Monthly Archives: February 2019

In the financial world, those who subscribe to the contrarian school of thought (including myself) keep an eye out for certain cues or indications that a trend has become overcrowded and is nearing its end. Some examples of these contrarian indicators are investor sentiment indexes, fear gauges such as the CBOE Volatility Index or VIX, the construction of record-breaking skyscrapers, and also the topics that are chosen for finance and business magazine covers. The last example is called the Magazine Cover Indicator and the logic behind it is that, by the time a trend has gained enough momentum or attention to justify its own cover story, it is about to become passé. In an infamous example, Businessweek published the cover story “The Death Of Equitieson August 13, 1979, right before the secular bull market began.

Bloomberg Businessweek’s latest cover story is called “Is Inflation Dead?,” which should make contrarians question whether the actual risk is higher inflation (or hidden inflation, as I will explain).

Here are the first few paragraphs from this piece –

If economics were literature, the story of what happened to inflation would be a gripping whodunit. Did inflation perish of natural causes—a weak economy, for instance? Was it killed by central banks, with high interest rates the murder weapon? Or is it not dead at all but just lurking, soon to return with a vengeance?

Like any good murder mystery, this one has a twist. What if the apparent defeat of inflation blew back on the central bankers themselves by making them appear expendable? Far from being lauded for a job well done, they’re under populist attack. “If the Fed had done its job properly, which it has not, the Stock Market would have been up 5000 to 10,000 additional points, and GDP would have been well over 4% instead of 3% … with almost no inflation,” President Donald Trump tweeted on April 14. On April 5, channeling Freddie Mercury of Queen, he said “you would see a rocket ship” if the central bank eased up.

The irony of Trump’s criticism of the Federal Reserve is that by historical standards, the bank is remarkably dovish—that is, inclined to keep rates low. After decades of working to tamp down inflation, even at the cost of inducing recessions, and finally succeeding, central bankers in developed economies have spent most of the past 10 years reversing course and trying to reignite it, with very little success. At a press conference on March 20, Fed Chairman Jerome Powell said low inflation is “one of the major challenges of our time.”

This “Is Inflation Dead?” cover story was published just a couple days after I published a detailed piece called “Where Is Inflation Hiding? In Asset Prices.” In that piece, I explained that the economics world was being fooled into believing a very dangerous fallacy over the last several years, which is the idea that there is very little inflation in the U.S. economy. I went on to explain how inflation is concentrated in asset prices (including stocks and bonds) rather than in consumer prices in this particular unusual economic cycle. Belief in the “low inflation” myth stems from the overly rigid reliance on conventional inflation indicators while completely ignoring the inflation in asset prices, which has resulted in extremely large and dangerous bubbles that will ultimately burst with disastrous consequences. As the chart below shows, assets such as global stocks and bonds have risen at a much higher rate than global real economy prices since the current bull market began in March 2009.

The people who are currently scratching their heads about low inflation while ignoring the massive asset bubbles that are growing right under their noses are the same ones who didn’t see the housing bubble’s warning signs in the mid-2000s. They were the ones justifying the growth of the housing bubble by saying “housing prices are rising because our population is growing,” “Americans are becoming wealthier and want larger, more luxurious homes,” and so on. During a bubble, the “crowd” will always tell themselves lies so that they don’t have to acknowledge the scary implications of the bubble and its coming burst. Once the bubble pops, they claim it was a freak occurrence that “nobody could have seen coming!” We’re making the same mistakes that we made during the housing bubble, but it’s just occurring in different industries, assets, and countries.

Just recently, David Robertson ran an article discussing the deviation which has grown between “fantasy” and “reality” in the investing markets.

“The phenomenon of extreme differences is also increasingly appearing in financial numbers, which are the life blood of markets. Andrew Smithers conducted research on the usefulness of accounting numbers and his work was summarized by Jonathan Ford

‘Corporate data now provide worse information than before.’

The ironic consequence of all this is that investors increasingly rely on non-Gaap numbers for valuation. These are not only idiosyncratic, and thus not always capable of comparison, they are also devised by bosses whose views may well be richly coloured by their own outsize incentives.’

Henny Sender highlights some prominent examples of “unusual measures of corporate performance.” Specifically, she mentions “gross merchandise value” as a metric commonly used by e-commerce firms and “community adjusted” earnings which is a controversial metric recently introduced by WeWork.

The entire article is a great read. However, what struck a cord with me was it brought up the memories of the late 1998-2000 bull market run when start up-IPO internet companies were being valued with “eyeballs per page” since most traditional measures of profitability, such as cash flows, earnings, and revenue were non-existent.

I know…most of you reading this article probably weren’t investing in the late 90’s, however, the few of you who were in the trenches with me will remember it all to well. Names like Enron, Worldcom, Global Crossing, Lucent Technologies, and a vast graveyard of others have long been forgotten and are now ancient artifacts of an age gone by.

Much like then, today we see companies going public like Lyft, Uber, Instagram, and others who have massive cash burn rates, little to no prospect for profitability in the near future, and astronomical valuations. Companies that are public, like Facebook (FB), are valued on “Monthly Average Users” or “MAU’s” which is highly suspect given that studies have suggested that as much as 50% of Facebook, Twitter, and YouTube’s users may be “fake.” Further, there is no verification process for what constitutes a valid account and as such, the stats are mostly just taken at the companies word. Importantly, the point is that creative use of new “metrics” are being used to justify valuations to satiate investor appetites.

Much like the late 1990’s, no one “really” wants to know the real answer, they just want to buy high and sell higher.

This is what Wall Street does, and does very well,  as David noted in his missive.

“The potential to create a very misleading impression of financial condition with alternative metrics was the subject of a report on the cloud software industry in the FT’s AlphavilleThe article highlights the fact that the average free cash flow margin for the cloud companies is 8.6% which is impressive. However, that margin falls to a far less impressive -0.6% when the real expenses of stock compensation are included.

At the end of the day, alternative metrics like these are better designed to tell stories than to provide information content. Sender notes, rightly, that such alternative measures “are no substitutes for profits or a path to them.” As the Alphaville report also points out, however, ‘Investors don’t seem to care that much.’”

Well, they may not care much at the moment.

But they will.

If You Can’t Make It, Fake It?

I just recently reviewed the latest completed earnings season (Q4). As has become the norm, companies once again beat drastically lowered earnings estimates with a variety of measures. To wit:

“Since the recessionary lows, much of the rise in “profitability” have come from a variety of 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 is directly connected to a consumption-based economy, has remained muted. 

Since 2009, the reported earnings per share of corporations has decreased from 353% in Q2-2018 to just 285% in Q4. However, even with the recent decline, this is still the sharpest post-recession rise in reported EPS in history. 

Moreover, the increase in earnings did not come from a commensurate increase in revenue which has only grown by a marginal 56% during the same period. (Again, note the sharp drop in EPS despite both tax cuts and massive share buybacks. This is not a good sign for 2019.)”

The reality is that stock buybacks create an illusion of profitability. Such activities do not spur economic growth or generate real wealth for shareholders, but it does provide the basis for with which to keep Wall Street satisfied and stock option compensated executives happy.

However, the recent downturn in corporate profitability may be more than just due to an economic “soft patch” as currently suggested by the majority of Wall Street analysts. The problem with cost cutting, wage suppression, labor hoarding and stock buybacks, along with a myriad of accounting gimmicks, is that there is a finite limit to their effectiveness and a long term cost that must eventually be paid.

