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

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


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

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

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

Gamma Band Update 09/21/20

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

Smart Money Residual Index

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

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

SPX Skew – the Price of Protection

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

Gamma Band Background

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

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

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

Authors

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

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

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


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

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

This Time Is Different

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

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

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

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

Investing Versus Speculation

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

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

Let me give you an example:

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

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

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

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

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

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

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

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

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

The Discounting Of Value

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

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

Such is also the purest definition of market speculation.

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

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

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

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

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

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

Why Value Investing Wins The Long-Game

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

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

What Is A “Margin Of Safety”

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

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

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

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

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

An Example Of Intrinsic Value

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

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

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

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

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

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

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

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

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

Art Of Doing Nothing

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

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

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

There are two critical takeaways from the graph above:

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

Mirror Opposites

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

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

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

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

The Art Of Doing Nothing

Such was a point Jesse Felder recently noted:

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

His comment defines “investment” versus “speculation.” 

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

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

Conclusion

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

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

I agree with Jesse’s conclusion:

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

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

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

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

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

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

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

Major Market Buy/Sell Review 09-21-20

S&P 500 Index

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

Dow Jones Industrial Average

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

Nasdaq Composite

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

S&P 600 Index (Small-Cap)

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

S&P 400 Index (Mid-Cap)

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

Emerging Markets

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

International Markets

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

West Texas Intermediate Crude (Oil)

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

Gold

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

Bonds (Inverse Of Interest Rates)

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

U.S. Dollar

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

The Pre-Election Correction Continues, Is It Over?


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

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

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

Catch Up On What You Missed Last Week


The Correction Continues

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

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

However, we also said:

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

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

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

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

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

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

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

Presidential Elections & Market Outcomes

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

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

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

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

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

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

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

Will Policies Matter

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

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

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

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

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

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

The Great Divide

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

Such is particularly the case today.

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

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

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

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

It’s Not A Risk-Free Outcome

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

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

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

These risks are all undoubtedly possible.

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

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

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

Portfolio Positioning For An Unknown Election Outcome

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

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

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

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

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

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

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

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


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

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

Weekly Stock Screens

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

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

S&P 500 Growth Screen

Value Screen

Technical Trading Screen


Portfolio / Client Update

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

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

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

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

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

Portfolio Changes

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

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

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

There were no changes to the ETF Portfolio this week.

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

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

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

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

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

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

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

Commentary 09-18-20

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

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

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

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

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

Overview

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

Pros

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

Cons

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

Key Assumptions

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

Sensitivity Analysis

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

Technical Snapshot

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

Value Seeker Report Conclusion On PETS

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

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

#MacroView: Newton, Physics & The Market Bubble

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

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

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

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

The South Sea History

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

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

Interesting Absurdities

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

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

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

A Speculative Mania

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

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

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

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

Newton’s Folly

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

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

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

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

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

History Never Repeats, But It Rhymes

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

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

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

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

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

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

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

The Speculative Cycle

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

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

The full cycle is shown below.

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

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

The Latest Mania

Let’s go back to Andy for a moment:

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

We have seen these manias repeated throughout history.

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

In 2020?

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

See any similarities.

Yes, that’s Tesla

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

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

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

This Time Is Different

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

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

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

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

Fixing The Cause Of The Crash

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

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

I previously quoted Bob Bronson on this point:

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

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

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

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

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

Yes, this time is different.

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

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

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

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

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


We Need You To Manage Our Growth.

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

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

What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 09-18-20


What You Missed: Video Of The Week

What Fed Said And Didn’t Ssay

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



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

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

TPA Analytics: Economist Explains Why Economy May Be Rough


Note from the RIAPro Team:

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

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

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

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

Using RIAPro To Screen For Value

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

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

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

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

Screen For Value

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

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

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

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

Understanding The “Score” Systems

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

Piotroski “F” Score

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

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

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

Profitability

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

Leverage, Liquidity, and Source of Funds

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

Operating Efficiency

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

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

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

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

Mohanram “G” Score

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

Growth Signals

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

Stability Signals

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

Accounting Conservatism

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

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

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

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

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

Such is where the RIAPro Rank comes into play.

RIAPro Rank

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

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

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

Putting In All Together

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

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

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

Digging In

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

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

You can also use the “scan” page streamline your choices further by adding in “technical overlays” such as moving averages, performance, volatility, momentum, etc.

Conclusion

In the coming months, we will be adding a variety of other screening options to help you deepen your research further. We will also provide more models from which you can choose and follow.

Screening for value in the current market environment is challenging. As noted in our recent articles, there is currently a deep underperformance of “value stocks.” If you are focused more on short-term growth, you may want to concentrate your scans on more “technical factors.”

However, if you do choose to go down the “value” path, you are going to have to be very patient and follow some basic rules.

  1. Understand that your performance relative to the market will lag in the short-term. 
  2. Despite a stock being a “fundamental value,” such does not mean you can abandon “risk” management and capital preservation strategies. (Maintain stop levels)
  3. Realize that some value stocks may well turn out to be “value traps.” Such is always a danger when digging into companies that appear to fundamentally cheap but aren’t. 
  4. Lastly, start small into your positions and add to them as your fundamental and value thesis begins to show positive results. Then scale “up” into the position over time.

I hope you find this guide useful.

If you have comments or suggestions for additional features or guides, please email us.

Growth or Value? Take Our Blind Taste Test

Growth or Value? Take Our Blind Taste Test

Given limited resources, it should be no surprise that we aim to maximize the value of our everyday purchases. In most cases, we seek to optimize between acquiring the best product at the most reasonable price.

Intriguingly, most investors do not apply the same discretion when investing their hard-earned wealth. Think about the problem: we seek value when we spend our wealth, but few seek value in protecting and growing their wealth.

In this article, we give a blind taste test. From this, we hope to show you how the lack of discernment, blindly picking stocks based on cache, and yesterday’s momentum is winning out over the logic of maximizing value through prudent intellectual rigor.

Blind Taste Test

Imagine going to your favorite winery and being presented with three bottles of wine. The bottles do not have labels or prices. You smell each wine’s aroma and then take a sip from each bottle. After the tasting, you decide to buy the bottle of wine you like the most.

The vintner then shares with you the price of each bottle. Taste and cost are the two factors that you must weigh to make a decision. Wine snobs may disagree, but to be honest, do you need anything more to buy a bottle of wine? While impossible to quantify, most people will unknowingly compute a ratio of sorts comparing the taste to price. The ratio will likely dictate the decision-making process.

Our wine buying calculus may look something like the table below. The taste scale is from 1 to 10, 1 for the worst, and 10 for the best.

The ratio column allows us to compare price to taste. The wine with the lowest ratio is the one, by our assessment, that provides the best taste per dollar. Which wine would you choose?

We opt for wine B. While it’s not the cheapest, it is the tastiest. Importantly, it gives us the most value per dollar.

Blind Equity Valuations

Now, let’s do a similar exercise comparing three stocks.

Instead of using a price to taste ratio, as above, we provide a host of fundamental data and ratios to help you pick a favorite. We leave out the names of the companies and the stock tickers.

Put your imaginary blindfold on and pick your favorite stock.

Stocks A and B are in the retail trade, and stock C is in the medical industry. Specifically, stock A is classified by Zack’s as Retail/Restaurants, stock B as Retail/Pharmacies, and stock C as Medical/Biomedical and Genetics.

Ownership of stocks, just like ownership of any corporation, represents a claim on the future earnings and cash flows of the company. As such, we share recent revenue and net income growth trends of the three companies.

We now have some appreciation for sales and earnings trends over the last decade. You can think of this to some degree as taste. The table below offers more clues about “taste” as well as price and value.

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

The Moment of Truth: Pick a stock

Now comes the moment of truth. We gave you a sample of three companies. We fully recognize you are missing insight into each company’s prospects. With that said, these are well-established companies in very competitive businesses. Trends of the past five and ten years should provide useful guidance for future growth.

Now pick the stock you would prefer to own.

Did you pick the stock with the surging stock price, high momentum score, and extreme valuation ratios? Or did you choose from one of the two others with cheap valuations, decent dividend yields, yet poor price performance?

If the object was to pick the stock that did the best in prior periods, the answer is easy. You, however, now must select the stock most likely to provide the best returns in the future.

Which one gives you the most value for the money?

Remove Your Blindfold

  • A is Chipotle (CMG).
  • B is CVS (CVS).
  • C is Bristol Meyers (BMY).

Summary

Like wine, investors have their preferences for types of stocks. We know the allure of chasing a stock like CMG is powerful. Who does not want triple-digit gains? If we could invest in hindsight, we would all choose CMG. Unfortunately, all gains and losses are in the past. We can only look forward and try to assess which stocks will provide us with the greatest reward per dollar cost in the future. Most frequently, that strategy also includes protection against steep losses.

With CMG’s lofty valuations and relatively weak earnings and revenue trends, is it worth paying many multiples of the cost of CVS and BMY? Maybe CMG investors are banking on a surge in sales and a sharp reduction in their competition. Possibly there are new bestselling products or innovative product lines to which they will shift. If so, CMG may be at a more reasonable price than we portray. One thing is sure, CMG must sell a lot of burritos to justify their current valuation.

From a pure momentum-based short-term (speculative) trading perspective, CMG may be worth reviewing. However, to maximize the value of our investment dollars in the longer run, we vastly prefer value stocks like CVS or BMY.

Sector Buy/Sell Review: 09-15-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 09-15-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine not only decision making about what to own and when, but what sectors to overweight or underweight to achieve better performance.

