally on Friday was not surprising.

As noted in our daily commentary (subscribe for free email delivery):

“We agree with Stocktrader’s Almanac:

“Many of the same geopolitical, political, fundamental, and technical headwinds we highlighted in the September and October Outlooks remain present. Congress passed the funding bill to avert a government shutdown just before the market closed today ahead of the September 30 midnight deadline. The biggest risk to the market remains the Fed. An uptick in taper talk or chatter about the Fed raising rates ahead of schedule could trigger another selloff.”

However, it is worth noted there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

The rally back above the 100-dma on Friday was strong and sets up a retest of the 50-dma. If the market can cross that barrier we will trigger the seasonal MACD buy signal suggesting the bull market remains intact for now.

“Seasonality is alive and well. So we stick with system. “ – Stocktrader’s Almanac

If you didn’t like the recent decline, you have too much risk in your portfolio. We suggest using any rally to the 50-dma next week to reduce risk and rebalance your portfolio accordingly.

While the end of the year tends to be stronger, there is no guarantee such will be the case. Once the market “proves” it is back on a bullish trend, you can always increase exposures as needed. If it fails, you won’t get forced into selling.



Lessons To Learn From The Recent Decline

As noted, we expected the recent decline and previously discussed raising cash and reducing risk. Such allowed us to weather to correction without losing (too much) sleep at night. However, for most, the recent decline brought to light just how much risk exposure many have in portfolios.

While the decline was minimal, many investors suffered damage far more significant than the overall market decline. Such came from two sources:

  1. For those “doing it themselves,” much of the damage came from more speculative stocks investors piled into to chase market returns.
  2. Individuals who had financial advisors, also suffered damage as they put their “financial advisors” into the position of chasing market returns or suffering career risk. 

Such should not be surprising. I consistently meet with individuals who swear they are conservative when it comes to investing. They don’t want to take any risk but require S&P 500 index returns. 

In other words, they want the impossible:

“All of the upside reward, but none of the downside risk.” 

The lesson we seem to need to learn continually is the understanding of risk. The demand for performance above what is required to reach our goals requires an exponential increase in risk. When clients demand greater returns, such forces advisors to “chase returns” rather than “do what is right” for the client. 

For the advisor, such leads to “career risk.” Specifically, if the advisor doesn’t acquiesce to client demands, they lose the client to another advisor who promises the impossible.

Such is why “buy and hold” index investing has gained such popularity with advisors. If the market goes up, clients get market returns. When the market crashes, the excuse is,

“Well, no one could have seen that coming. But remember, it’s ‘time in the market’ that matters.”

Media Driven Hype

While the advisor takes no liability for giving clients average performance, the client loses the ability to reach their financial goals.

“But if I had been conservative, I would have missed out on the bull market.” 

Almost daily, there is some advisory firm, financial media type, etc., suggesting that you need to buy and hold an S&P 500 index fund if you want to get rich.

During bull markets, such advice certainly seems sound. But, unfortunately, during bear markets and even near 5% corrections, the error of excessive risk becomes prevalent.

The truth is that a more conservative approach to investing can not only get you to your financial goals intact but can do so without triggering the numerous emotional mistakes that lead to worse outcomes.

Shown below is the total inflation-adjusted return of stocks versus bonds. Since 1998, the difference between a 100% stock versus a 100% bond portfolio is just $50. More importantly, during the two major bear markets, an all bond portfolio vastly outperformed with much lower volatility.

A 60/40 blend performed substantially better than an all-stock portfolio and currently only lags by $18. An all-bond portfolio outperformed an all-stock portfolio until 2019. That underperformance will likely revert to outperformance over the next decade.

It is hard to resist getting caught up in an accelerating market.

However, remember that while the cost of entry into the casino is cheap, the exit can be expensive.

Things You Can Do To Perform Better (And Sleep At Night)

Here are the core principles we use with every one of our clients.

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

Markets are not cheap by any measure. If earnings growth continues to wane, economic growth slows, not to mention the impact of demographic trends, the bull market thesis will fail when “expectations” collide with “reality.” 