Wall Street is well aware that “missing earnings,” even by the slightest margin, can have an extremely negative impact on their current share price. As such, it should come as no surprise that companies manipulate bottom line earnings to win the quarterly “beat the estimate” game. By utilizing “cookie-jar” reserves, heavy use of accruals, and other accounting instruments they can mold earnings to expectations.

“The tricks are well-known: A difficult quarter can be made easier by releasing reserves set aside for a rainy day or recognizing revenues before sales are made, while a good quarter is often the time to hide a big ‘restructuring charge’ that would otherwise stand out like a sore thumb.

What is more surprising though is CFOs’ belief that these practices leave a significant mark on companies’ reported profits and losses. When asked about the magnitude of the earnings misrepresentation, the study’s respondents said it was around 10% of earnings per share.


It should not be surprising that more than 90% of the companies surveyed pointed to “influence on stock price” and “outside pressure” as reasons for manipulating earnings.

Note: For fundamental investors this manipulation of earnings skews valuation analysis particularly with respect to P/E’s, EV/EBITDA, PEG, etc.

A couple of years ago, the Associated Press has a fantastic article entitled: “Experts Worry That Phony Numbers Are Misleading Investors:”

“Those record profits that companies are reporting may not be all they’re cracked up to be.

As the stock market climbs ever higher, professional investors are warning that companies are presenting misleading versions of their results that ignore a wide variety of normal costs of running a business to make it seem like they’re doing better than they really are.

What’s worse, the financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they’re largely passing along the rosy numbers in reports recommending stocks to investors.

Here are the key findings of the report:

  • Seventy-two percent of the companies reviewed by AP had adjusted profits that were higher than net income in the first quarter of this year. That’s about the same as in the comparable period five years earlier, but the gap between the adjusted and net income figures has widened considerably: adjusted earnings were typically 16 percent higher than net income in the most recent period versus 9 percent five years ago.
  • For a smaller group of the companies reviewed, 21 percent of the total, adjusted profits soared 50 percent or more over net income. This was true of just 13 percent of the group in the same period five years ago.
  • Quarter after quarter, the differences between the adjusted and bottom-line figures are adding up. From 2010 through 2014, adjusted profits for the S&P 500 came in $583 billion higher than net income. It’s as if each company in the S&P 500 got a check in the mail for an extra eight months of earnings.
  • Fifteen companies with adjusted profits actually had bottom-line losses over the five years. Investors have poured money into their stocks just the same.
  • Stocks are getting more expensive, meaning there could be a greater risk of stocks falling if the earnings figures being used to justify buying them are questionable. One measure of how richly priced stocks are suggests trouble. Three years ago, investors paid $13.50 for every dollar of adjusted profits for companies in the S&P 500 index, according to S&P Capital IQ. Now, they’re paying nearly $18.

The obvious problem, when it comes to investing in individual companies, is that playing “leapfrog with a unicorn,” pun intended, ultimately has very negative outcomes. While valuations may not matter currently, in hindsight it will become clear that such valuation levels were clearly unsustainable. However, by the time the financial media reports such revelations it will be long after it matters to anyone.

As David noted in his article, it is important to be aware of the difference, and ultimately what constitutes, “Fantasy” and “Reality.” Most portfolio managers are using valuation measures today based on recent 5- or 10-year averages, or worse, forward “operating earnings.”  They will be unpleasantly surprised by the depth of the reversion when it eventually comes.

A couple of years ago, Wade Slome, penned an excellent article pointing out four things to look for when analyzing corporate earnings:

  • Distorted Expenses: If a $10 million manufacturing plant is expected to last 10 years, then the depreciation expense should be $1 million per year. If for some reason the Chief Financial Officer (CFO) suddenly decided the building would last 40 years rather than 10 years, then the expense would only be $250,000 per year. Voila, an instant $750,000 annual gain was created out of thin air due to management’s change in estimates.
  • Magical Revenues: Some companies have been known to do what’s called ‘stuffing the channel.’ Or in other words, companies sometimes will ship product to a distributor or customer even if there is no immediate demand for that product. (Think Autos) This practice can potentially increase the revenue of the reporting company, while providing the customer with more inventory on-hand. The major problem with the strategy is cash collection, which can be pushed way off in the future or become uncollectible.
  • Accounting Shifts: Under certain circumstances, specific expenses can be converted to an asset on the balance sheet, leading to inflated EPS numbers. A common example of this phenomenon occurs in the software industry, where software engineering expenses on the income statement get converted to capitalized software assets on the balance sheet. Again, like other schemes, this practice delays the negative expense effects on reported earnings.
  • Artificial Income: Not only did many of the troubled banks make imprudent loans to borrowers that were unlikely to repay, but the loans were made based on assumptions that asset prices would go up indefinitely and credit costs would remain freakishly low. Based on the overly optimistic repayment and loss assumptions, banks recognized massive amounts of gains which propelled even more imprudent loans. That said, relaxation of mark-to-market accounting makes it even more difficult to estimate the true values of assets on the bank’s balance sheets.

These points are more valid today than they were then. The abuses to financial statements to meet earnings estimates have continued to grow. However, most investors don’t look beyond the media headlines before click the “buy” button on the latest “bull call de jour” on CNBC.

However, for longer term investors who are depending on their “hard earned” savings to generate a “living income” through retirement, understanding the “real” value of a stock will mean a great deal. Unfortunately, there are no easy solutions, on-line tips or media advice will not supplant rolling up your sleeves and doing your homework.

Investors would do well to remember the words of the then-chairman of the Securities and Exchange Commission Arthur Levitt in a 1998 speech entitled “The Numbers Game:”

‘While the temptations are great, and the pressures strong, illusions in numbers are only that—ephemeral, and ultimately self-destructive.’”

The reality is that this “time is NOT different.” The eventual outcome will be the same as every previous speculative/liquidity driven bubble throughout history. The only difference will be the catalyst that eventually sends investors running for cover.

Each week we produce a chart book of 10 of the current positions we have in our equity portfolio. Specifically, we are looking at the positions which warrant attention, or are providing an opportunity, or need to be sold.

While the portfolios are designed to have longer-term holding periods, we understand that things do not always go the way we plan. This monitoring process keeps us focused on capital preservation and long-term returns.


There are four primary components to each chart:

  • The price chart is contained within the shaded area which represents 2-standard deviations above and below the short-term moving average.  
  • The Over Bought/Over Sold indicator is in orange at the top.
  • The Support/Resistance line (green) is the longer-term moving average which also acts as a trailing stop in many cases.
  • The Buy / Sell is triggered when the green line is above the red line (Buy) or vice-versa (Sell).

When the price of a position is at the top of the deviation range, overbought and on a buy signal it is generally a good time to take profits. When that positioning is reversed it is often a good time to look to add to a winning position or looking for an opportunity to exit a losing position.

With this basic tutorial let’s get to the sector analysis.

NOTE: I was traveling on Tuesday and Wednesday and was unable to post the weekly position review. Since Friday is a holiday, I am posting the Position Review today and will pick up the Long-Short Idea List again next week. Thank you for your patience.

AAPL – Apple Inc.

  • Despite recent headlines about AAPL, it continues to lead the market higher as of late after breaking above resistance.
  • Given the recent buy signal, and not being overbought as of yet, we will continue to hold our position for now.
  • We have moved our stop loss up to $190.

AEP – American Electric Power

  • Utilities had gotten extremely extended and we have been cautioning on a pullback which will provide a better entry opportunity.
  • That pullback has been occurring not only in our Utility holdings but Real Estate as well.
  • On a pullback to $80-82 we can look to add to our position.
  • We have a stop-loss at $79.