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

There are three primary components to each chart below:

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

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

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

SECTOR BUY/SELL REVIEW: 09-15-20

Basic Materials

  • Looking at XLB, you would not guess we were in an economic recession. Nonetheless, XLB is outperforming the S&P 500 index for the first time in a long while.
  • With XLB pushing into very overbought conditions with a historically high “buy signal,” there seems to be a lot less reward in the sector currently. 
  • It isn’t advisable to chase the sector currently. Look to buy on dips and short-term oversold conditions.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
    • Stop-Loss moved up to $60
  • Long-Term Positioning: Bearish

Communications

  • We noted previously that “XLC has pushed into extremes with the largest deviation from the 200-dma in its history, 3-standard deviations above the 50-dma, and the most overbought buy signal ever. A correction is coming. It is just a question of “when” and “what causes it.”
  • We suggested taking profits and reducing risks, and that correction has now happened. 
  • Currently, XLC is trying to hold the 50-dma but has not become oversold as of yet.
  • Adding a trading position is possible with a very tight stop at $58.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Reduced position by 1%. Will continue doing so until a correction occurs.
  • Long-Term Positioning: Bearish

Energy

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

Financials

  • Financials continue to underperform and remain a sector to avoid currently.
  • However, XLF did hold up better than the market during the recent decline. 
  • As noted previously, the 200-dma continues to be a problem for XLF.
  • The bit of pickup on rotation was disappointing, and banks remain out of favor for now.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • Industrials remain extremely extended and overbought.
  • Like materials, industrials are well ahead of the underlying fundamentals. We have grossly reduced our exposure to the sector and are looking for a better opportunity to add back to our position.
  • As suggested previously, take profits and rebalance risk. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bearish

Technology

  • Technology stocks, and the Nasdaq, have finally started the long-overdue correction. 
  • While the sector remains overbought and extended well above long-term means, the index is trying to hold the 50-dma and the breakout support of the upper bullish trendline. 
  • We used the pullback to add mildly to our technology positions after taking profits previously. These are “rental trades” we will sell into any short-term rally. 
  • The risk remains to the downside for now.
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Added 1% to XLK previously.
  • Stop-loss set at $105
  • Long-Term Positioning: Bullish

Staples

  • As noted previously, “XLP is overbought and is trading at 3-standard deviations above the mean. A correction is coming; timing is the only question.”
  • That correction came but has likely not concluded as of yet. XLP remains elevated above both short and long-term means. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $60 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Sold PG and added slightly to CLX
  • Long-Term Positioning: Bullish

Real Estate

  • XLRE has triggered a buy signal and is holding support at the 200-dma. 
  • We added some exposure back to REITs previously, and we expect some offsetting pickup if the rest of the market begins to correct. 
  • Move stops up to $35.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Looking to add more the XLRE if the sector maintains performance.
  • Long-Term Positioning: Bullish

Utilities

  • XLU has been struggling with resistance at the 200-dma.
  • However, Utilities are holding support at the 50-dma, and we expect we should see a pick up in performance if interest rates pull back. 
  • The sector is oversold and is potentially in a better position relative to other sectors of the market, particularly for “defensive” positioning.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV finally corrected back to the 50-dma and is holding. 
  • With the sector back to oversold short-term, there is a tradeable opportunity. 
  • Trading positions are possible. Put a stop at $104.
  • The 200-dma is now essential support for XLV and needs to hold, along with the previous tops going back to 2018. 
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • XLY continues to trade at extremes and is at the most significant deviation from its 200-dma in history. 
  • The same goes for its buy signal. 
  • I have no idea what trips this sector up, but it is coming, and the correction will be substantial. For now, the sector continues to hold up as the chase for AMZN continues.
  • Take profits and hedge risk. 
  • Stop-loss set at $130
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • The rally in XTN remains exceptionally extended. 
  • The sector is performing better but is grossly overbought. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and will wait for a correction to add back to our holdings. 
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Bearish

Technically Speaking: Is Everything “Priced In?”

Is everything “priced in?” Investors have gone “all in” with a disregard for caution. But with markets extended and overvalued what should investors do now?

As discussed in this past weekend’s newsletter, investors got even more speculative during the recent correction, which is the opposite of what you would expect. But if markets anticipate “good news,” then are there any “surprises” left?

In other words, if markets have priced in perfection, then there is not a lot of room for “disappointment.” Such was a point I made this morning on Twitter:

As we have discussed previously, “market momentum” is a hard thing to kill. Such is particularly the case when the “Fear Of Missing Out” overrides logic. In this past weekend’s missive, we laid out the case for a “sellable rally.” To wit:

“You can see the failure of the market at the 20-dma and the support at the 50-dma. What is essential are the upper and lower indicators.

  1. Both of the upper indicators are currently registering short-term oversold conditions, suggestive of at least a reflexive bounce next week.
  2. Conversely, both of the lower “sell signals” have been triggered, and as noted in the video, it suggests there is additional selling pressure on stocks currently.”
Chart updated through Monday’s close:

Lot’s Of Risks To The Bullish Outlook

While we used the sell-off to add some holdings to our portfolios, we remain cautious for several reasons.

  1. The market has fully priced in whatever economic recovery we are likely to see near-term. 
  2. There is clear evidence of weakening economic data and slower earnings growth.
  3. Investors are counting on a “vaccine” to restore the economy to its previous strength fully. 
  4. The markets have entirely discounted the potential for an election “event.” 
  5. Market participants have discounted the need the additional stimulus to sustain economic growth and recovery. 
  6. The Fed is on the sidelines for now. Without additional Treasury issuance, the Fed has less ability to provide additional liquidity to the market. 
  7. While the economy is indeed recovering, along with employment, it will still likely fall well short of pre-pandemic levels stifling future earnings growth and revenues.
  8. Investors are paying exceedingly high valuations based on a full earnings recovery, which is unlikely to be the case.

Sluggish Growth

The problem, as discussed in Insanely Stupid,” the ability for stocks to continue to grow earnings at a rate to support such high valuations is problematic. Such is due to rising debts and deficits, which will retard economic growth in the future. To wit:

“Before the ‘Financial Crisis,’ the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.

The ‘COVID-19’ crisis led to a debt surge to new highs. Such will result in a retardation of economic growth to 1.5% or less.” 

bullishness willful blindness, Justifiable Bullishness Or Is It Willful Blindness?

Slower economic growth, combined with a potential for higher taxes, increases the probability that “risk” may well outweigh “reward” at this juncture. However, all of these issues will take time to play out.

In the short-term, it’s all about sentiment.

3750 Or Bust!

Stocks can, and likely will, try and go higher in the near term. There is a tremendous amount of bullish sentiment in this regard. Options speculators have not been deterred by the recent sell-off and continue to “buy the dip.”

Such is why, despite some likely wiggles along the way, our target of 3750 may still be viable because of momentum and extreme levels of “bullish bias.” 

“With the markets closing just at all-time highs, we can only guess where the next market peak will be. Therefore, to gauge risk and reward ranges, we have set targets at 3500, 3750, and 4000 or 4.4%, 12.2%, and 19.5%, respectively.” 

Since that time, the market did indeed rally to, and exceeded, our initial target of 3500. The subsequent pullback to the 50-dma held the bullish uptrend from April for now and did reverse the short-term overbought condition.

Also, as we showed our RIAPro Subscribers (30-Day Risk-Free Trial), the sharp sell-off in Technology specifically pulled the sector out of its Risk/Reward range, providing a “bullish setup.”

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

It’s Still A “Sellable Rally.” 

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

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

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

Note that since 2009, whenever the monthly MACD “buy signal” was this elevated, it typically correlated to a short- to intermediate-term market peak. At each point, the “bullish story” was the same.

However, the primary warning signs to investors were also the same:

  • A failure of the economy to live up to market expectations
  • A rise in volatility
  • A decline in bond yields.

Some Upside, But Downside

Could that change? 

Indeed, and if it does, and our “onboarding” model turns back onto a “buy signal,” we will act accordingly and increase equity risk in portfolios. However, for now, the risk still appears to be to the downside.

Overall, our assessment remains one of caution. In the short-term, we could well see an oversold bounce that could even recover back to the previous highs.

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

While we did add some exposure near the lows, we will be using the rally to sell into and increase our portfolio hedges heading into the election. 

If you disagree, that is okay.

However, these are the questions we ask ourselves every time we add exposure to portfolios:

  1. What is the expected return from current valuation levels?  (___%)
  2. If I am wrong, given my current risk exposure, what is my potential downside?  (___%)
  3. If #2 is greater than #1, then what actions should I be taking now?  (#2 – #1 = ___%)

How you answer those questions is entirely up to you.

What you do with the answers is also up to you.

Ignoring the results and “hoping this time will be different” has never been a profitable portfolio strategy. 

Viking Analytics: Weekly Gamma Band Update 9/14/2020

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

Gamma Band Update 09/14/20

  • From an options market analysis perspective, we view the SPX to be at an important inflection point. Some of our indicators have turned cautious, while other options indicators remain bullish.
  • As of Friday’s close, the S&P 500 (SPX) is below Gamma Neutral.
  • Since the SPX has higher volatility below Gamma Neutral, our indicator reduces SPX exposure to 30% out of 100%.
  • Our model is also limiting exposure due to the negative slope of Gamma Neutral.
  • If the SPX closes on a daily basis below the lower band (currently near 3,070), our indicator will cut SPX exposure to 0%.
  • Our options Smart Money Indicator remains bullish, however, and we discuss that in greater detail below.

Smart Money Residual Index

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

Despite a lot of discussion about speculative call buying forcing market makers to buy stocks into the stratosphere, the overall data for SPX does not completely support this narrative.  At the moment, hot money is more cautious than smart money. Accordingly, our indicator views this as generally bullish.

Gamma Band Background

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

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

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

Authors

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

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

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


TPA Analytics: Top 10 Buys & Sells As Of 09-14-20

Note from the RIAPro Team:

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

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

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

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


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

Major Market Buy-Sell Review: 09-14-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 09-14-20

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

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

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

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

Major Market Buy/Sell Review 09-14-20

S&P 500 Index

  • Last week I wrote: “That correction came with a vengeance on Thursday and Friday but has done little to reverse the massive overbought conditions. While we suspect we will see some attempts at “dip buying,” there is a high degree of risk to the market still.”
  • Such remains the case this week. The market remains stringently overbought, and if the market breaks the 50-dma next week, the 200-dma will become the next target. 
  • Use rallies to reduce risk, take profits, and potentially add a short-position into.
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow remains extremely overbought, and as with the S&P, we will likely see some dip buying next week, but likely that will fail and a test of the 50-dma is likely. 
  • Use rallies to sell into for now and reduce risk. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • QQQ’s outperformance of SPY turned down last week as Tech stocks received the brunt of the selloff for a second week. 
  • The QQQ’s remain massively overbought, and the buy signal remains grossly extended.
  • Use rallies next week to reduce risk and raise cash.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No changes this week.
    • This Week: Taking profits.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

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

S&P 400 Index (Mid-Cap)

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

Emerging Markets

  • Emerging markets have performed better on a relative basis during the correction.
  • However, they remain extremely extended and well deviated above their 200-dma.
  • As with all other markets, the buy signal is at the highest level on record.  
  • The dollar decline, responsible for EEM performance, is well overdone. Look for a counter-trend rally, which will push EEM lower. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $40 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • EFA was holding up better. It will be necessary for EFA to hold support at the 200-dma, but the overbought condition puts this at risk. 
  • The dollar is extremely oversold, so a rally in the dollar could impact the EFA. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • We noted last week that the rally above the 200-dma quickly failed after pushing up against 3-standard deviations and an extreme overbought condition. 
  • Pay attention to the risk. 
  • Oil is currently 3-standard deviations oversold so a bounce is likely next week. However, a continued dollar rally could halt that. 
  • We are reducing our energy exposure for the time being to reduce our performance drag until the sector begins to improve.
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Sold XOM
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

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

Bonds (Inverse Of Interest Rates)

  • As noted last week: “On Friday we sold that added position to take profits on news the ‘Chinese threatened to dump bonds in retaliation to Trump’s threats.’  This is a non-threat and we will likely see bonds rally next week.”
  • The rally in bonds this past week picked up some steam as we anticipated. There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold position.
    • This Week: Hold positions.
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

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

The 5-Ingredients For Another Market Event Remains

A typical mainstream media claim is the March decline was “the bear market,” and the next bull market cycle has begun. Unfortunately, March was not a “bear market,” but just a correction within the ongoing bull market that started in 2009. As such, the 5-ingredients for another market “event” remains.