Such is not a dire prediction of doom and gloom, nor is it a “bearish” forecast. It is a function of how the “math works over the long term.”


In Case You Missed It


Not Out Of The Woods Just Yet

Yes, September was a rough month for the market. However, as we noted previously, a 5-10% correction would “feel” much worse due to the high levels of complacency. Judging by the amount of “teeth-gnashing” on the financial media, you would have thought the roughly 4% correction for the month was a massive bear market.

With the recent sell-off working off some short-term overbought conditions, the market is now better positioned for the “seasonally strong” period. As shown, while October can also tend to be a weaker month, it tends to be stronger than September. November and December are usually well into the green.

However, such is not a guarantee. The end of 2018, as the Fed was tapering its balance sheet and hiking rates, was not a positive experience for investors.

While the Fed is likely many months away from hiking interest rates, they are some very definite headwinds facing stocks into year-end.

  • Valuations remain well elevated.
  • Inflation is proving to be much sticker than expected.
  • The Fed will likely move forward with “tapering” their balance sheet purchases in November.
  • Economic growth continues to weaken
  • Corporate profit margins will shrink due to higher inflationary pressures.
  • Earnings estimates will get revised downward keeping valuations elevated.
  • Liquidity is contracting on a global scale
  • Consumer confidence continues to wane

While none necessarily suggest a more significant correction is imminent, they will make justifying current valuations more difficult. Moreover, with market liquidity already very thin, a reversal in market confidence could lead to a more significant decline than currently expected.

Such is why we have been adding bonds as of late.

Bob Farrell’s Rule #5

Bob Farrell once quipped that investors tend to buy the most at the top and the least at the bottom. Such is simply the embodiment of investor behavior over time.

Our colleague, Jim Colquitt of Armor ETFs, reminded us of that axiom with a recent post.

The graph below compares the average investor allocation to equities to S&P 500 future 10-year returns. As we see, the data is very well correlated, lending credence to rule #5. Note the correlation statistics at the top left of the graph.

More importantly, current allocations to equities are more than two standard deviations above the norm. Per Jim:

Since 1952, we’ve only had 4 quarterly observations above the two standard deviation line. Each of which resulted in negative returns (CAGR) for the subsequent 10 years. We now have a 5th.”

Over the next decade, there is a genuine possibility that bonds will provide a higher return than equities on a “buy and hold” basis.

Such is something worth considering.



Portfolio Update

We discussed last week that after taking profits in August and raising cash, we slowly started adding back into our equity holdings. The recent spike in bond yields also allowed us to increase the duration of our bond portfolio this week.

We agree with Societe Generale’s view this week:

From return ‘on’ capital, to return ‘of’ capital. In the wise words of Dr. Dre, ‘Remember, anybody can get it, the hard part is keeping it.’ Investor portfolios have seen exceptional returns over the past 18 months to such an extent that the pension funding ratios (asset to liability ratio) in the US are only slightly below 100%.

The natural reaction to finding oneself in this situation is to 1) move out some allocation from risky assets to bonds, or 2) increase the hedging activity if one chooses to keep exposure to risky assets. The incessant demand for hedging and the high levels of skew are not surprising when viewed through this lens.”

We are still slightly underweight equities, slightly overweight in cash, and our duration is shorter than our benchmark. While we are looking for a market recovery through the end of the year, we are not drastically increasing our risk exposure. If we are wrong and the market breaks vital support levels, we can reverse our positioning.

For now, we are giving the market the benefit of the doubt. However, we are keeping our positioning on a very short leash. With valuations still elevated, the technical deterioration of the market remains a primary concern.

If the markets cannot regain their footing heading into October, we will begin looking to increase our hedges and reduce risk accordingly.

Have a great weekend.

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” are oversold. The current reading is 50.96 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

Our “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 55.5 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market. (Ranges reset on the 1st of each month)
  • 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

The markets continued to struggle this week as threats of a debt default lingered in the air. While the pressure was relieved somewhat on Thursday afternoon with Congress passing a “Continuing Resolution” to fund the government, quarter-end portfolio selling kept a lid on prices.