ABT – Abbott Labs

  • Healthcare took a hit (ABT, UNH, HCA) on the back of “Medicare For All” talk from the Democratic hopefuls.
  • As they say – “This too shall pass” and the sell off in our positions is giving us a “gift” to buy fundamentally strong stocks on “rumor driven declines.”
  • It is too early to buy the sector right now, but when an oversold condition is achieved we will aggressively add to our holdings.
  • We are moving our stop-loss to $65

CMCSA – Comcast Corp.

  • CMCSA has broken out to all-time highs keeping its buy signal intact.
  • We are holding our position for now and allowing it to work as there is a rising view that “cutting the cord” may not have been as good of an idea as originally thought.
  • We are moving our stop-loss up to $40 to protect profits.
  • Our absolute stop is moved up to $36

COST – CostCo Wholesale

  • COST is flirting with its all-time highs after setting them a couple of weeks ago.
  • Current on a “buy signal” but very overbought we are going to give the position room to operate.
  • We are moving a “profit stop” up to $235 to protect our profits.
  • Stop-loss is moved up to $225

MDLZ – Mondelez International

  • MDLZ has been continuing to rise since breaking above previous resistance.
  • We have taken profits in the position once and will likely do so again fairly soon.
  • We are moving our “profit stop” up to $48
  • Our full stop-loss is moved to $46

MSFT – Microsoft

  • MSFT is one of the few stocks which continue to contribute to a rising market due to its massive weighting in the index.
  • After triggering a buy signal and breaking out to all-time highs, there has been little to stop the advance.
  • On a buy signal currently but extremely overbought, look for a correction for a better entry point.
  • We are moving our stop-loss up to $115

MMM – 3M Corp.

  • MMM has continued to benefit from the hopes of a trade war resolution coming soon.
  • On a buy signal and breaking above resistance a couple of weeks ago the trend is bullish.
  • However, with MMM very overbought look for a pullback to support to add to the position.
  • We will continue to hold our position for now
  • Stop-loss is moved up to $205

PEP – Pepsi Co.

  • PEP had already broken out to all-time highs before announcing strong earnings which sent the stock scorching higher.
  • We will look to take profits here soon with the position now very overbought and 2-standard deviations above the intermediate moving average.
  • A “profit stop” has been set at $122
  • Stop loss is currently set at $114

UNH – United Health Care

  • As noted with ABT above, Health care had a sharp selloff this past week on concerns about “Medicare for all.”
  • UNH just reported exceptionally good earnings but is selling off over concerns of legislation which is likely to never see the light of day.
  • This is likely a stellar opportunity to add to our holdings, which we will, but need to see the sell-off stabilize first.
  • We are moving our stop lower to give UNH some room to base between $210 and $220.
  • We will add to our holding at $230
  • Stop-loss is moved to $200

At the end of 2018, the global financial markets were reeling, the S&P 500 briefly fell into official bear market territory, and fear gauges were spiking. Sure enough, the Fed started to panic and backpedal on its previously hawkish tone regarding future rate hikes and quantitative tightening. Around the same time, Treasury Secretary Steven Mnuchin summoned the “Plunge Protection Team” or PPT to help shore up the U.S. financial markets. Since then, the S&P 500 is up over 24% and mainstream investors naively think “everything is great again!”  

As a result of the Fed’s flip-flop and resulting market surge, investors are very complacent once again (“why worry? the Fed has our backs!”). For example, the Volatility Index or VIX – a popular investor fear gauge – has been below 15 for the past couple months. Unfortunately, that is a reason for concern because the VIX also hit similar low levels before the last two volatility spikes and stock market plunges in early-2018 and late-2018 (volatility spikes when the stock market falls). In addition, the “smart money” or commercial futures hedgers (who tend to be right at major market turning points), are building up another bullish position in VIX futures, just like they did before the last two spikes. At the same time, the “dumb money,” or large traders (who tend to be wrong at major turning points), have built up a large short position, like they did before the last two spikes.

Worrisome investor complacency can also been seen in SentimenTrader’s Dumb Money Confidence index, which shows that the “dumb money” in the stock market are the most confident in a decade:

Another indicator that supports the “higher volatility ahead” thesis is the 10-year/2-year Treasury spread. When this spread is inverted, it leads the Volatility Index by approximately three years. If this historic relationship is still valid, we should prepare for much higher volatility over the next few years. A volatility surge of the magnitude suggested by the 10-year/2-year Treasury spread would likely be the result of a recession and a bursting of the massive asset bubble created by the Fed in the past decade (please read my recent article about this).

As a result of the Fed’s aggressive inflation of the stock market in the past decade, the S&P 500 rose much faster than earnings and is now at 1929-like valuations, which means that a painful correction is inevitable one way or another:

While it’s tough to say for certain that a volatility spike is imminent because we’re in an artificial market that is manipulated by the Fed and other central banks, the warning signs I showed are certainly worth keeping an eye on. Undoubtedly, the conditions necessary for another market rout and volatility spike are already present – the only thing that is holding the market up is faith that the Fed will continue to guide it higher even though economic data continues to deteriorate. At some point, investors will be forced to face reality.

In the months leading up to the Presidential election of 1992, Bill Clinton advisor James Carville coined the phrase “It’s The Economy Stupid” as a rallying cry for his candidate. At the time the U.S. economy was mired in weak economic growth despite having recently emerged from a recession. Democratic hopeful Bill Clinton was quick to remind voters of the circumstance and place direct blame on his opponent, George H.W. Bush. The strategy James Carville and Bill Clinton employed focused on the fact that presidential incumbents fare poorly when the economy is suffering.

“Long in the tooth” and “bottom of the ninth inning” are phrases we have recently used to describe the current economic cycle. In just a matter of days, this economic expansion will tie the period spanning 1991-2001 as the longest era of uninterrupted growth since at least 1857.  

Whether the current expansion ends with a recession starting next week, next month or next year is unknown. What is known is that the odds of a recession occurring before the presidential election in a year and a half are reasonably high. As evidenced by public Fed-bashing for raising interest rates, this point is clearly understood by President Trump. 

Boosting Growth Beyond Its Natural Bounds

Donald Trump can certainly win reelection, but his chances are greatly improved if he avoids a recession and keeps the stock market humming along. Accomplishing this is not an easy task for several reasons as we expand on.

Trend Economic Growth

The natural growth rate of the economy is about 2% per annum and declining. The graph below shows the ten-year average growth rate and its trend over the last 60 years.

Data Courtesy: St. Louis Federal Reserve

The slope of the trend line is -0.0336x, meaning that trend growth is expected to decline further by 0.0336% per year or approximately 0.34% per decade.

Fiscal Stimulus

During Trump’s term, economic growth has run 0.50-0.75% above trend in large part due to various forms of fiscal stimulus, including tax reform, hurricane/fire relief, and increased deficit spending. In 2018 for example, Treasury debt outstanding increased by $1.48 trillion as compared to an increase of $515 billion in the prior year. The difference of nearly $1 trillion directly boosted GDP for 2018 by approximately 1.30%.

Even if the Treasury’s net spending were to increase by another $1.48 trillion this year, the incremental contribution to GDP growth for 2019 would be zero. Any decline in Treasury spending from prior year levels will reduce economic growth.  It is a story for another day, but most economic measures are centered on percentage growth rates and not absolute dollars, meaning what matters most is the rate and direction of change.  

Given that control of the House of Representatives is in Democratic control we find it unlikely that deficits can increase markedly from current levels. Simply, the Democrats will not do anything to boost the economy and help Trump’s election chances.