A History Of Crashes

Throughout history, there are numerous “financial events,” which have devastated investors. The major ones are marked indelibly in our financial history: “The Crash Of 1929,” “The Crash Of 1974,” “Black Monday (1987),” “The Dot.Com Crash,” and the “The Financial Crisis.” 

The belief that each of these previous events would be the last is common. Each time the “culprit” was addressed, it assured the markets the problem would not occur again. For example, following the crash in 1929, Congressed rushed to establish the Securities and Exchange Commission and the 1940 Securities Act. The goal was to prevent the next crash by separating banks and brokerage firms and protecting individuals against another Charles Ponzi. (In 1999, Congress passed legislation to allow banks and brokerages to reunite. 8-years later, we had a financial crisis and Bernie Madoff. Coincidence?)

Reactionary Response

In hindsight, the government always acts to prevent the “cause” of the previous crash “after the fact.” Most recently, Congress passed the Sarbanes-Oxley and Dodd-Frank legislation following the market crashes of 2000 and 2008.

Such a “reactionary” response to a crisis is specifically what Bob Bronson previously alluded to:

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

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

Instability

But legislation isn’t the cure for what causes markets to crash. The legislation only addresses the visible byproduct of the underlying ingredients. For example, Sarbanes-Oxley addressed faulty accounting and reporting by companies like Enron, WorldCom, and Global Crossing. Dodd-Frank legislation primarily addressed the “bad behavior” by banks. (Since the banks have successfully lobbied a repeal of the majority of the act).

While faulty accounting and “bad behavior” certainly contributed to the result, those issues were not the cause of the crash. To quote John Mauldin on this issue:

“In this simplified setting of the sandpile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point. What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size.

While the idea is correct, this assumes that at some point, the markets collapse under their weight when something gives.

The Ingredients

Think about it this way. If I gave you a bunch of ingredients such as nitrogen, glycerol, sand, and shell, you would probably stick them in the garbage can and think nothing of it. There are innocuous ingredients and pose little real danger by themselves. However, when they are combined, and a process is applied to bind them, you make dynamite. But even dynamite, while dangerous, does not immediately explode as long as it is stored properly. Only when dynamite comes into contact with the appropriate catalyst does it become a problem. 

“Mean reverting events,” bear markets, and financial crisis are all the result of a combined set of ingredients to which a catalyst was applied. Looking back through history, we find similar elements every time.

Leverage

There is a consensus that “debt doesn’t matter” as long as interest rates remain low. However, it was the ultra-low interest rate policy of the Federal Reserve, which fostered the “yield chase.” The extremely accommodative policies also led to a massive surge in debt since the “financial crisis.”  

Importantly, debt and leverage, by itself is not a danger. Leverage is supportive of higher asset prices as long as rates remain low, and the demand and return on other assets remain high.

Valuations

Likewise, high valuations are also “inert” as long as everything asset prices are rising. Rising valuations are supportive of the “bullish” thesis as higher valuations represent a rising optimism about future growth. In other words, investors are willing to “pay up” today for expected further growth.

The chart shows both the peaks and troughs in valuations. Peak optimism about the markets also come with peak valuations and vice versa.

The same applies to the secular cycles of the market. As asset prices rise, there is an eventual decoupling from the underlying value that can be generated by economic growth. Those overvaluations eventually must revert during the second half of the full-market cycle.

While valuations are a horrible “timing indicator” for managing a portfolio in the short-term, valuations are the “great predictor” of future investment returns over the long-term.

Psychology

One of the critical drivers of the financial markets in the “short-term” is investor psychology. As asset prices rise, investors become increasingly confident and are willing to commit increasing levels of capital to risk assets. The chart below shows the level of assets dedicated to cash, bear market funds, and bull market funds. Currently, the level of “bullish optimism,” as represented by investor allocations, is near the highest level on record.

Again, as long as nothing adversely changes, “bullish sentiment begets bullish sentiment,” which is supportive of higher asset prices.

Ownership

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

Once again, we find rising levels of ownership are a good thing as long as prices are rising. As prices rise, individuals continue to increase ownership in appreciating assets, which, in turn, increases the purchase price of the assets.

Momentum

As prices rise, demand for increasing assets also rises, which creates a further demand for a limited supply of assets, increasing the prices of those assets at a faster pace. Growing momentum is supportive of higher asset prices in the short-term as investors get sucked into a “speculative frenzy” phase near market peaks.

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

Conclusion

Like dynamite, the individual ingredients are relatively harmless. However, when the ingredients are combined, they become potentially dangerous.

Leverage + Valuations + Psychology + Ownership + Momentum = “Mean Reverting Event”

Importantly, in the short-term, this particular formula does indeed remain supportive of higher asset prices. Of course, the more prices rise, the more optimistic investors become.

While the combination of ingredients is indeed dangerous, they remain “inert” until exposed to the right catalyst.

What causes the next “liquidation cycle” is currently unknown. It is always an unexpected, exogenous event that triggers a “rush for the exits.”

Many currently believe “bear markets” and “crashes” are a relic of the past. Central banks globally now have the financial markets under their control, and they will never allow another crash to occur.

Maybe that is indeed the case. However, it is worth remembering that such beliefs were always present, to quote Irving Fisher, “stocks are at a permanently high plateau.” 

Correction Makes Speculators Even More Speculative


In this issue of “Correction Makes Speculators Even More Speculative.”

  • The Correction We Warned About
  • Speculators Get Even More Speculative
  • Longer-Term Market Still Very Overbought
  • Portfolio Positioning Update
  • MacroView: A Permanent Shift To Valuations
  • Sector & Market Analysis
  • 401k Plan Manager

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September 12th from 8-9 am

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Catch Up On What You Missed Last Week


Special Video

Much of today’s commentary is also in the interview I did on Thursday with our friends over at Peak Prosperity. We discuss the market, portfolio management, risk controls, and why there is potentially still more downside risk to stocks in both the short- and intermediate-term.

The Correction We Warned About

A couple of weeks ago, in “Winter Approaches,” we discussed the potential of the correction this past week.

“None of this data means the market is about to crash. What it does mean, is that a correction of 5-10% has become increasingly likely over the next few weeks to two months.

While a 5-10% correction may not seem like much, it will feel much worse due to the high level of complacency by investors currently.”

When markets are pushing extremes, it seems like it is a “no-lose” scenario for investors. It is at those moments when “selling high” becomes opportunistic, but is incredibly hard to do for the “Fear Of Missing Out (FOMO)”

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

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

For now, the market remains trapped.

Trapped Between Resistance And Support

Thursday morning, I posted our 3-minutes video discussing the market’s failure at the 20-dma resistance.

(We publish “3-Minutes” Monday-Thursday. Click here to subscribe to our YouTube channel for email notification of all of our video postings and live-streams.)

The chart below shows much of the same picture as above, but with a few more overlays. You can see the failure of the market at the 20-dma and the support at the 50-dma. What is essential are the upper and lower indicators.

  1. Both of the upper indicators are currently registering short-term oversold conditions, suggestive of at least a reflexive bounce next week.
  2. Conversely, both of the lower “sell signals” have been triggered, and as noted in the video, it suggests there is additional selling pressure on stocks currently. 

As we note below in our “portfolio positioning” section, this suggests that over the next couple of weeks, investors should use rallies to reduce risk.

Speculators Get Even More Speculative

Another reason for our short-term concern is that you would typically expect a market decline to pull some of the “greed” out of the market. Such was not the case this time, and the drop did little to dent the “enthusiasm” of speculative options traders betting on a one-way ticket to wealth.

“Over the last three trading sessions, more than 1m Tesla calls traded a day, 50% above average over the last 20 days. Close to 2.5m Apple calls traded on average each day during the selloff, roughly double what’s been typical in the last 20 days.” – Bloomberg

The chart below is the 10-day moving average of the “put/call” ratio. While the market peaked, speculators got even more “speculative” on “buying the dip.” Such is akin to doubling down in Las Vegas, it may work for a while, but eventually, the “house always wins.” 

Let me be clear. In the very short-term, there is a high probability of a market bounce. That bounce should most likely be sold into as the longer-term dynamics remain overbought, extended, and deviated from norms.

Long-Term Market Remains Extremely Overbought

Such was a point I discussed with our RIAPRO Subscribers (30-day Risk-Free Trial) last week.

  • On a weekly basis, the market backdrop remains much more bearish.
  • The market is very extended, overbought, and deviated on an intermediate-term basis.
  • The correction barely moved the needle of a market trading 3-standard deviations above the long-term moving average.
  • Read “A Tale Of Two Bull Markets” for more explanation and detail on this and other relevant charts.
  • Remain patient. The odds are high that more downside risk remains if the economy begins to show signs of weakening again.

Technical Analysis Review 09-10-20, S&P 500 Technical Analysis Review 09-10-20

With the potential for a disruptive political election, weakening economic data, and a failure to garner more stimulus for households, the risks to earnings and growth have increased.

On a longer-term basis, the technical backdrop is also problematic.

Monthly

  • First, from an investment standpoint, look at the last two bull market advances compared to the current Central Bank fueled surge. The present extension failed at the top of the rising upper-trend line forming a “megaphone” pattern.
  • This pattern is more indicative of a market topping process, rather than a continuation pattern.
  • Secondly, the market is trading MORE THAN 2-standard deviations above the long-term mean, which was ideal for a more considerable corrective decline.
  • The good news, however, is that a monthly BUY signal did get triggered with the liquidity fueled advance. Usually, these signals are slow to turn. However, in recent years these signals are becoming more frequent due to the increased volatility.

Technical Analysis Review 09-10-20, S&P 500 Technical Analysis Review 09-10-20

Importantly, MONTHLY data is ONLY valid at the end of the month. Therefore, these indicators are VERY SLOW to turn but do provide relevant analysis on price trends. However, this is why we use both Daily and Weekly charts to manage portfolio risk. 

Portfolio Positioning

Over the last few week’s we have repeatedly discussed reducing risk, hedging, and rebalancing portfolios as we suspected this decline was a real possibility. As noted in “Tending The Garden:” 

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

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

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

With the actions we have taken over the last few weeks, we now have some cash to deploy into assets that provide us our next opportunity.

Getting Back To Even

Such is the primary problem with “buy and hold” investing.

Riding markets up and down is okay to a point, but eventually, the market will decline and provide a real opportunity to buy assets at discounted prices. Unfortunately, since a “buy and hold” strategy never raised any cash, there is nothing to buy discounted assets with. Yes, eventually, the market will recover its losses, and portfolios will return to even. However, you can never recover the time lost. (You also don’t have 100+ years to invest.)

Such is why the primary rule of every great investor throughout history is to “buy low and sell high.” While it seems simple, it is incredibly hard to do, particularly when emotions overtake logic.