With markets pushing into deeply oversold territory on a short-term basis, the reflexive rally on Friday could extend into next week. We will evaluate our positioning on that rally and rebalance risks as needed.

We continue to be mindful of the risk exposure the portfolio has currently, but we are also entering into the seasonally strong period of the year. With a much-needed correction now behind us, we don’t want to get too conservative just yet, particularly as global money flows remain exceptionally strong currently.

Asset flows will eventually slow, particularly as Central Banks starting tightening monetary policy in 2022. However, we aren’t there just yet. There will be a point to become very defensive, and we will drastically reduce our equity risk. However, the bullish bias remains for now, even though the recent correction may have dented it just a bit.

We continue to monitor our portfolios closely. However, if you have any questions, do not hesitate to contact us.

Portfolio Changes

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

*** Trading Update – Equity and Sector Models ***

“As noted in this morning’s Daily Commentary, the recent spike in interest rates has given us a decent opportunity to add to our longer-duration bond portfolios. We have an article coming out on Friday discussing the history of “debt ceiling” debates and the outcome for bonds. With bonds bouncing off support at the 200-dma and oversold, such has historically provided a decent entry point to add exposure.” – 09/29/21

Equity & ETF Models

  • Add 1% to both IEF and TLT respectively.

As noted in this morning’s Daily Commentary, with the market triggering its “money-flow” buy signal, we are continuing to increase our exposure in both models. This morning we added a bit more to our Utility exposure which increases our overall portfolio dividend yield and gives us a bit of defensive positioning. We also increased our stakes in energy and financials.” – 09/27/21

Equity Model

  • Add 1% to DUK, XOM and JPM bringing total portfolio weight to 2% each. 

ETF Model

  • Add 1% to the current holdings of XLE, XLU, and XLF 

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors



Attention: The 401k plan manager will no longer appear in the newsletter in the next couple of weeks. However, the link to the website will remain for your convenience. Be sure to bookmark it in your browser.

Commentary

On Thursday, the market retested its recent peak to trough correction of 5%. However, as discussed previously, such a correction is within the norms for any given market year. However, since we remain in a very low volatility market this year, we warned the correction would “feel” worse than it was.

With the correction complete, and markets very oversold short-term, portfolio allocations can remain at current levels. Cash that accumulated over the past few weeks can now get deployed to allocations. Also, rebalance your bonds back to weightings after the recent rise in rates.

We are moving into the seasonally strong period of the year, so we want to be positioned accordingly. Keep exposures primarily allocated to domestic equity and reduce mid-and small-cap exposure accordingly. Very likely, we are going to see a rotation into large-cap equities as earnings come under pressure from slower growth, higher inflation, and the Fed taper.

There is no need to be aggressive here. There is likely not a lot of upside between now and the end of the year.

Model Descriptions

Choose The Model That FIts Your Goals

Model Allocations

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

Or, let us manage it for you automatically.


401k Model Performance Analysis

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.

Have a great week!

Cartography Corner – October 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


The Cartography Corner

October 2021

By: J. Brett Freeze, CFA

www.globaltechnicalanalysis.com

September 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESZ1) during September 2021. In our September 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                4860.50

o M1                4662.00

o M3                4651.50

o PMH             4542.25

o Close            4520.50           

o M2                4471.50

o MTrend        4350.67     

o PML              4347.75       

o M5                4273.00

Active traders can use PMH: 4542.25 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 September 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The intra-session highs of the first four trading sessions tested, and exceeded on September 3rd, our isolated pivot level at PMH: 4542.25.  However, the market price never settled above that level.

Over the following three trading sessions, the market price declined to, and through, our first isolated support level at M2: 4471.50.  That support level acted as a magnet for the next four sessions, with the intra-session highs exceeding it yet settling below.  Energy was building for the next move.  On September 17th, the market price began a (3.82%, close-to-low) two-session descent.  The intra-session low of September 20th stopped 0.48% short of our isolated Monthly Downside Exhaustion level at M5: 4273.00.  The market price settled that session amid our isolated clustered support levels at MTrend: 4350.67 and PML: 4347.75.  (If bearishly inclined, not achieving the Downside Exhaustion Level is a good outcome.  The reason is that the signal was not triggered to anticipate a two-month high over the following four to six months.)