Monetary Stimulus

Without the help of fiscal stimulus and a low rate of natural economic growth, Trump’s best hope to sustain 3-4% economic growth and avoid a recession by 2020 is for the Fed to lower interest rates and quite possibly re-introduce QE. Trump and his economic team have been publically insistent that the Fed does just that. Consider the following clips from the media:

3/29/2019 – White House economic advisor Larry Kudlow says he wants the Fed to cut its overnight lending rate by 50 basis points “immediately.”

4/5/2019 – (Reuters) – “I think they should drop rates,” Trump told reporters. “I think they really slowed us down. There’s no inflation.”  The U.S. president also suggested that the central bank pursue an unconventional monetary policy called “quantitative easing” that was used to nurse the economy back after the global financial crisis. “It should actually now be quantitative easing,” Trump said.

3/26/2019 – Stephen Moore, Donald Trump’s nominee for a seat on the Federal Reserve Board, told the New York Times that the central bank should immediately reverse course and lower interest rates by half a percentage point.


The Fed has partially acquiesced to Trump’s public demands. Over the last three months, the Fed has gone from a steadfast policy of further rate hikes and QT on “autopilot,” to ending the prospect of interest rate increases this year and halting QT by the end of the third quarter.

As far as the next step, reducing rates and possibly reengaging in QE, the Fed does not seem willing to do anything further. Consider the following clips from the media:

3/27/2019 – “I doubt we’re accommodative, but I also doubt we’re restrictive,” said Dallas Fed President Robert Kaplan. “If we’re restrictive, it is very modest.”

4/12/2019 – Minneapolis Fed President Neel Kashkari says it isn’t time to cut rates.

3/20/2019 – Per the FOMC statement from the most recent meeting- The Fed expects the benchmark rate to stay near 2.4 percent by the end of 2019.

4/11/2019 – “We’re strictly nonpartisan” “We check our political identification at the door” -Jerome Powell

4/12/2019 – Per Bond Buyer: Powell said to tell Democrats Fed won’t bend to pressure.

Based on the statements above and others, the Fed appears comfortable that their current policy is appropriate. It does not seem likely at this time that they will “bend to pressure” to get Trump and his team off their backs. 


Given that fiscal stimulus and the anemic growth trend will do little to help Donald Trump win reelection, all eyes should focus on the Fed. Pressure on the Fed to lower rates and start back up QE will become much stronger if the economy slows further and/or the stock market declines.

We believe the Fed will try to protect its perceived independence and keep policy tighter than the President and his team prefers. This dynamic between the President wanting a stronger economy to help his election chances and a Fed focused on maintaining their independence is likely to fuel fireworks on a scale rarely if ever seen in public. The market implications of such a publically waged battle should not be ignored.

This article is a prelude to another following soon which discusses the investment implications and consequences if Donald Trump were to fire or replace Chairman Powell.

Just in case you are wondering we believe the President can fire the Chairman despite no historical precedence for such an action. The paragraph below is from the Federal Reserve Act.

When one bets on a sporting event the facilitator of the bet, referred to as a bookie, charges the winner of the bet the vigorish. The vigorish, commonly known as the vig, is a fixed percentage of the bet that serves as compensation to the bookie for providing numerous betting options (liquidity) and the financial surety of collecting on winning bets.

Financial institutions, like bookies, are intermediaries. They link borrowers with lenders and investors and provide financial security similar to bookies. The fees, or vig, they charge can be thought of as a tax on capital transactions and thus a tax on the economy. If the vig is excessive, individuals, businesses, and the government are unnecessarily sacrificing capital and wealth to bolster the profits of financial institutions.

Regulation is a form of interventionism representing a direct or indirect tax on the economy. More often than not, regulations are sand in the gears of the economic engine with few redeemable benefits and a multitude of unintended consequences. However, sometimes regulation is well worth its cost as it provides benefits that outweigh the economic tax and the burden put on others. 

The Glass-Steagall Act of 1933 was one such example. While the act narrowed the lines of business in which banks could participate, it protected the banks and, more importantly, the nation’s populace from economic depression. Many factors have weighed heavily on the economy in recent years, and in our opinion, the repeal of Glass-Steagall is one of them. Its repeal in 1999 provides a clear breakpoint in the history of financial institutions and the activities this regulation once restricted.  

Removing the Handcuffs

Financial institutions serve as a crucial cog in the economic engine by allowing capital to flow more efficiently. Consider how hard it would be to get a mortgage or auto loan if you had to go to family and friends to borrow money. The task is infinitely complicated when one considers companies and governments that seek hundreds of millions, billions and even trillions of dollars.

Financial institutions that facilitate capital transactions of all sorts are paid fees in various forms. When a financial institution acts as a broker in the trading of secondary market securities, they are typically rewarded with a bid/offer spread or a commission. In the case of new equity and debt offerings, they are paid a fee by the issuing entity. Interest rates on traditional loans to individuals and businesses are typically offered at a spread to the institution’s cost of borrowing, thus ensuring compensation for the financial institution providing the loan. Financial institutions require these fees to incent them to commit their capital and, equally importantly, to protect them from the financial risks embedded within these transactions.

The Glass-Steagall Act of 1933 was enacted to combat over-reaching banking activities that led to financial instabilities and fueled the Great Depression. The act’s primary purpose was to prevent another banking collapse like the one that was crippling banks and leaving depositors penniless at the time.  The legislation’s main thrust was to separate traditional banking activities from trading and investing practices. From 1933 until its repeal in 1999, banks taking deposits were prohibited from trading and underwriting in non-government and non-investment grade securities. The act did not prevent financial crises from occurring, but it certainly prevented a crisis anywhere near the magnitude of the Great Depression. 

In 1999, Congress passed the Gramm-Leach-Bliley Act (also comically known as the Financial Services Modernization Act of 1999) which repealed Glass-Steagall. The repeal, heavily lobbied for by the banking sector, was promoted to the public as a means to unleash bankers’ ability to provide more capital and liquidity to spur economic activity. Less than ten years after the Gramm-Leach-Bliley Act was signed, financial institutions imploded to a degree not seen since the Great Depression. Without the lifeline of massive tax-payer funded bailouts, unprecedented monetary policy, and questionable accounting standards changes, the financial carnage from the crisis of 2008 might have equaled or even surpassed that of the Great Depression. 


Many experts warned at the time that the repeal of Glass-Steagall was another instance of greedy bankers looking for a way to pad the bank’s bottom lines and their paychecks with little consideration for the financial stability of their institutions or the potential economic consequences. The bankers won the battle and, as expected, profits in the financial industry soared almost immediately.

The graph below plots quarterly annualized financial corporate profits from 1948 to current. The data is separated by color to highlight the periods before and after the repeal of Glass-Steagall. Additionally, the red dotted regression trend line, showing trend profit growth pre-repeal, serves as a useful gauge to estimate the financial benefit to the banks of repealing Glass-Steagall.

Data Courtesy: St. Louis Federal Reserve (FRED) (NIPA profits with IVA and CC adjustments, Domestic – BEA)

As seen by the gap higher in profits in 1999, and how profits reset to an approximate 50% premium to the pre-1999 trend line, the repeal of Glass-Steagall was a windfall to the financial industry.

The financial industry claims that the significant jump in profits, post-repeal, is not just good for them but indicative of the benefits they deliver to corporate America and the economy. Ignorantly, such arguments fail to consider the massive costs shouldered by the citizens of the United States as a result of bailouts and the massive monetary stimulus that continue in unprecedented fashion to this day.