Currently, the “speculative frenzy” has engulfed the markets and the media. Such can last a lot longer than most expect, but it will eventually end.

Sometimes, the best investment strategy is knowing when to stop. Remember, no rule states you can’t play again tomorrow after a hot meal and a good night’s sleep.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels.

Sector-by-Sector

Improving – Financials (XLF), Staples (XLP), and Industrials (XLI)

During the correction this past week, Financials continued to outperform the S&P 500 by not falling nearly as much. Likewise, Industrials and Staples held up as well. The outperformance during the correction was not surprising, as they have lagged the S&P 500 on the way up. The sectors are still way too overbought to buy into, so we may yet see more of a correction in the near term.

Current Positions: XLI, IYT, XLP

Outperforming – Materials (XLB), and Discretionary (XLY)

Discretionary stocks, which were being primarily being driven by AMZN, had a sharp correction back towards the 50-dma. The correction was not surprising, as we have been talking about the risk for the last few weeks. After taking profits previously, we are now looking for an opportunity to build back into our holdings.

Current Positions: None

Weakening – Technology (XLK), and Communications (XLC)

Technology and Communications holdings are also finally corrected. After having taken profits previously, we are looking for an entry point to increase our weightings again. We are maintaining tights stops currently.

Current Position: XLK, XLC

Lagging – Energy (XLE), Healthcare (XLV), Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Energy continues to underperform for the time being and has weakened further. At this juncture, our stops were broken, so we have reduced our exposure to the sector currently. We still value in the industry, but for now, the market does not agree with us.

We continue to maintain our core defensive positions Healthcare, Staples, Utilities, and Real Estate, which performed better than the market during the correction. Currently, we are looking for opportunities to add to our positions we took profits in previously.

Current Position: XLU, XLV, XLP, XLRE

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Both of these markets continue to underperform, and declined back to their respective 50-dma’s last week. These markets need to hold here if they are going to get a bid. We had suggested taking profits previously. If these markets can continue to remain above critical support while working off the overbought conditions, we may have a reasonable entry point to add exposure for a trade. We are getting close to an oversold condition, so we will look for further weakness as a potential setup for a trade. 

Current Position: None

Emerging, International (EEM) & Total International Markets (EFA)

Emerging and International Markets have performed better during the decline as well. However, last week they also corrected back to their respective 50-dma. Like small and mid-caps, they must hold these levels next week. There may be an opportunity to add to these names short-term, but the risk is high. Furthermore, the dollar remains extremely oversold, which is also a threat to international exposures.

Current Position: None

S&P 500 Index (Exposure/Trading Rentals) – We currently have no “core” holdings.

Current Position: None

Gold (GLD) – We continue to hold our gold and gold miner positions. No change this week.

Current Position: IAU, GDX, UUP

Bonds (TLT) –

We continue to hold our bond holdings as a hedge against market risk. As noted, we did take some profits out of Treasuries. This week bonds rallied again as market weakness showed up. (Lower rates.)

Current Positions: TLT, MBB, & AGG

Portfolio / Client Update

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

Over the last week, we have taken some further actions to reduce risk during the recent decline. While the market is currently holding its 50-dma, and we will likely see a bounce next week, we suspect there is still some downside risk heading into the election.

As such, we are preparing portfolios accordingly to minimize that risk.

As noted in the main body of this missive, “momentum” is tough to kill, so we are looking for a short-term trading opportunity to rebalance risk in portfolios. We are also maintaining very tight stops just in case.

Also, over the next few months, we are going to consolidate our portfolio holdings to reduce our total holdings from 32 to 25. Such will provide us with the ability to concentrate positions a bit more to increase overall portfolio yield, while also improving performance on a relative basis to the market.

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

Portfolio Changes

We have a new report out on one of our value holdings CVS which is seen currently as grossly underpriced.

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

In both of our portfolios, we did sell two positions this week due to violations of stop losses.

While we like Exxon Mobil (XOM) very much as a company, it is underperforming the sector and did violate a rather generous stop loss. We can’t give it any more room for now, but we will be watching the company for signs of relative strength to add it back to the portfolio eventually.

We also sold Pfizer (PFE) in the equity portfolio. It was an initial position, which failed to perform as anticipated and violated its stop loss.

EQUITY PORTFOLIO:

SELL

  • 100% of XOM
  • 100% of PFE

ETF PORTFOLIO:

SELL

  • 100% of XOM

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

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

Arete’s Observations 9/11/2020

Market observations

‘Downbeat’ US executives dump most stock in a month since 2015

“US executives sold $6.7bn of stock in their own companies last month [August], cashing in on a record-breaking market rally with the biggest burst of selling in five years.”

“Chief executives have been much more downbeat in their outlooks than investors.”

CEOs are normally optimistic about the companies they run. After all, that’s partly what they get paid to do. When they sell, then, it rarely bodes well for the stock. And, by the way, they know better than anyone else how the company is performing. This particular bout of selling meaningfully contradicts the market optimism at the end of the summer.

Economy

The US is having a Wile E Coyote moment

“More than 29m Americans are still collecting some form of unemployment aid, yet federal and state unemployment benefits fell by around $60bn last month compared with July, according to research from Evercore ISI.”

“Consumption will also be damped by evictions. The Cares Act provided rental assistance and a temporary moratorium on evictions that expired in late July. Last week the government issued a new eviction moratorium but without funding for rental assistance, so that tenants unable to cover rent will face a massive balloon payment or eviction at the end of the year. This hardly gives them new financial breathing space.”

The main message of this story is that many millions of Americans are still struggling economically. This important fact seems to get overlooked in many stories and represents a major hurdle to returning to any sense of normalcy.

My greatest concern is not that nothing will get done. There will be new policy measures and at least some of them will be directed at the challenges highlighted. As Gary Shilling pointed out in his latest letter, he knows there will be more federal spending, it’s just a matter of “how much and who gets it.”

I worry instead that whatever new policy measures are introduced in the fall and thereafter will only be ameliorative in nature and not corrective. The downside is that millions of people will be left on economic life support on a semi-permanent basis.

And economic life support will be needed. One of the simplest metrics of economic hardship is hunger. The graphs shows a striking increase in the percentage of households with children that sometimes or often go hungry. No need for caveats or hedonic adjustments here.

Credit

It is common for companies to reduce debt when entering a recession. After all, with diminishing prospects for revenue growth and profitability, that debt becomes harder to support. Even relatively small deviations from expectations can cause existential dilemmas.

This recession stands in stark contrast to the historical cyclical pattern. Instead of reducing debt going into a downturn, companies are massively increasing debt. This is being done more through capital markets than bank debt, but nonetheless speaks to bizarre and fragile financial foundations.

Companies

A GE whodunnit

“For decades GE managers had an over-exalted sense of their own abilities, which led to narcissism, hubris and the bending, if not breaking, of accounting rules to hit their profit targets. This eclipsed any strategic vision they may have had.”

“A third common problem is stockmarket mythmaking. Ms Comstock’s approach to digging GE out of a hole was to, as she put it, “pick a simple story…and tell it again, and again”.

GE makes an interesting case study. The stock reached a peak in 2000 when its operations were arguably most impenetrable to outside analysis. It’s many failures along the way are instructive for investors and analysts.

The common thread that seems to run through the pantheon of failures at GE was the perpetuation of “success theatre.” This is a fairly common problem that often manifests itself in the form of managing to metrics rather than business logic. Once the practice gets institutionalized, the company ends up with a corps of managers whose main expertise lies in circumventing rules. I strongly suspect the lessons from GE also apply to many of the big tech companies today.

Fresh starts

When: The Scientific Secrets of Perfect Timing by Daniel H. Pink

“First, they [temporal landmarks] allowed people to open ‘new mental accounts’ in the same way that a business closes the books at the end of one fiscal year and opens a fresh ledger for the new year. This new period offers a chance to start again by relegating our old selves to the past. It disconnects us from that past self’s mistakes and imperfections, and leaves us confident about our new, superior selves.”

“The second purpose of these time markers is to shake us out of the tree so we can glimpse the forest. ‘Temporal landmarks interrupt attention to day-to-day minutiae, causing people to take a big picture view of their lives and thus focus on achieving their goals’.”

Dan Pink does a nice job in this book of highlighting how important timing is in our lives – and how we often do not pay sufficient heed to this reality. One phenomenon of timing I observe recurring across many different dimensions is that of the “fresh start”. As Pink describes, fresh starts allow us to separate from the past and start anew and also to disrupt daily routines in a way that provides perspective.

Although the coronavirus pandemic has caused a great deal of hardship, a silver lining is that it also provides a landmark of sorts from which to make a fresh start. What is the right tradeoff between commuting to work and working from home? What are the best living conditions for one’s family? While many of us are contemplating tradeoffs in our personal lives, the same exercise is being conducted across other domains as well.

Future of work: how managers are harnessing employees’ hidden skills

“’I haven’t seen anything tremendously creative or innovative,’ he says.”

“We moved from the adrenalin phase, to the real estate phase — ‘maybe we don’t need that office any more’ — to the adulatory phase: ‘Now we have a return plan!’”

“Most companies are still missing a big opportunity to ‘fundamentally re-examine what the employer-worker relationship, or the worker-worker relationship is going to be’.  The risk, he says, is that ‘companies haven’t considered the second-order effects’ of some of the consequences of widespread remote working, including how to integrate the people they hire and how to maintain a corporate culture.”

These comments from Laszlo Bock, head of Humu and former head of personnel at Google, captures both the risk and opportunity from pandemic related disruptions to the work environment. Many managers have simply flipped on their emergency switch and aggressively reacted. However, there is also a terrific opportunity to make a fresh start in determining what the “worker-worker relationship is going to be”.

Politics

Republican party battles over its post-Trumpian soul

“Politicians are not known for decency or decorum, but typically they wait for a leader’s defeat before diving into the scrum for a successor. Not this time. Even before US President Donald Trump gets his chance at a second term, a battle has begun over where the Republican Party may turn after.”

“Genuinely conservative Republicans envision a different post-Trump future. They draw lessons from his political success but focus on the challenges that caused it. They ask: What has gone wrong with the market, and what role can policymakers play in fixing it? Their task is to apply conservative principles to contemporary conditions.”

One interesting point from this article is that the tepid support for Trump echoes the tepid support for Hilary Clinton in the 2016 election. The lack of enthusiastic support from notables in the same party sends a message in itself.

A second point is the glimmer of a fresh start among certain Republicans. Although the author acknowledges ideological reform in the Republican party would be an uphill battle, it is interesting to watch the movement gain legs before the election.

Technology

Battle lines drawn as Australia takes on Big Tech over paying for news

“’I must say in 10 years of fighting Google, in seeking a fair share of value, [the Australian proposal] is the best I have seen so far,’ said Thomas Höppner, a partner at law firm Hausfeld, who filed the original antitrust complaint for publishers against Google in 2009. ‘It’s brilliant. They’ve learned the lessons from Europe. And it will have precedent character [for the rest of the world]’.”