Over the following five trading sessions, the market price rallied 1.95% close-to-close.  The intra-session high at the peak of the rally on September 27th was on top of our first isolated support level at M2: 4471.50, now acting as resistance.  Hmmm.

The final three trading sessions saw the market price roll over again, pausing at clustered support levels at MTrend: 4350.67 and PML: 4347.75, before descending again towards our isolated Monthly Downside Exhaustion level at M5: 4273.00. 

Figure 1:

Random Length Lumber

We continue with a review of Random Length Lumber Futures (LBX1) during September 2021.  In our September 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                800.00

o MTrend        700.37

o PMH             650.00

o Close            533.40

o WTrend        504.48

o PML              462.00              

o M1                447.60       

o M3                445.60

o M2                424.00       

o M5                71.60

Active traders can use WTrend: 504.48 as the initial pivot, maintaining a long position above that level and a flat or short position below it.  As the weeks of September progress, continue to use the updated Weekly Trend as the pivot.  A retracement up to Monthly Trend is the initial target.

Figure 2 below displays the daily price action for September 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first four trading sessions in September saw the market price ascend to 695.00, just shy of our isolated target at MTrend: 700.37.  Also, for the entirety of September, the market price did not have a weekly settlement below Weekly Trend. 

The remainder of September saw the market price consolidate within a 97-point range.   

Figure 2:

October 2021 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESZ1).  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Weekly Trend         4438.52        

o Monthly Trend        4398.39

o Daily Trend             4352.67        

o Current Settle         4297.75        

o Quarterly Trend      4135.58

The relative positioning of the Trend Levels is bearish.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for six quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Below Trend: 1 Months”, settling below Monthly Trend for the first time in eleven months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Down”, with three consecutive closes below Weekly Trend.

Is the bull market over?  Within our framework, only Quarterly Trend prevents us from answering “yes”.  Given the 20-day Average True Range of 54.04 points, Quarterly Trend can be broken in the next three trading sessions.  Is that highly probable, no, but it gives the correct context of just how close the market price is.  Our fundamental work on growth, the inverse relationship between P/E multiples and inflation, and the immediate path of monetary policy (domestic and international), collectively, affirm the recent price action… as if an inflection point has been crossed.   

Support/Resistance:

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

o M4                4747.25

o M1                4552.75

o PMH             4547.50

o MTrend        4398.39

o Close            4297.75           

o PML              4293.75

o M2                4239.75     

o M3                4075.00       

o M5                4045.25

Active traders can use MTrend: 4398.39 as the pivot, maintaining a long position above that level and a flat or short position below it.

Bitcoin Futures

For October, we focus on Bitcoin Futures.  We provide a monthly time-period analysis of BTV1.  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Weekly Trend       45,815           

o Quarterly Trend    44,891

o Current Settle       43,615           

o Monthly Trend      42,485           

o Daily Trend           42,201

The relative positioning of the Trend Levels is in the early stages of transitioning from bullish to bearish.    Think of the relative positioning of the Trend Levels like you would a moving-average cross.  As can be seen in the quarterly chart below, bitcoin is “Trend Up”, having settled six quarters above Quarterly Trend.  Stepping down one time-period, the monthly chart shows that bitcoin is “Above Trend: 2 Months”, having settled two months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that bitcoin is “Trend Down”, having settled below Weekly Trend for three weeks.

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 month of May to anticipate a two-month high within the next four to six months.  That high was achieved in August.  The signal was given in 1Q2021 to anticipate a two-quarter low within the next four to six quarters (now two to four).  That low can be achieved this quarter with a trade below 28,840.  The Quarterly Downside Exhaustion level for this quarter is effectively zero.  As you snicker… the last time our work suggested a negative Downside Exhaustion level, WTI Crude Oil traded negative.   Is that highly probable, no, but we keep an open mind. 

It appears that the pressure on “risk” assets is increasing.  While we are not certain that the bull market is complete, we do warn a regime change is looking more probable from our technical viewpoint as well as from a fundamental perspective.    