Measuring the Vig

Excluding the 2008 bailouts, whose costs are measured in the trillions, we attempt to quantify how much the repeal of Glass-Steagall is costing or benefiting economic activity. Said differently, how has the Vig, or economic tax, changed since 1999.

If the bankers are correct that deregulating financial institutions increased economic growth, then we should see an uptick in economic growth commensurate with the increased banking profits as shown above. As highlighted in the graph of GDP below, economic growth did not benefit. In fact, over the last 16 years, the GDP growth rate has been about 2.50% less than the pre-Glass Stegall era. Further, there has not been a quarterly increase in GDP higher than the average growth rate of the prior 50 years.

Data Courtesy: St. Louis Federal Reserve (FRED)

To further highlight the discrepancy claimed in the chart above, the graph below plots financial institution profits as a percentage of GDP.

Data Courtesy: St. Louis Federal Reserve (FRED) (NIPA profits with IVA and CC adjustments, Domestic – BEA)

Since 1999, bank profits (green) as a percentage of GDP are running about 1% higher than the red trend line of the prior 50 years. Our blunt take based on the graph above is that the repeal of Glass-Steagall effectively increased the VIG on the economy by 1%.

Furthermore, the collapse in profits in 2008 and 2009 was more than restored to financial institutions through the bailouts and extraordinary monetary policies used in the post-financial crisis era. As discussed above, those policies amount to massive subsidies coming at the cost of taxpayers and savers. They are directed at the banks, allowing them to quickly recoup self-inflicted losses.

Corporations are the heart and soul of the economy. They produce our goods, offer our services, pay our wages, and invest in productivity-enhancing projects. Therefore the capital flows of these companies are an important factor in economic growth. The more efficiently they can borrow and invest, the more innovation they can generate.

Before Glass-Steagall was abolished, financial institutions accounted for 20% of total corporate profits. Over the last 18 years, that amount has doubled to 40%. We remind you that banks do not innovate; their profits represent a missed opportunity for someone else to innovate.


When banks take a bigger share of the economic pie, labor, investment activity, corporations and shareholders suffer. The removal of Glass-Steagall has resulted in a large shift of capital from those that consume and innovate to the financial intermediaries or the economic bookies. You may think it a trivial matter that financial institutions are subsidized and profit at the expense of others. After all, those additional bank profits accrue to shareholders who in turn invest the capital back into the economy. While plausible, the fact of the matter is banking stocks have not reflected the higher profits. 

The KBW Bank Index has risen about 1% on an annualized basis since the Gramm-Leach-Bliley Act was passed. In other words, the shareholders have not been the beneficiaries of the enormous profit growth. Therefore, the riches graphed above have largely gone to those executives and other highly paid employees of these institutions. These circumstances have also widened the wealth imbalance that is so prevalent in the working population today.

If you happen to be one of the beneficiaries of the policies aimed at the financial industry, then you probably have done very well and had no complaints. For the other 99% of the working class, there may be some resentment to the fact that they were not only left behind but that they subsidized the policies fueling the wealth of the top 1%.

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Drive For Show

In golf there is an old axiom:

“Drive for show. Putt for dough.” 

This past weekend, Tiger Woods completed a comeback on Sunday by capturing his fifth Master’s title and his 15th major tournament win. It was a victory that snapped a decade-long championship drought and instantly returned him to the top of the sports world.

While his drives were some of the best on display, it was his final two-putt, likely the greatest bogey of his career, which put him 13-under par clinching the title.

Yes, Tiger Woods is back at “all-time” highs.


However, Tiger Woods’ journey back to the peak of the golfing world after being outside of the top 1000 in 2017 is not only a major accomplishment but a story of tragedy along the way.

Many wrote off Woods’ career as the injuries took their toll on his form, world ranking, and quality of life along with a high profile divorce, a bit of a scandal, and personal issues. However, despite the odds, Tiger Woods is back with a story that the world had resigned itself to never seeing again.

In many ways, investors over the last decade have endured much the same.

Investors were on top of the game in 1999, as the markets soared higher. There seemed to be nothing that could stop the advance despite high valuations and questionable accounting metrics. However, after 13-years in the “investment wasteland,” investors finally got back to even had they held onto their S&P index fund and religiously dollar cost averaged (DCA) into it.

Unfortunately, there were very few who did.

As repeated studies have shown, while “buy and hold” investing sounds like a workable plan, the fallacies of “being human” tend to deviate it from our goals. For Tiger Woods, it was his human frailties, both physically and emotionally, which deviated him from his dominance in golf. For investors, it is much the same as our emotions of “greed” and “fear” destroy the best laid of plans.

A recent study by DALBAR, a financial research firm, has shown how the general temptation for investors to buy and sell at the wrong times repeatedly results in the investor losses. (Chart courtesy of American Funds)

As we discussed in our recent weekly newsletter (Subscribe for free E-delivery)this same behavior was on display during the December sell-off in the markets. To wit:

“Many investors are finally getting back to even, assuming you didn’t ‘sell the bottom’ in December, which by looking at allocation changes, certainly appears to be the case for many.”

“Not surprisingly, historically speaking, investors had their peak stock exposure before the market cycle peaks. As the market had its first stumble, investors sold. When the market bounces, investors are initially reluctant to chase it. However, as the rally continues, the ‘fear of missing out or F.O.M.O’ eventually forces them back into the market. This is how bear market rallies work; they inflict the most pain possible on investors both on the bounce and then on the way back down.”

As the markets near their all-time highs, investors are finally wading back into the markets. As Chris Matthews noted for MarketWatch:

“But individual investors are once again wading into the market, indicating renewed bullishness in surveys and flow data released in recent days. 

The latest E-Trade StreetWise survey, released Friday, showed 58% self-directed investors calling themselves ‘bullish’ on the stock market in the second quarter of this year, a 12 percentage-point increase from the first quarter, when a 54% majority indicated they were ‘bearish’ in their stock market outlook.”

Rising markets are exciting.

“Drive For Show”

The most exciting part of golf is watching the Pro’s “drive for show.” A hushed silence falls over the crowd as the golfer looks down the fairway at the distant flag. You can almost hear the breathing stop as the backswing begins. The camera chases the ball as it flies through the air as the excitement builds that it will land on the green.

It is the same with investors.

With all eyes focused on the market as it flies higher, it’s exhilarating.

Currently, with markets rising on hopes the Federal Reserve is returning to more “accommodative” ways and consistent headlines of a conclusion to “Trump’s Trade War,” there seems to be nothing that can stop the market’s advance. “Hope” is an incredibly virulent toxin that blocks the “logic pathways” of investor intellect. One of the clues of its presence is the belief that “this time is different.” 

However, it is when the “ball lands on the green” the real work begins.

The most challenging aspect of golf, and where it counts the most, is minimizing the number of strokes required to “putt” the ball into the cup. Those most skilled are the ones who win more often than not.

In investing it is much the same. As markets approach major important inflection points, it is the skill of mitigating risk and repositioning portfolios which reduces the number “strokes” in the investment game.

Since the December swoon, most investors have forgotten the pain they felt, and the “fear of losing” has once again been replaced with the “Fear of Missing Out.” However, while many investors spent their time “driving for show,” bond investors won by consistently “putting for dough.”

This is where we are today.

“Putting For Dough”

Currently, the market is as extended as it has been at other major points throughout history with a similar backdrop of slowing earnings and economic growth, higher interest rates, and geopolitical stresses. Also, complacency is back as volatility continues to subside as the “fear of a correction” has subsided substantially since the December lows.