“The stakes are high on both sides. If Google and Facebook withdrew local services it would inevitably lead to a drop in traffic to Australian news websites and affect other businesses. But blocking access to news on their platforms in the country would be complex and fraught with legal risk for the US groups …”

One of the recurring themes in regard to big tech companies is unfair advantage. This particular story addresses news and publishing which have been used, but not compensated for, by Google. The key point for me is the imminent prospect of a compromise that makes sense.

If an agreement can be reached, there is a good chance its effects will be far-reaching. For one, the model can be applied to other countries around the world. For another, it can create a level playing field to support industries such as publishing which have been undermined by parasitic activities. Finally, there are several other fronts where the tenets of shared value may help define the boundaries of peaceful coexistence. If an agreement is not reached, the legal battles will persist.

Google’s problems are bigger than just the antitrust case

“Google employees were allowed to spend 20% of their time working on what they thought would most benefit the firm, even if that often led to them working 120%.”

“Where Mr Brin and Mr Page were technologists and Mr Schmidt a technologist-manager, the new team are simply managers.”

As an analyst it is always interesting to get a glimpse into how a company actually operates. For Google, the 20% “free” time sounded almost too good to be true. It was. In addition, apparently, “Leaking, particularly to the press, was a sackable offence.” In sum, the characterization of Google’s culture has more than a hint of John Grisham’s The Firm.

It is also interesting to watch how a company evolves over time. The change in leadership from technologists to “simply managers” is one that has precedents and is not a trivial one. Such changes can fundamentally change the culture and priorities of a company.

Monetary policy

Grant’s Interest Rate Observer, 9/4/20

“Omissions featured heavily among the highlights of the Jackson Hole message. Powell admitted no error and conceded no policy trade-offs. He said nothing about the mischief-making properties of ground-hugging interest rates—how they facilitate overborrowing, incite speculation, misallocate capital, entrench in cumbent businesses, prolong the lives of marginal businesses (a.k.a., zombies) and contribute to the ever more familiar ‘episodes of financial instability’ that wind up curtailing expansions.”

It seems like some kind of state of denial. Powell delivers his Jackson Hole presentation. He outlines policies and provides right-sounding explanations. Reporters dutifully highlight key changes and frame the narrative. Investors give polite applause (figuratively) and the show goes on.

And then you actually read the comments. You hypothesize what could have been said and should have been said. You consider all the things you would do (and not do) if the country’s monetary policy was your responsibility. And you come up with totally different answers. I don’t know when it is going to happen, but it seems like the Fed is set up for a huge fall in credibility.

Public to private equity in the United States: A long-term look

When people are eager to learn about investing they often flock to the writings of Warren Buffett, Howard Marks and other successful investors. I would put Michael Mauboussin right at the top of that list. I still refer to his collection of Consilient Observers from his days at CS First Boston in the early 2000s and his books Expectations Investing and The Success Equation should be required reading for anyone interested in markets and investing.

His latest piece provides an extensive overview of public and private markets. A lot has changed over the last 25 years and I highlighted some of the implications in a June 2019 blog post, “Stocks: One person’s treasure is another person’s trash”. Mauboussin’s work methodically describes the ecosystem and in doing so provides a wealth of useful information and insights. With all of this background, it is easier to understand the growth in private equity and venture capital.

Bumper year for IPOs is also a harbinger of long-lasting change

“The current system is ‘systematically broken and is robbing Silicon Valley founders, employees and investors of billions of dollars each year’.”

“Mr Mortara estimates that Spac listings and direct listing together could eventually account for a quarter to a third of all listings.” 

This FT story provides an interesting companion note to Mauboussin’s background on public and private markets. One highlight is the degree to which the IPO process is “systematically broken”. This has been true for a long time, but nonetheless the same basic system has remained intact.

More recent evidence suggests this is changing. There have been some successful experiments with direct listing, for example. In addition, although the increase in SPACs (special purpose acquisition companies) is at least partly opportunistic, it is also at least partly an effort to improve the process of a private company going public.

Implications for investment strategy

GOVERNMENT BONDS HAVE GIVEN US SO MUCH and A ROADMAP FOR NAVIGATING TODAY’S LOW INTEREST RATES

“All investing is about trade-offs. For almost all portfolios, those trade-offs have suddenly gotten worse because of what has happened to the yields on cash and government bonds.”

“In a world where historical performance is much less relevant for forward-looking expectations, it will require more thought and creativity than it once did.”

GMO is one of the more thoughtful asset managers and Ben Inker always shares useful insights in its quarterly letters. In highlighting the consequences of low rates, he touches on many of the same subjects I discussed in the June blog post, “It’s time to retire the 60/40 strategy”.

One of the most valuable aspects of Inker’s message, in my opinion, is his honest communication of difficult challenges. Yes, investing is all about tradeoffs. There are no silver bullets. Yes, those tradeoffs have gotten worse. And yes, historical performance is much less relevant for forward-looking expectations. These are hard truths and he does not dance around them like many would.

Reading through his commentary sparked another thought for me though. Inker talks of the importance of diversification for investors, which is true to a point. The purpose of combining bonds with stocks, however, has more to do with providing an insurance policy against big stock losses.

In this sense, one could argue that the value of that insurance policy is greater for the advisor than the investor. The investor actually sacrifices higher potential long-term returns by including bonds. The advisor benefits by avoiding the types of selloffs that may spook an investor and cause them to either liquidate investments or transfer to a different advisor. It will be interesting to watch if the diminished ability of bonds to offset portfolio return volatility results in higher client turnover.

60/40 Strategy Will Flop Fairly Soon, Paul McCulley Says

“This [the reason financial markets have done well over the last 40 years] is the result of a political victory by those who control capital over those who provide labor, he says. ‘Unambiguously, we’ve had 40 years of disinflation, and that’s because we’ve shifted power in our economy, both domestically and globally, from labor to capital’.”

“’I really hope that my old profession figures out a new paradigm,’ he said. ‘What’s worked the last 40 years should not work unless you want democracy to fail’.”

McCulley takes a different tack in discussing the consequences of low rates. Rather than focusing just on investment consequences, he puts things into a broader social perspective. He is absolutely right that power has shifted from labor to capital and he is also right to highlight the inherent conflict between democracy and many tenets of capitalism over the last 40 years.

My question is, why now? McCulley was right in the middle of things during most of those 40 years and made plenty of money riding that wave. I don’t remember him complaining quite so vociferously at the time about the damage being caused to democracy. He’s not the only one who helped stoke a financial system that undermined democracy and he’s not the only one who is virtue signaling at the end of his career. It’s still disappointing that more effort was not exerted to solve the problem at the time rather than complain about it after the damage is done.

Principles for Areté’s Observations

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

Note on references

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

Comments

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

Disclosures

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

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

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

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

#MacroView: A Permanent Shift In Valuations?

During extended bull markets, rationalization becomes commonplace to justify overpaying for value. One such rationalization is the permanent shift in valuations higher due to changes in accounting rules, share buybacks, and greater adoption by the public of investing (aka ETFs.)

The chart shows the apparent shift to valuations.

  1. The “median” CAPE ratio is 15.24 times earnings from 1871-1980.
  2. The long-term “median” CAPE is 16.52 times earnings from 1871-Present (all-years)
  3. The “median” CAPE is 22.91 times earnings from 1980-Present.

There are two critical things to consider concerning the chart above.

  1. The shift higher in MEDIAN valuations was a function of falling economic growth and deflationary pressures; and,
  2. Increasing levels of leverage and debt, which eroded economic growth, facilitated higher prices. 

A General Deficit

The chart below tracks the cumulative increase in “excess” Government spending above revenue collections. Notice the point at which nominal GDP growth stopped rising. It is also the point that valuations shifted higher.

You can see this shift occur more clearly when looking at when the government began to run a deficit consistently. Rising deficits directly correlate with weaker rates of economic growth.

Given that economic leverage (corporate, consumer, financial, and Government debt) is at records and rising, the ability to create more robust, sustainable, economic growth (which would lead to higher rates of inflation) remains little more than a hopeful goal. (Read 5-Reasons The Fed Will Fail)

The problem with the idea that valuations have permanently shifted upward is the market anomaly form 1990-2000 skewed valuations above the long-term medians. However, given economic growth remains mired at 2%, or less,  over the long-term, average valuation ranges will begin to trend lower in the future.

Confirmation

Such was a point Ed Easterling of Crestmont Research previously made:

“However, as real economic growth significantly declined over the past two decades, it triggered a series of adjustments that represent the forces behind The Big Shift. Most importantly, the downshift in real economic growth disrupted the financial relationship of profits, future growth, and market value.

Slower growth drives P/E downward for similar reasons that it drives EPS upward.”

Of course, as noted above, since the “Financial Crisis” lows, much of the rise in “profitability” has come from cost-cutting measures and accounting gimmicks rather than actual increases in top-line revenue. While tax cuts certainly provided the capital for a surge in buybacks, revenue growth, which connects to a consumption-based economy, remained muted. Now, the “economic shutdown” has crushed revenue growth entirely. As detailed in “Earnings Don’t Support The Bullish Thesis:”

“Since 2009, the operating earnings per share of corporations has risen by just 158%. However, the increase in earnings did not come from an increase in revenue. During the period, sales (which is boosted due share reductions) grew by a marginal 41%.

However, investors have bid up the market more than 365% from the financial crisis lows of 666.”

fundamentally, Fundamentally Speaking: Earnings Don’t Support Bullish Thesis

Effect Of Slower Growth

Furthermore, to this point, Ed digs into the overarching problem:

“Therefore, since future economic growth is expected to be slower, it is only consistent that the future average for the market P/E will be lower. The new normal growth rate (i.e., slower) for the economy will drive slower overall earnings growth. Such slower growth will drive market P/E lower, just as previously higher growth supported the market’s P/E at a higher level.

The inflation rate also drives the level of market P/E, but it occurs within the range driven by the growth-rate environment. Higher inflation drives P/E lower; deflation drives P/E lower. The level of P/E peaks when the inflation rate is low and stable. Thus, while the growth rate drives the level of the P/E range, the inflation rate drives the relative position of P/E within the range. 

Figure 6 illustrates these effects. The bar on the left illustrates the range for P/E under a historically average level of growth. The bar to its right illustrates the range for P/E under slower growth. Not only does the range downshift, the expected long-term average P/E also downshifts. This has major implications for analyzing the stock market.”

, Weekend Reading: A Permanent Shift To Valuations?

Value Is What You Pay

“Going forward, we should expect a new paradigm. Slower growth drives the ranges for P/E lower, which will affect future assessments of fair value. Keep in mind that, had real economic growth averaged 2% instead of 3.3% over the past century, the historical average for P/E would have been near 11—not 15 or 16. In the future, the fair value for P/E when the inflation rate is low will be 13 to 15. With average inflation, expect P/E to be near 11. During periods of high inflation and significant deflation, expect the low range for P/E to be 5 to 8.”