Support/Resistance:

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

o M4                68,950

o M1                55,605

o PMH             53,125

o Close            43,615

o M2                43,038

o MTrend        42,485                    

o PML              40,169              

o M3                39,840

o M5                29,693

Active traders can use MTrend: 42,485 as the initial 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.

 

Technical Value Scorecard Report – Week Ending 10-01-21

Relative Value Graphs

  • Yesterday’s generals, the FAANG stocks, are leading the way lower. Only two sectors had negative excess returns versus the S&P 500 last week. They were technology giving up 1.39% and healthcare losing 0.22% to the S&P, respectively.
  • Value/cyclical stocks outperformed on a relative basis. The energy sector led the way, up 2.3%, while the S&P gave up 3.3%. Among the other relative outperformers were industrials, financials, and transportation. While early, the market is signaling a rotation to a reflationary bias. The third graph below shows our inflationary index has picked up about 7% on the deflationary index over the last few weeks. The rotation is not confirmed, as the bond market’s 5-year implied inflation rate is stable at 2.50%.
  • As far as relative scores, the cyclical, inflationary sectors are now to the left side of the graph with the highest relative scores. Oddly missing is the materials sector. It is struggling in part due to China’s slowing growth. China is the world’s largest user of many metals.
  • The factor/index scores paint a similar story, with small and mid-caps posting high scores. Both small caps, transportation, energy, and financials, have scores at or above 50%. While overbought, they may have more room to run on a relative basis.

Absolute Value Graphs

  • Energy’s outperformance is highlighted in the absolute charts. Despite a poor week in the markets, its absolute score increased to 50%. Like in the relative charts, it is overbought but has room to run higher.
  • Healthcare, industrials, materials, and staples stocks are the most oversold. The score on industrials fell despite its relative outperformance versus the market. The sector is down about 2.5% this month, while the S&P is approximately 4% lower.
  • All factors/indexes are now in oversold territory. None, however, are oversold enough to warrant buy signals.
  • The S&P 500 absolute score is now -40%. As shown in the bottom right graph of the absolute section, it is the most oversold in a year. The market is likely due for a bounce. Whether it’s a temporary bounce or a move back to its highs is up for consideration. The trend is the bull market’s friend, but this sell-off looks different than prior short-lived ones over the last year.
  • The fourth table below provides another reason to suspect a bounce of sorts is ahead. 8 of the 12 sectors are extended beyond two standard deviations from their 50 dma. However, they are not nearly as deviated from the more critical 200dma.   

Users Guide

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

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

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

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)

Stock Futures Slump To Kick Off The Seasonally Strong Period.

Stock futures slump to kick off the seasonally strong fourth quarter of the year. As expected, the market did sell off to the 5% correction level in September, as discussed in August. We do not expect a major correction in October, but a further correction is possible with the 200-dma the likely limit of that decline. That would be in the vicinity of the 10% decline from the recent August/September highs noted previously.

It is important to keep emotions under control and maintain the proper perspective of the current correction. Such can be difficult with the media pumping headlines about the correction, making it seem like we are in the middle of a full-on crash. However, this remains a well-controlled, normal, and needed correction to work off the recent overbought conditions.

As noted, with markets now very oversold, we are watching for the next MACD buy signal to suggest the seasonally strong period of the year is getting underway. However, while we are maintaining a more optimistic outlook momentarily, we are well aware of the risks and the numerous headwinds ahead.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Personal income, August (0.2% expected, 1.1% in July)
  • 8:30 a.m. ET: Personal spending, August (0.7% expected, 0.3% in July)
  • 8:30 a.m. ET: Personal consumption expenditures core deflator, month-over-over, August (0.2% expected, 0.3% in July)
  • 8:30 a.m. ET: Personal consumption expenditures core deflator, year-over-year, August (3.5% expected, 3.6% in July)
  • 9:45 a.m. ET: Markit manufacturing PMI, September final (60.5 in prior estimate)
  • 10:00 a.m. ET: Construction spending, month-over-month, August (0.3% expected, 0.3% in July)
  • 10:00 a.m. ET: University of Michigan sentiment, September final (71.0 expected, 71.0 in prior print)
  • 10:00 a.m. ET: ISM Manufacturing, September (59.5 expected, 59.9 in August)