Also, as shown in the next chart, the negative “cross over” is still intact AND it is doing so in conjunction with an extreme overbought weekly condition and a “negatively diverging” moving average divergence/convergence (MACD) indicator. This combined set of “signals” has only been seen in conjunction with the previous market peaks. (The corrections of 2012 and 2015-16 were offset by massive amounts of Central Bank interventions which are not present currently.)

Clearly, the “drive for show” is now behind us. 

As we prepare for the “putt,” it is time to focus on the “lay of the green.”

In the short-term the market remains bullishly biased and suggests, with a couple of months to go in the “seasonally strong” period of the year, that downside risk remains limited. Importantly, while downside risks are somewhat limited, this doesn’t mean there is a tremendous amount of upside reward either.

Currently, our portfolio allocations:

  • Remain long-biased towards equity risk
  • Have a balance between offensive and defensive sector positioning
  • Are tactically positioned for a trade resolution (which we will sell into the occurrence of.)

However, the analysis also keeps us cautious with respect to the longer-term outlook. With the recent inversion of the yield curve, deteriorating economic data, and weaker earnings prospects going forward, we are focused on risk management and capital controls. As such we are:

  • Continuing to carry slightly higher levels of cash
  • Overweight bonds 
  • Have some historically defensive positioning in portfolios. 
  • Continue to tighten-up stop-loss levels to protect gains, and;
  • Have outright hedges ready to implement when needed.

In your own portfolio, there are simple actions you can take to improve your chances of “sinking the putt.”

  1. Trim positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits)
  2. Sell underperforming positions. If a position hasn’t performed during the rally over the last three months, it is weak for a reason and will likely lead the decline on the way down. 
  3. Positions that performed with the market should also be reduced back to original portfolio weights. Hang with the leaders.
  4. Move trailing stop losses up to new levels.
  5. Review your portfolio allocation relative to your risk tolerance. If you are aggressively weighted in equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.
  6. Look to reposition portfolio composition from “risk” toward “safety.” Look to reduce assets specifically tied to economic growth and increase holdings in assets which tend to be more defensive in nature. 
  7. If you just don’t know what to do – cash is the best alternative. With cash now yielding more than the S&P 500, holding cash IS an option until you figure out what to do. Remember, investing is about making a bet where the potential for reward outweighs the risk of loss. If you can’t find that opportunity right now, cash is the best alternative until you do.

How you personally manage your investments is up to you. I am only suggesting a few guidelines to rebalance portfolio risk accordingly. Therefore, use this information at your own discretion.

But if you need help click here.

A very dangerous fallacy has taken the world of economics by storm over the last several years: the idea that there is very little inflation in the U.S. economy, therefore interest rates should remain at unusually low levels for an even longer period of time. As I will prove in this piece, the people who believe in the “low inflation” myth are being fooled by the fact that inflation in this unusual, central bank-driven economic cycle is concentrated in asset prices rather than in consumer prices. By holding interest rates too low for too long, a massive asset bubble has inflated and is poised to inflate even further as long as economists and central banks like the Fed continue to be fooled by the “low inflation” myth. Unfortunately, the ultimate bursting of this unprecedented asset bubble is going to throw the U.S. and global economy into another depression.

One of the most fervent believers in the “low inflation” myth is President Donald Trump himself. Trump has complained many times about the Fed’s interest rate hikes that have occurred during his presidency. Over the past three years, the Fed hiked rates from 0% to 2.5%, which is still extremely low considering that rates above 5% were common throughout history. As Trump said earlier this month –

“Well I personally think the Fed should drop rates,” Mr. Trump said. “I think they really slowed us down. There’s no inflation. I would say in terms of quantitative tightening, it should actually now be quantitative easing. Very little if any inflation. And I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship. Despite that, we’re doing very well.”

Trump reiterated his “no inflation” belief in a tweet yesterday:

Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, recently summarized the Fed’s position that inflation is still low and even believes that the Fed should let inflation run above its target for a few years:

Many prominent financial journalists and commentators including my friend Pedro da Costa believe that the Fed has been hiking interest rates too aggressively:

The well-known investing pundit and host of CNBC’s “Mad Money” TV show Jim Cramer is a vocal Fed rate hike critic and believer in the “low inflation” myth:

“Memo to Powell: keep listening. Be patient. Enjoy the employment gains. Let’s keep the strength going by waiting a little and not being too judgmental about rate hikes like some of your colleagues,” Cramer said.

The “Mad Money ” host reiterated his distaste in some Fed officials’ tendency to stick to traditional metrics when gauging how the economy is doing.

“How can you claim to be data-dependent if you’ve made up your mind before you see the data that you need one or two more rate hikes to get back to normal?” he asked. “Normal is where the data says you should go. Normal is the natural progression of jobs being created without a lot of inflation. Normal is not a percent.”

Belief in the “low inflation” myth stems from the overly rigid reliance on conventional inflation indicators even though we have been in an unconventional economic cycle since 2009 (because it has been driven by record low interest rates and trillions of dollars worth of quantitative easing). In this type of environment, it is wise to think outside of the box and to consider all information available, but most economists are still stuck in the past as if we are in a garden-variety business cycle in the twentieth century.

The Federal Reserve’s preferred inflation indicator is the core personal consumption expenditure price index (excluding volatile food and energy), which tracks the prices of U.S. consumer goods and services. The Fed has an official target of 2% annual inflation, but inflation has been running cooler than that since the Great Recession according to the core PCE index.

The inflation index most commonly referenced in the financial media is the core Consumer Price Index or CPI (excluding volatile food and energy). The core PCI tells a similar message as the core PCE index: consumer price inflation has been tepid since the Great Recession.

Wage growth has also been quite low since the Great Recession:

Overly rigid reliance on conventional inflation indicators has made the mainstream economics community completely blind to the elephant in the room, which is the fact that inflation has been concentrated in asset prices rather than consumer prices. As the chart below shows (which I’ve recreated from a chart made by Goldman Sachs a couple years ago), assets such as global stocks and bonds have risen at a much higher rate than global real economy prices since the current bull market began in March 2009.

Consumer price inflation has remained low while asset price inflation has exploded because asset prices have been acting like a relief valve for inflationary pressures that have been created by record low global interest rates and the pumping of trillions of dollars worth of liquidity into the global financial system. This doesn’t mean that we don’t have an inflation problem; we have a tremendous inflation problem on our hands, but you need to know where to look.

This Wikipedia entry explains how relief valves work in the mechanical world –

A relief valve or pressure relief valve (PRV) is a type of safety valve used to control or limit the pressure in a system; pressure might otherwise build up and create a process upset, instrument or equipment failure, or fire. The pressure is relieved by allowing the pressurised fluid to flow from an auxiliary passage out of the system. The relief valve is designed or set to open at a predetermined set pressure to protect pressure vessels and other equipment from being subjected to pressures that exceed their design limits. When the set pressure is exceeded, the relief valve becomes the “path of least resistance” as the valve is forced open and a portion of the fluid is diverted through the auxiliary route. The diverted fluid (liquid, gas or liquid–gas mixture) is usually routed through a piping system known as a flare header or relief header to a central, elevated gas flare where it is usually burned and the resulting combustion gases are released to the atmosphere. As the fluid is diverted, the pressure inside the vessel will stop rising. Once it reaches the valve’s reseating pressure, the valve will close.

A pressure relief valve. Image source: Wikipedia

As discussed earlier, the U.S. is currently experiencing a massive asset bubble due to the Fed’s aggressive, unconventional monetary policies during and after the Great Recession. The first of these policies is known as zero interest rate policy or ZIRP. The Fed cut its benchmark interest rate (the Fed Funds rate) to virtually zero and held rates at record low levels for a record length of time. Asset and credit bubbles often form when central banks cut interest rates to artificially low levels because it becomes much cheaper to borrow, low rates discourage saving and encourage speculation in riskier assets & endeavors, and because they encourage higher rates of inflation, to name a few examples. The dot-com and U.S. housing bubbles formed during relatively low interest rate periods as well.