With markets currently trading near 30x earnings, a revaluation will be just as painful to investors in the future as they have previously.

While this time may indeed appear to be different, it will most likely end the same as every other period in history.

“Price is what you pay; value is what you get.” – Warren Buffett.

Starting Valuations Matter Most

When discussing valuations, the starting level when you begin your investment journey is the most critical. Such was a point discussed previously:

“The chart below shows the history of secular bull market periods going back to 1871 using data from Dr. Robert Shiller. You will notice that secular bull markets tend to begin with CAPE 10 valuations around 10x earnings or even less. They tend to end around 23-25x earnings or higher. (Over the long-term valuations do matter.) “

The two previous 20-year secular bull markets start with valuations in single digits. At the end of the first decade of those temporal advances, valuations were still trading below 20x. Currently, valuations are still hovering near 30x.

But that is just today. Over the next couple of quarters, the “E” will drop markedly as the impact of the economic shutdown settles in. While investors hope there will only be a mild-reduction in earnings, historically, earnings have reverted past the long-term exponential trend.

Given 13% unemployment rates and a recession of nearly 20%, earnings will likely revert toward $80/share. Such a decline will push current valuations to historically high levels assuming prices remain elevated.

The 1920-1929 secular advance most closely mimics the current 2010 cycle. While valuations started below 5x earnings in 1919, they eclipsed 30x earnings ten-years later in 1929. The rest, as they say, is history. Or instead, maybe “past is prologue” is more fitting.

Overpaying For Value On Every Measure

The mistake investors repeatedly make dismissing the data in the short-term because there is no immediate impact on price returns. As noted above, valuations by their very nature are HORRIBLE predictors of 12-month returns. Investors avoid any investment strategy which has such a focus. In the longer term, however, valuations are strong predictors of expected returns.

It isn’t just trailing valuations suggesting markets are overpriced and expensive. The chart below shows Dr. Robert Shiller’s cyclically adjusted P/E ratio compared with Tobin’s Q-ratio. The Q-ratio measures the “replacement cost” for the firm’s assets in the broad Wilshire 5000 index. (This measure has nothing to do with earnings.)

Unsurprisingly, Tobin’s Q is also at historically expensive valuations hitting the highest level since the peak in 2000. Furthermore, note forward 10-year returns do NOT improve from historically expensive levels but decline sharply.

The tables below show various valuation metrics for the S&P 500 and the major sectors. The table compares current valuations to both the 3-, 5- and full-time series “median” and “average” valuations.

What you should immediately notice is that except for Financials and Energy, which have many underlying fundamental problems currently, investors are overpaying on every metric on both a short- and long-term basis.

PEG: Price / Earnings Growth

P/B: Price / Book Value

P/E: Price / Earnings Trailing 12-Months

P/FPE: Price / Earnings Forward 12-Months

P/S: Price / Sales 

EV/S: Enterprise Value / Sales

As you can see, there is not a lot of “value” currently in the market. Such is why investors have to begin to “rationalize” valuations to justify “speculative” positioning.

The Risk Of Overpaying

While it is “bullish” to come up with reasons to justify overpaying for assets in the short-term, outcomes are quite different long-term.

No matter how many valuation measures you use, the message remains the same. From current valuation levels, the expected rate of return for investors over the next decade will be low.

There is a large community of individuals who suggest differently, as they make a case as to why this “bull market” can continue for years longer. Unfortunately, any measure of valuation does not support that claim.

Such does not mean that markets will produce single-digit rates of return each year for the next decade. The reality is there will be some tremendous investing years over that period. There will likely also be a couple of tough years in between.

That is the nature of investing. It is just part of the full-market cycle.

The economic cycle is tied closely to demographics, debt, and deficit. If you agree with this premise and the data, then the media’s optimistic views are unlikely. 

In our opinion, rationalizing high valuations today will likely lead to disappointing future outcomes.

Technical Value Scorecard Report For The Week 09-11-20

The Technical Value Scorecard Report for the week of 09-11-20, uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis, versus the assets logical benchmark, and on a stand-alone basis.

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

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma is based on the ratio of the asset to its benchmark. The second set of graphs is computed purely on the price of the asset.

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

Commentary 09-11-20

  • The graphs below are revised to directly compare the score and the normalized score (sigma).
  • We found that normalizing data into standard deviations (sigmas), of the last 200 trading days, can minimize the degree of overbought or oversold when the asset has been trading in that state for a while. To compensate we show the sigma and the actual score. A score of +/-100% means that every indicator is maximum bullish or bearish. An extreme reading of +/-100% is almost impossible.
  • The Technology sector led us to make these changes. If you notice its sigma is negative and its score is positive. It has been relatively strong versus the S&P, however, the recent short bout of weakness pushed its sigma to slightly oversold. The score remains firmly in overbought territory.
  • We also updated the scatter plot to include the scores versus the prior 20-day excess returns versus each asset’s respective benchmark. We found this increases the R-squared significantly.
  • On a relative basis, Transportation, Discretionary, and Material are the most overbought sectors on a sigma and score basis. Energy is clearly the most relatively oversold sector with Healthcare following.
  • The sigma on value versus growth is improving, but its relative score remains low, as does small-cap, mid-cap, and other more value-oriented sectors. Momentum and the NASDAQ (QQQ) are the only sectors with a relative score in overbought territory. In both cases, however, the sigma is oversold slightly.
  • On an absolute basis, the results are similar except in the case of utilities which are also oversold to nearly the degree of the energy sector. Value appears to be the most oversold sector using sigma and score.
  • The S&P 500 score is now approaching fair value, after having been extremely overbought two weeks ago at 80%.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

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

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

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

Overview

  • CVS is a provider of health care services to corporations and individuals in the US and Puerto Rico. The Company has a market cap of $75.9B and is in the Health Care sector.
  • CVS has four operating segments: Pharmacy Services, Retail/Long-Term Care, Health Care Benefits, and Corporate/Other.
  • CVS stock is currently trading at $58.00 per share. Using our forecasts, we arrive at an intrinsic value of $85.35 per share. This implies an upside of 47.1% on the investment.

Pros

  • Although the Health Care sector has clawed its way back to just 5.2% below its 52-week high, CVS still lingers almost 25% below its 52-week high. This is quite puzzling, as the pandemic’s impact on CVS does not warrant the market’s reaction.
  • CVS has paid a quarterly dividend of $0.50 per share in each of the last three years and there is little doubt CVS will be able to maintain the dividend. The stock’s current dividend yield is 3.45%.
  • Our forecasts (as shown below) indicate that CVS will produce the free cash flow required to maintain its dividend and repay some debt over the forecast period.
  • The stock trades at a Price to Earnings (P/E) ratio of 7.3. The chart below illustrates the significant discount CVS investors are receiving from a P/E standpoint.   

Cons

  • With Amazon’s (NYSE: AMZN) entry into the health care sector, competition has intensified as CVS and its peers race for better positioning. Although AMZN still faces some regulatory barriers, the e-commerce giant’s resources pose a threat to CVS’ margins.  
  • One of the more apparent risks to an investment in CVS is that the stock price simply fails to move it intrinsic value in a timely manner. Just as we see no reason for the stock’s underperformance thus far, we cannot pinpoint a catalyst for the stock’s move to intrinsic value.

Key Assumptions

  • Revenue growth for 2020 is based on results from the first half of the year as well as Management’s comments and outlook. We assume growth in 2021 and beyond will remain muted, as CVS is a mature firm with revenue growth supported by acquisitions.    
  • We forecast CVS operating margins to begin slightly below their 2019 level as CVS faces incremental expenses related to the pandemic. By 2023, margins will return to pre-pandemic levels then slowly fade to the long-term forecast as competition heats up.
  • Management has mentioned debt repayment as being a priority through 2022. Accordingly, we forecast debt to decrease as a portion of assets, and included the effects in the free cash flow and dividend analysis.
  • CVS will continue to increase its scale through acquisitions. Acquisition activity will remain relatively weak at first, as Management improves the balance sheet. Beyond 2022, cash acquisitions will move toward CVS’ 5-year historical average, although they will not quite reach that level.

Sensitivity Analysis

  • A brief note on why we present sensitivity analysis can be found here.
  • The analysis helps us understand that the level of acquisitions needed for CVS to achieve the forecast revenue growth will be critical to the stock’s intrinsic value. Fortunately, in the least favorable of the outcomes explored, CVS still offers attractive upside.
  • Realized EBITDA margins also will be critical to CVS’ intrinsic value. If AMZN intensifies competition and lowers industry margins as a whole, CVS’ investors could see little upside.

Technical Snapshot

  • After receiving a pummeling, which began in mid-August, the stock is approaching critical support at $58 per share. At the same time, CVS is approaching its most oversold level since the beginning of 2020. There will be a good buying opportunity if the stock can bounce off that support.  
  • If CVS holds support at $58, it will face a few instances of minor resistance in the near term. However, the real test will be whether the stock can break above its 200-day moving average. It has failed to do so in its last three attempts.

Value Seeker Report Conclusion On CVS

  • CVS is currently priced at a deep discount to its intrinsic value. We forecast that roughly 47.1% of upside remains on the stock.
  • We cannot find justification for its lagging performance, and thus cannot pinpoint a catalyst that will move the stock to its intrinsic value. However, even considering the possibility that the stock continues to lag before moving to intrinsic value, the deep discount makes the investment worthwhile. In the meantime, investors will receive a dividend yield of 3.45%.

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

#WhatYouMissed On RIA This Week: 09-11-20

What You Missed On RIA This Week Ending 09-11-20

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

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


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September 12th from 8-9 am

Send in your questions, and Rich and Danny will answer them live.


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 09-11-20


What You Missed: Video Of The Week

Market Sell Off – Is The Correction Over

Just in case you missed it, we took a quick look at the selloff. With Wednesday’s bounce, is the correction over, or is there more to go?



Our Best Tweets For The Week: 09-11-20

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

S&P 500 Technical Analysis Review 09-10-20

S&P 500 Technical Analysis Review 09-10-20

A technical review of the S&P 500 using daily, weekly, and monthly charts to determine overbought, oversold, and risk/reward scenarios for carrying equity exposure.

Over the last couple of weeks, we have discussed the probability of a 5-10% correction in the market. Via Winter Approaches:” 

“A correction of 5-10% has become increasingly likely over the next few weeks to two months. While a 5-10% correction may not seem like much, it will feel much worse due to the high level of complacency by investors currently.

So, did the “sell-off” over the last few days resolve the overbought technical conditions? More importantly, was the rally yesterday sustainable? Or is there more correction potentially coming?