Earnings

  • No notable reports scheduled for release

Politics

  • A government shutdown was averted after Congress passed a bill to keep the lights on and President Biden signed it into law just hours ahead of last night’s midnight deadline. The new government funding is effective today but only lasts until Dec. 3.
  • Also, late last night, U.S. House of Representatives Speaker Nancy Pelosi delayed the vote on the $1.2 trillion infrastructure bill as moderates and liberals in her caucus failed to come to an agreement on the measure that had passed the Senate with bipartisan support. Biden is set to continue working the phones to push lawmakers to reach an agreement on the infrastructure bill and the larger package of social spending.

Watching For A MACD Buy Signal

We agree with Stocktrader’s Almanac this morning:

“Many of the same geopolitical, political, fundamental, and technical headwinds we highlighted in the September and October Outlooks remain present. Congress passed the funding bill to avert a government shutdown just before the market closed today ahead of the September 30 midnight deadline. The biggest risk to the market remains the Fed. An uptick in taper talk or chatter about the Fed raising rates ahead of schedule could trigger another selloff.”

However, it is worth noted there are two primary support levels for the S&P. The previous July lows (red dashed line) and the 200-dma. Any meaningful decline occurring in October will most likely be an excellent buying opportunity particularly when the MACD buy signal gets triggered.

“Seasonality is alive and well. So we stick with system. “ – Stocktrader’s Almanac

How to Play the Dodging Debt Game

Stocks Worth Watching

A quick screen of the S&P 500 stocks on RIAPRO with the strongest relative strength AND the strongest trends turns up some interesting candidates to watch for a potential buying opportunity.

QE Is In The Budget Fray

As if the Democrats did not have enough trouble passing a budget deal, they have a new hurdle per the headline below. Fed independence continues to weaken as it is now a pawn in the budget battle.

MANCHIN TOLD SCHUMER HE WANTED THE FED TO END QE AS A CONDITION FOR A BUDGET DEAL

Chip Shortage For Autos

Want to know why production at most major auto manufacturers is being sharply reduced? The Bloomberg illustration below shows the average car uses 1,400 chips. Some estimates claim the chip shortage may not be fully resolved until 2023.

Lost Productivity

Yesterday we published China Plays The Long Game While The U.S. Blows Bubbles. The article discusses recent actions China is taking to boost productivity. Also, in the article, we criticize the U.S. and other capitalistic countries for failing to prioritize productivity. For example: “For the better part of the last five years, S&P 500 companies have given back to investors via dividends and buybacks about 100% of their earnings. Why not? Executives are paid handsomely to boost share prices today, not to be more productive and profitable in the future.

To further emphasize the point we share the Fidelity graph below which breaks down buybacks by industry. Since 2004, U.S. companies have spent $11 trillion to buy back their own shares. Instead, imagine if they invested $11 trillion into productive ventures. Corporate earnings, economic growth, and wages would certainly be higher today and more sustainable.

Claims on the Rise

Initial Jobless Claims rose for a third week in a row to 362k. We are not overly concerned with the recent increase as there are seasonal aspects and hurricane Ida affecting hiring/firing patterns. However, we do not want to see the recovery in claims stop at this relatively high level. Prior to the pandemic, initial claims ran in the low 200k range.

Dollar Breakout?

The dollar was up over .60 cents yesterday and is now hitting formidable resistance as we show below. The dollar appears to be forming a head and shoulder bottom. Based on the pattern, a breakout above the red resistance line (neckline) might likely result in the dollar index moving up another $5. Commodities and possibly equities are at risk if that occurs.

Stocks and Bonds Travelling Together

Bonds typically fall in yield during measurable declines in the stock market, making them a great diversifier. The graph below shows that on average, annual “sell-offs” over the last ten years saw bonds rise in price. That is not the case in 2021. It’s early to claim bonds will not diversify equities if the current decline continues, but it bears watching.