In addition to ZIRP, the Fed utilized an unconventional monetary policy known as quantitative easing or QE, which pumped $3.5 trillion dollars worth of liquidity into the U.S. financial system from 2008 to 2014. When conducting QE, the Fed creates new money digitally for the purpose of buying bonds and other assets, which helps to boost the financial markets. The chart below shows the growth of the Fed’s balance sheet since QE started in 2008: 

The Fed’s ZIRP and QE policies caused the S&P 500 to surge over 300% from its 2009 low:

The chart below compares the Fed’s balance sheet to the S&P 500. Notice how each expansion of the Fed’s balance sheet led to a corresponding increase in the S&P 500.

As a result of the Fed’s aggressive inflation of the stock market in the past decade, the S&P 500 rose much faster than earnings and is now at 1929-like valuations, which means that a painful correction is inevitable one way or another:

The Fed’s aggressive inflation of stocks and other assets has created a dangerous bubble in U.S. household wealth (see my presentation about this). U.S. household net worth has hit record levels relative to the GDP in recent years, which is a sign that household wealth is overly inflated and heading for an inevitable crash. The last two times household wealth became so stretched relative to the GDP were during the dot-com bubble and housing bubble, both of which ended in disaster. Terrifyingly, the current household wealth bubble blows the last two out of the water. There is a direct link between how large our current household wealth bubble is and how interest rates have been at record low levels for a record length of time. Unfortunately, the coming household wealth crash will be proportional to the run-up. (The Fed-driven household wealth bubble is also the main driver of growing U.S. wealth inequality, as I explained in Forbes recently.)

In addition to the fact that U.S. consumer price inflation has been low since the Great Recession because inflation has been concentrated in asset prices, there are many reasons to believe that consumer price inflation is actually running a lot hotter than mainstream economists think it is (or want you to think it is). According to John Williams, the proprietor of Shadow Government Statistics, the U.S. CPI formula has been changed over the years for the purpose of understating inflation.

For example, if we use the same CPI formula as we did in 1980 (blue line), it shows that inflation has been running at a nearly 10% annual rate for the past decade rather than the roughly 2% annual rate that today’s CPI (red line) indicates:

Similarly, the 1990 CPI formula (blue line) shows that inflation has been running at a roughly 5% annual rate rather than 2%:

One of the primary ways that our modern CPI formula understates inflation is through hedonic quality adjustments. In simple terms, consumer goods that experience technological improvements are considered to have fallen in price when calculating the CPI even if the price has stayed the same or even increased in real life. For example, if a computer with an eight-core processor costs $1,000 today and most computers have sixteen-core
processors but cost $1,300 in two years from now, it may get recorded as only costing $800 for the purpose of calculating the CPI. Of course, that’s no consolation to the consumer who actually has to pay $1,300.

Because so many high-tech consumer products have entered our lives over the past forty years and those products have improved at a rapid rate, they have masked the very real inflation that has occurred in big ticket necessities like housing, healthcare, childcare, and higher education. Sure, it’s great that laptops, cell phones, and big screen TVs have been falling in price while gaining more features, but that doesn’t help Americans who are going bankrupt due to exorbitant medical bills, being crushed under the weight of student loans, and can’t find affordable housing anywhere.

The chart below from the American Enterprise Institute shows the dichotomy between high-tech consumer products, which have been falling in price, and big ticket necessities that have surged in price and are becoming increasingly out of reach for many Americans:

To summarize, America has a very real inflation problem, but it’s not where everyone is looking. The pervasive, but wrong belief that interest rates should remain at ultra-low levels will only serve to further inflate the asset bubbles that the mainstream economics world is ignoring or in denial of. Unfortunately, these bubbles are eventually going to burst and will cause an economic depression. We should not expect a different outcome when the same characters who completely missed the housing bubble’s obvious warning signs are still employed at the Fed, the big banks, investment firms, academia, and financial media.

Each week we produce a chart book of the S&P 500 sectors to review where money is flowing within the market as whole. This helps refine not only decision making about what to own and when, but what sectors to overweight or underweight to achieve better performance.


There are three primary components to each chart:

  • 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 have a tendency of working better than when below the zero line.

With this basic tutorial let’s get to the sector analysis.

NOTE: I am traveling today, so these charts were done mid-day yesterday. Any price discrepancies between publication and close will be corrected in the next update.

Basic Materials

  • The recent “catch up” rally over the last couple of weeks has pushed XLB into the top of its downtrend resistance.
  • The “buy” signal has now gotten extremely extended as noted by the horizontal dashed red line.
  • As noted previously, the breakout cleared the path for a move higher. However, the move is now likely complete.
  • Take profits and rebalance back to target weights..
  • Short-Term Positioning: Neutral
    • Last Week: Rebalance and hold position.
    • This Week: Hold position.
    • Stop-loss moved up to $55.
  • Long-Term Positioning: Bearish


  • XLC has rallied above resistance with the market as of late.
  • With the current “buy” signal very extended, and the sector very overbought, be patient for a better entry point.
  • Short-Term Positioning: Neutral
    • Last Week: Recommended to “hold” 1/2 position
    • This Week: Hold 1/2 position
    • Stop-loss moved up to $46
  • Long-Term Positioning: Bearish


  • With the recent rally in oil prices, XLE broke above resistance and is currently holding.
  • The current “buy signal” remains intact but the sector is back to
  • Currently, XLE has reversed back up to extreme overbought short-term.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position.
    • This week: Hold and wait for a pullback to support, or a break out, to add.
    • Stop-loss moved up to $64
  • Long-Term Positioning: Bearish


  • XLF did hold critical support and bounced last week with hopes for better bank earnings.
  • While a “buy” signal has been triggered (bottom panel) the recent rally has pushed into important resistance.
  • XLF has reversed back to overbought.
  • Short-Term Positioning: Neutral
    • Last week: Recommended “hold” 1/2 position
    • This week: Hold 1/2 position, add on a breakout above $27.
    • Stop-loss moved up to $25.00
  • Long-Term Positioning: Bearish


  • We noted previously that XLI had rallied sharply on hopes of a resolution on trade. However, whatever deal is struck, it has likely already been priced in.
  • Buy signal in lower panel is very extended and at the highest levels we have seen in recent history.
  • XLI has completely reversed back to overbought as well.
  • Short-Term Positioning: Bullish
    • Last week: Recommended “hold” 1/2 position
    • This week: Rebalance holdings. Hold 1/2 position, we missed the opportunity to add to our position previously. Add on a breakout above resistance that holds.
    • Stop-loss moved up to $72
  • Long-Term Positioning: Neutral


  • Currently XLK is on a “Buy” signal (bottom panel) but that signal is “crazy” extended like many other sectors of the market.
  • However, the good news is XLK has broken out to all-time highs which continues to suggest that the overall market will break out to new highs as well.
  • There is no resistance overhead so this makes the previous resistance level now incredibly important support.
  • Short-Term Positioning: Bullish
    • Last week: Recommended “hold” 1/2 position
    • This week: Hold 1/2 position, Add on test of previous resistance.
    • Stop-loss moved up to $70
  • Long-Term Positioning: Neutral