For those answers, let’s take a look at the charts. (Be sure and review the Major Market Review each week for updates)

Daily

  • The sell-off of the S&P 500 broke the 20-dma and essentially tested the 50-dma. It also pushed toward the 2-standard deviation band of the 20-dma. This set the market up for a bounce yesterday.
  • However, the bounce did not reverse the current sell signals.
  • The market is reasonably oversold very short-term so a follow-through rally will be critical before taking on additional equity exposure.
  • As shown the market failed at the 20-dma yesterday, which suggests we could see more weakness by the end of the week. A test of the 50-dma is very likely.
  • While we have added some exposure to portfolios recently, we have done so very cautiously with tight stops. We will also add a short-hedge back to our portfolio if the market rallies back to the 20-dma and fails a second time.

Daily Overbought/Sold

  • The chart above shows a variety of measures from the number of stocks above their 50-dma to momentum and deviation from intermediate-term moving averages.
  • The sell-off did reverse some of the very short-term overbought conditions, which gave support to the rally yesterday.
  • However, most other measures still remain overbought short-term suggesting we could see more selling pressure on stocks near-term.
  • Be patient. We are likely going to have a series of corrections back to support that allow for better entry points to add positions.

Weekly

  • On a weekly basis, the market backdrop remains much more bearish.
  • The market is very extended, overbought, and deviated on an intermediate-term basis.
  • The correction barely moved the needle of a market trading 3-standard deviations above the long-term moving average.
  • Read “A Tale Of Two Bull Markets” for more explanation and detail on this and other relevant charts.
  • Remain patient. Odds are high there is more downside risk particularly if the economy begins to show signs of weakening again.

Monthly

  • On a monthly basis, the bearish backdrop is evident.
  • First, from an investment standpoint, look at the previous two bull market advances compared to the current Central Bank fueled explosion. The current extension failed at the top of the rising upper-trend line forming a “megaphone” pattern.
  • In that article, I explain what the technical significance of this pattern is.
  • Secondly, the market is trading MORE THAN 2-standard deviations above the long-term mean which was ideal for a larger corrective decline.
  • The good news, however, is that a monthly BUY signal was triggered with the liquidity fueled advance. Normally these signals are slow to turn, however, in recent years these signals are triggering much more often due to the increased volatility.
  • Importantly, MONTHLY data is ONLY valid at the end of the month. Therefore, these indicators are VERY SLOW to turn. Use the Daily and Weekly charts to manage your risk. The monthly and quarterly chart (below) is to give you some ideas about overall risk management.

Quarterly

  • As noted above, this chart is not about short-term trading but long-term management of risks in portfolios. This is a quarterly chart of the market going back to 1920.
  • Note the market has, only on a few rare occasions, been as overbought as it was earlier this year. The March decline and rebound were so fast that it barely registers on the chart. It also did very little to reduce the long-term risk of a larger decline during the second-half of the current ful-market cycle.
  • Secondly, in the bottom panel, the market has never been this overbought and extended in history, previous corrections last much longer than one month and were very brutal to investors before conditions were reversed.
  • As an investor it is important to keep some perspective about where we are in the current cycle, there is every bit of evidence that a mean-reverting event will eventually happen. Timing is always the issue which is why use daily and weekly measures to manage risk.
  • Don’t get lost in the mainstream media. This is a very important chart.

S&P 500 vs Yield Curve (10yr-2yr)

  • The chart above compares the S&P 500 to the 10-2 year yield spread.
  • The relationship between stocks and bonds is the visualization of the “risk/reward” trade-off.
  • When investors are exceedingly bullish, money flows out of “safe” assets, i.e. bonds, into “risk” assets, i.e. stocks.
  • What the chart shows is that when the yield-spread reverses, which is normally coincident with the onset of a recession, such tends to mark peaks of markets and ensuing corrections in stock prices.
  • While markets have defied the “reversion” of the yield-curve currently, due to massive amounts of stimulus and interventions, you should not become complacent this will continue to be the case.
  • The average recession last 12-18 months and bear markets tend to co-exist during that time frame.
  • The END of bear markets occurs when the yield spread peaks and begins to decline. That is not happening currently.
  • Pay attention, all of the market indicators currently suggest risk outweighs rewards and patience will likely be rewarded with a better opportunity to add exposure.
  • As with the Monthly and Quarterly charts above, this is a “warning” sign to pay attention and manage risk accordingly.

TPA Analytics: What A K-Shaped Recovery Means For Investors

What A K-Shaped Recovery Means For Investors

The U.S. economic recovery has taken on a K-shaped recovery when examining it at the industry level. This K-shape is what TPA has been using to steer clients toward sectors with the highest probability of success.

Suzanne Clark, President of the U.S. Chamber of Commerce, said,

“Depending on where you sit in the COVID economy, your business could be booming or on the brink of bankruptcy. The Pandemic’s uneven economic impact on industries and workers has been stark. Enter the K-Shaped Recovery. Long gone is the notion that we’ll have a V-Shaped Recovery—a deep economic decline followed quickly by sharp rebound. Instead, what we’re looking at is a recovery that will be vigorous for some sectors while others remain in freefall.”

The chart of this K-shaped recovery is provided below.

K-shaped Recovery

The relative performance chart below shows how these areas have performed in the stocks market 2020 year to date. TECH, Software and Services, and Retailing are in green. Hotels, Airlines and Leisure are in red.

RELATIVE PERFORMANCE OF SECTORS 2020 YTD

On 5/11/20, TPA showed clients the possible shapes of recovery, as described by Experian economic analysts (charts provided below). These shapes did not capture the nuances of the Covid-19 recovery in which the difference between the winners and losers is stark. In the 5/11/20 report, however, TPA spelled out what sectors clients should focus on and which they should avoid. TPA wrote in the World Snapshot:

“TPA feels that the most important point from the report for investors is what sectors and subsectors to focus on as the economy continues to feel the effects of Covid-19 and the shutdown.

Experian looks at it in terms of net job losses, but this is also telling in terms of business impact.

Leisure and Hospitality will continue to feel the worst effects of the crisis. Healthcare services, Business services, Retail trade, and Construction will also be negatively affected. On the other end of the spectrum, Government, IT, and Utilities will either be less affected or positively affected.

The table may be a roadmap for investors during the Pandemic. Be positioned away from those stocks most negatively affected (Leisure and Hospitality, Healthcare services,

Business services, Retail trade, and Construction) and focus on those sectors and subsectors that are either better positioned to withstand the storm or may even benefit from it (IT and Utilities).”

TPA’s advice has remained the same throughout the past 3 months and will continue to be consistent until there is a true solution for the Pandemic. Stick with those stocks that are either insulated from the effects of Covid-19 or benefit from the Pandemic.

POSSIBLE SHAPES FOR THE ECONOMIC RECOVER – EXPERIAN MAY 2020


Note from the RIAPro Team:

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

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

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

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

How To Find Value In An Upside Down World

How To Find Value In An Upside Down World

When the world turns upside down, the best thing to do is turn right along with it.”   – Mary Poppins

Is Mary’s advice proper when it is your hard-earned wealth at stake?

There is no doubt that investors are living in an upside down world. A speculative frenzy fueled by extreme monetary policy is sending stock markets to all-time highs and bond yields and spreads to record lows. At the same time, a global recession is raging, and social unrest is worsening by the day. We shouldn’t forget a pandemic is still having a significant effect on our lives.

Maybe investors are just an optimistic bunch and able to look beyond the current problems. However, it could be that investors are again falling victim to greed and cannot see the forest for the trees. More bluntly, maybe they cannot see the risks for the hope.

Another consideration is that desperate times call for desperate measures. Despite no visibility into the future, investors are frantic to own anything offering a positive return with little regard for the embedded risk.

In this piece, we quantify the upside down world in which stock investors find themselves in. Does it make sense? Absolutely not, but as we will show, a strong understanding of market dynamics exposes some valuable gems. When the time comes, these stocks will make playing defense productive.

Market Cap Is All That Matters

The major stock indexes sit at record highs despite a large swath of underlying stocks plodding along. The gains are superficial, a mask of sorts, resulting from the outperformance of the largest companies.

The S&P 500 and NASDAQ are market-cap-weighted indexes, meaning the largest companies contribute more to the index than the smallest. To be specific, and as shown below, within the S&P 500, the largest 100 companies account for 72.77% of the index. The smallest 200 only accounts for 6.67%. If those smallest 200 stocks all went to zero tomorrow, the S&P 500 would only decline by 6.67%. 

A closer look reveals that the problem is even more acute. Within the S&P 500 top 100 largest companies, the five biggest by market cap account for 33%. That is a stunning and unhealthy concentration.

Perspective Matters

If we change perspective from index performance to a comprehensive accounting of the index constituents, we get a much different picture. One look at the chart below shows the gains are poorly distributed. The largest 30% of companies are where the gains are found.

If we strip out the five largest companies (AAPL, AMZN, MSFT, GOOG, and GOOGL) from the “highest 30%” grouping, the market-weighted gain falls from 25.56% to 10.23%.

*The S&P 500 return differs from the average, as shown below. This analysis uses current weightings and year to date returns, whereas the index uses daily weightings and returns.

Are the Largest and Best Performing Companies the Cheapest?

An initial glance at the data above may lead one to assume that the biggest companies are the most fundamentally sound. That would certainly explain why they are outperforming. If that is the case, price and financial fundamentals should rightfully be traveling in lockstep.

The graphs below highlight four widely followed measures of equity valuation. Each again contrasts the market cap-weighted and equal-weighted perspectives and the three market cap groupings (bottom 30%, mid 40%, and top 30%). We also separate the five most expensive companies for each valuation metric and the average valuation for each metric.

Contrary to what most would expect in a normal world of markets and valuation, the charts show YTD performance quite the opposite. The more expensive the stock groupings are, on average, the better their performance. Even more insane, the five companies with the most egregious valuations in each metric excelled.

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

Value is Dead, Long Live Value

Anyone can discuss the latest trend, but the best investors always look for the next trend.  It is easy to restate the obvious and point out what happened; it is much harder to forecast what will happen.

This analysis shows the market is running on the strength of a few stocks while many stocks struggle. As this continues, opportunities emerge – opportunity in the form of companies whose stocks are going nowhere despite having cheap valuations.

CVS, for example, is one such company. The table below shows how CVS’s valuation stacks up against the S&P 500 and the top 30% by market cap.

Over the last five years, CVS has grown earnings and revenue at an annualized rate of approximately 12%. That is three times the rate at which the S&P 500 has increased for each.

Despite the strong fundamentals, CVS is badly underperforming the S&P 500. The graph below shows CVS lags by over 25% this year.

The passive investing phenomenon of indiscriminately chasing the popular stocks and the largest companies is leaving behind some gems. CVS is just one of many companies worth exploring.

Summary  

The market valuations of the companies in which the media and investors focus the most attention are confounding. At the same time, there is little discussion about stocks like CVS, which offer significant relative value. Stocks where you can get a whole lot more for your money.

When the euphoria of the current environment ends, cheap companies have the potential not only to limit downside risk but also to provide healthy returns when the market comes to its senses.

Viking Analytics: Weekly Gamma Band Update 9/8/2020

We are thrilled to announce that Viking Analytics will be providing RIA Pro subscribers their Weekly Gamma Bands update. The report uses options gamma to help you better manage risk and your equity allocations. In the future, we will release this report each Monday.

9/8/2020 Gamma Band Update

  • The S&P 500 (SPX) traded towards the upper band and sold off to end the week just above the Gamma Neutral level.
  • Accordingly, if the SPX closes below the Gamma Neutral level (3397.15), our Gamma Band model will begin to reduce allocation to equities.

Background

Market participants are increasingly aware of how the options markets can affect the equity markets. In this case, it can be viewed as the “tail wagging the dog.”

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

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

Authors

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

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

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


The 1998 Correction & The Run To The Peak

Over the last few months, the markets have become engulfed by a palpable feeling of exuberance. I remember the last time investors were engulfed in a near “panic” to invest. It was 1998, where following a correction, the market began a seemingly endless run to the peak in 2000.

I’m not too fond of market analogs as no two market environments are ever the same. However, there are many comparisons currently to the late 90s to explain the current bull market. The chart is below.

Another comparison is valuations.

Currently, the S&P 500 is trading at 31x trailing CAPE earnings. For comparative purposes, I have capped CAPE at 25x in the chart above, which aligns it with every valuation peak throughout history.

The deviation in valuations above the long-term average also only occurred in the late 90s.

Tech Bubble, #MacroView: Navigating The Tech Bubble & Living To Tell About It.

Late 90’s Type Speculation

In the late 90s, there was also rampant speculation in unprofitable companies simply because they were associated with the rise of the internet. Stocks like JDS Uniphase, Lucent Technologies, Global Crossing, Enron, SDLI, and a host of others would rise each trading day by 50 points or more.

Making money was so easy in the market that people quit their jobs to become day traders. Everyone from grocery clerks to barbers became stock market gurus, and making money was so easy, why not lever up?

margin debt bull market, Technically Speaking: Margin Debt Confirms Bull Market

Or even better, use buy call options to increase the buying power of your money. Today, there are more call options on stocks than we saw then.

margin debt bull market, Technically Speaking: Margin Debt Confirms Bull Market

Value Is For Boomers

Previously, I discussed the disparity in value and the deviation between value and growth.

Part of those discussions related to similarities seen at previous market peaks where investors threw “caution to the wind” and paid astronomical prices to own the “hot stocks.” 

While most young investors today assume “buying value” is for “boomers,” it is worth remembering what Scott McNealy, then CEO of Sun Microsystems, told investors who were paying 10x Price-to-Sales for his company in a 1999 Bloomberg interview. 

“At 10-times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10-straight years in dividends. That assumes I can get that by my shareholders. It also assumes I have zero cost of goods sold, which is very hard for a computer company.

That assumes zero expenses, which is hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that expects you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10-years, I can maintain the current revenue run rate.

Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those underlying assumptions are? You don’t need any transparency. You don’t need any footnotes.

What were you thinking?”

Tech Bubble, #MacroView: Navigating The Tech Bubble & Living To Tell About It.

How Many Do You Own?

Currently, there are hundreds of companies trading well beyond 10x price-to-sales. Below is a list of some of the “hot stocks” young investors are piling into trading at 10x or more.

Of course, much of this is “forgotten history” as many investors today were either a) not alive in 1999, or b) still too young to invest. For the newer generation of investors, the lack of “experience” provides no basis for the importance of “valuations” to future outcomes. That is something only learned through experience.

Bubbles Are About Psychology

Just as was the case in 1999, investors believe that stocks are essentially a “one-decision” investment. You buy them, and they only go up in price. In 1999, a large majority of these companies were financially unstable or grossly overvalued at best. Today, as shown above, it isn’t much different.

Notably, In 1999, as it is today, there was “no one,” saying there was a “Tech Bubble.” As Mark Hulbert noted earlier this year, it was quite the opposite. It also smacks of current sentiment as well:

“After reading through my newsletter archives from January 2000, I was struck by the similarities between now and then. For example, one newsletter editor in mid-January 2000 said he was encouraged that the Fed was signaling that it wouldn’t be raising rates as aggressively as previously thought. Another said, “inflation is dead.” A third celebrated the strength of the economy, as evidenced by robust consumer spending in the Christmas season that had just ended.

Sound familiar? To be sure, these similarities don’t mean the U.S. market is at or near a top. It does illustrate the false comfort we gain when telling ourselves a bear market can’t happen since the economy is strong, inflation is moribund, and the Fed is accommodative.”

As Mark goes on to note, the extension of valuations is concerning. However, valuations are a poor measure of market “bubbles.” Why?  Because “bubbles” are a “psychological phenomenon” where investor “greed” completely overrides “logic” and “restraint.” 

Tech Bubble, #MacroView: Navigating The Tech Bubble & Living To Tell About It.

More Similarities Than You Think

The current bull market is by far and away one of the longest bull markets in history. Currently running 137 months and 2783 points from the March 2009 lows, it is one for the record books. However, it is also important to remember that it is only the first half of a full-market cycle.

Here are some similarities:

In 1999:

  • Fed was providing liquidity in anticipation of Y2k problems.
  • Economic growth was beginning to deteriorate.
  • Interest rates were falling.
  • Earnings were rising through the use of “new metrics,” share buybacks, and an M&A spree. (Who can forget the market greats of Enron, Worldcom & Global Crossing)
  • Margin-debt / leverage was at the highest level on record. 
  • The stock market was beginning to go parabolic as exuberance exploded in a “can’t lose market.”
  • The speculative asset of choice: Dot.com stocks

In 2007:

  • Fed was discussing that subprime was “contained.”
  • Economic growth was beginning to deteriorate.
  • Interest rates were falling.
  • Debt and leverage provided a massive “buying” binge in real estate, creating a “wealth effect” for consumers, and high-valuations were justified because of the “Goldilocks economy.” 
  • Margin-debt / leverage was at the highest level on record. 
  • The stock market was beginning to go parabolic as exuberance exploded in a “can’t lose market.”
  • The speculative asset of choice: Real Estate

In 2020:

  • Fed continues to “jawbone” markets with accommodative policies.
  • Economic growth has deteriorated.
  • Interest rates continue to decline.
  • Earnings are rising through the use of “new metrics,” share buybacks, and an M&A spree. 
  • Margin-debt / leverage is pushing back toward the highest level on record. 
  • The stock market is beginning to go parabolic as exuberance explodes in a “can’t lose market.”
  • The speculative asset of choice: Work-At-Home Stocks

Of course, those are just some of the similarities.

As noted above, valuations in all three cases exceeded the long-term market peaks of 23x reported earnings. Furthermore, just as we saw each time previously, investor confidence is pushing extremes.

Tech Bubble, #MacroView: Navigating The Tech Bubble & Living To Tell About It.

Seen This Before

Again, none of this suggests the market is going to crash tomorrow.

History suggests the markets can, and will likely continue to rise in the short-term. As I stated, momentum is a tough thing to kill.

However, I have played this game before, and as the old saying goes:

“The more things change, the more they remain the same.”

If you have been around the markets for any length of time, you can quickly spot the “pigeons at the poker table.” 

These are the ones that continually rationalize why prices can only go higher, why this time is different than the last, and solely focus on the bullish supports. Trying to “draw to an inside straight” is not impossible; it just leads to losses more often than not.

Gambling in the stock market may be fun in the short-term. However, it would be best if you always remembered why Las Vegas makes billions in profits every year.

If you play long enough, “the house always wins.” 

Major Market Buy-Sell Review: 09-07-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 09-07-20

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

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

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

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

Major Market Buy/Sell Review 09-07-20

S&P 500 Index

  • Last week I wrote: “Wow. SPY is now extraordinarily overbought and pushing well into 3-standard deviations above the 50-dma. As noted in this week’s #Macroview, the deviations of WEEKLY measures are at historical extremes. Such is the point where a correction usually begins to some degree. As noted in our PORTFOLIO COMMENTARY last week, we are now starting to make adjustments for a correction.”
  • That correction came with a vengeance on Thursday and Friday but has done little to reverse the massive overbought conditions. While we suspect we will see some attempts at “dip buying,” there is a high degree of risk to the market still. 
  • Trading positions can be added, but caution is advised. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow continues to underperform other major indices due to its lack of the 5-major FANG stocks, but it did slightly outperform the S&P last week. 
  • The Dow remains extremely overbought, and as with the S&P, we will likely see some dip buying next week, but likely that will fail and a test of the 50-dma is likely.
  • Trading positions only for now. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • QQQ’s outperformance of SPY turned down last week as Tech stocks received the brunt of the selloff.
  • The QQQ’s remain massively overbought, and the buy signal remains grossly extended. QQQ is pushing up well into 3-standard deviations above the 50-dma. A further correction is likely.
  • We added some short-term trading positions to our current technology stock holdings on Friday. On a bounce we will likely sell them. 
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No changes this week.
    • This Week: Taking profits.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps failed this past week after pushing into extreme overbought territory and small caps traded sideways. 
  • The bullish news is the 50-dma is crossing above the 200-dma which will add support for small caps at $62.
  • Trading positions can be added at that support level for now. 
  • Support is critical at the $62 level.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $62
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. However, MDY also corrected a bit last week. 
  • We continue to avoid mid-caps for the time being until relative performance improves.
  • Trading positions can be added on a pullback to support at $340.
  • The $330 stop-loss remains. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $330
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets have performed better on a relative basis during the correction.
  • However, they remain extremely extended and well deviated above their 200-dma.
  • As with all other markets, the buy signal is at the highest level on record.  
  • The dollar decline, responsible for EEM performance, is well overdone. Look for a counter-trend rally, which will push EEM lower. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $40 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • EFA was holding up better. It will be necessary for EFA to hold support at the 200-dma, but the overbought condition puts this at risk. 
  • The dollar is extremely oversold, so a rally in the dollar could impact the EFA. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • We noted last week that “Oil prices are struggling to move higher but did manage to climb above the 200-dma.”
  • That quickly failed this past week with a sharp decline in oil prices after pushing up against 3-standard deviations and an extreme overbought condition. 
  • Pay attention to the risk.  
  • Oil is also subject to a reversal in the dollar as well. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long in our current position in IAU, but as noted last week, “after taking profits previously, we used the correction back to support to add a little to both IAU and GDX.”
  • Keep sizing relatively small for now. Gold is consolidating and is close to testing support at the 50-dma where it must hold.
  • Set stops at $175
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Added 1% to current holdings of IAU and GDX. (See portfolio commentary.)
    • Stop-loss moved up to $175
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

 

  • As noted two weeks ago, “the correction in bonds occurred last week, and on Friday, we used the dip to add to our TLT position.” 
  • On Friday we sold that added position to take profits on news the “Chinese threatened to dump bonds in retaliation to Trump’s threats.”  This is a non-threat and we will likely see bonds rally next week. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold position.
    • This Week: Hold positions.
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

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