  • XLP continues to push towards all-time highs along with the rest of the market. The chase for defensive holdings remains concerning giving the current market backdrop.
  • XLP’s “buy” signal (lower panel) is back to extreme levels. So, taking profits is advised.
  • Currently still overbought, however the pullback to $54-$54.50 can be used to add exposure.
  • Short-Term Positioning: Bullish
    • Last week: Holding full position.
    • This week: Hold position
    • Stop-loss moved up to $53
  • Long-Term Positioning: Bullish

Real Estate

  • Real estate continues to remain incredibly extended to the upside, along with utilities (XLU) and staples (XLP), as the “defensive” play in markets continue. Take profits and be careful.
  • There has not been a decent risk/reward opportunity to increase exposure.
  • Buy signal has reached extreme levels (bottom panel) and the highest seen in recent history.
  • Remains at extreme overbought levels short-term. (top panel)
  • Short-Term Positioning: Bullish
    • Last week: “Hold” 1/2 position
    • This week: Hold 1/2 position
    • Add on any weakness that works off over-bought condition or holds support at $34
    • Stop-loss adjusted to $33.50
  • Long-Term Positioning: Bullish


  • XLU has finally taken a breather from its recent advance but not much of one.
  • Long-term trend line remains intact but is so extended now, it will correct,.
  • Previous support continues to hold.
  • Buy signal has gotten back to more extreme levels. (bottom panel)
  • Recent correction was not enough to work off much of previous overbought condition.
  • Short-Term Positioning: Bullish
    • Last week: Rebalance holdings and continue to hold.
    • This week: If you didn’t take profits last week, do so now and hold target weight.
    • Stop-loss moved up to $54 and we are approaching our target of $60 from January
  • Long-Term Positioning: Bullish

Health Care

  • Sell-signal (bottom panel) is being reversed but has not yet flipped to a “buy signal.”
  • The current overbought condition is being worked off slowly.
  • XLV is holding support currently at the long-term uptrend line but is trapped below recent highs.
  • Short-Term Positioning: Neutral
    • Last week: Hold current position.
    • This week: Hold current position.
    • Stop-loss remains at $89
  • Long-Term Positioning: Neutral


  • XLY broke through to all-time highs along with Technology.
  • Previous support was successfully tested in recent sell off.
  • A “buy” signal has been registered (lower panel) but that signal is now back to extreme levels.
  • Extreme overbought conditions currently limit upside.
  • The previous correction to $108 hit our target to add exposure.
  • Short-Term Positioning: Neutral
    • Last week: Hold current position.
    • This week: Hold current position
    • Stop-loss moved up to $110
  • Long-Term Positioning: Neutral


  • Transportation is finally trying to play catch up with the rest of the market.
  • The rally last week, while nice, is still confined to the current downtrend line and is wrestling with resistance from previous highs.
  • Buy signal. (bottom panel) is maintaining itself currently and has improved modestly.
  • The short-term oversold condition has been fully reversed to overbought.
  • The “sell stop” was triggered previously. No real need to rush back into adding a new position. We will watch and see what happens.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

The amount owed to retirees accelerated faster than assets on hand despite a record bull market.

The Wall Street Journal reports the Long Bull Market Has Failed to Fix Public Pensions.

“Some of the states allowed themselves to get so underfunded that the higher returns aren’t helping them enough,” said Michael Cembalest, chairman of market and investment strategy for the asset-management arm of JPMorgan Chase & Co. and the author of an annual study on the financial health of cities and states.

Illinois Tops the Worst State List

Illinois, New Jersey and Kentucky top the list of states in worst shape on a percentage of revenue basis.

Chicago the Worst City

Worst Cities on Percentage Basis

  1. Chicago, IL
  2. Baton Rouge, LA
  3. Pittsburgh,PA
  4. Atlanta, GA
  5. Lubbock, TX

Deeper Pension Cuts Didn’t Materialize

Many states and cities reduced benefits for new employees after 2008. But deeper cuts often met resistance from judges, unions and angry constituents—even in some of the most indebted states.

The Illinois Supreme Court in 2015 threw out cuts by the legislature that were expected to save tens of billions of dollars. Kentucky’s legislature last year declined to approve the governor’s proposed cuts to cost-of-living increases for retired teachers after protests brought thousands to the state capitol and forced cancellations of classes in several school districts.

Pension Plan Assumptions

The average pension plan assumption is about 7.3%. That’s not going to happen.

Please consider charts and commentary from John Hussman’s April 2019 post You Are Here.

Valuations Second Highest in History

Expected Total 12 Year Return is Zero

The following chart shows nonfinancial market cap/nominal potential GDP on an inverted log scale (left), with actual subsequent 12-year S&P 500 total returns on the right scale. As usual, note that speculative bubbles always make it appear that valuations haven’t “worked” in the period immediately preceding the top, precisely because a substantial, if temporary, violation of historical norms is required to get to those extremes. As indicated by other reliable measures, investors are presently facing the likelihood of prospective nominal 12-year S&P 500 total returns averaging roughly zero.

​I remember a little boy listening to a concert at a Fourth of July celebration one year. As the music played, the little boy waved his arms as if he was conducting the orchestra. Monetary authorities are a lot like that, except that everyone who watches these kids at play actually believes that they are, in fact, conducting the orchestra.

I’m utterly mesmerized by the credulity of investors who believe that the Federal Reserve is capable of saving them from every possible contingency, no matter how irresponsible their own speculative behavior might be.

Imagine the shock of pension plans if the 12-year average is as low as 4% a year let alone a total return of zero.

Last week, the Federal Reserve released their March FOMC meeting minutes. Following the release, the markets surged higher as the initial reading by the markets was “the Fed is done hiking rates.” As the Wall Street Journal reported in Fed Minutes: Officials See Little Need to Change Rates This Year.

‘Minutes of the March meeting released Wednesday showed officials see little reason to continue raising rates due to greater risks to the U.S. economy from the global growth slowdown and muted inflation readings that took more officials by surprise.

‘A majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year,’ the minutes said.

At the same time, the minutes show officials didn’t perceive any need to cut their benchmark rate absent a broader deterioration in the economy. Officials said their view of the appropriate setting for interest rates ‘could shift in either direction based on incoming data and other developments.’

Since officials last met, President Trump has said he would like to see the Fed undo its last two rate increases. Fed officials have said they will base their decisions on the economic outlook and not political pressure.’

See, nothing to worry about as there are no recessions predicted by the Fed…ever.

This image has an empty alt attribute; its file name is Shedlock-Fed-041019-1024x692.png

As Peter Bookvar noted Wednesday afternoon, don’t believe for a moment the Fed isn’t specifically targeting the market:

“I’ve said many times to insert ‘S&P 500’ for ‘financial developments’ because that is essentially what we’re talking about here when its cited. So the Fed is referring to ‘significant uncertainties’ with regards to the S&P 500. What uncertainties exactly now since the S&P 500 is just off all time record highs?

They also acknowledged that their jawboning which shifted policy to one that is more ‘flexible’ is what boosted the stock market. ‘In their discussion of financial developments (S&P 500), participants observed that a good deal of the tightening over the latter part of last year in financial conditions (S&P 500) had since been reversed; Federal Reserve communications since the beginning of this year were seen as an important contributor to the recent improvements in financial conditions (S&P 500). Participants noted that asset valuations had recovered strongly.’

Thanks Fed, high five and the parenthesis and underline are obviously mine.”

But here is the problem with the market’s assumption:

“The Fed Did Not Say They Were Done Hiking Rates”

While the Fed said they would be “patient” for now, there are already indications that economic growth and inflation will pick up over the next couple of quarters, (No, this isn’t the revival of the economy, but simply a normal seasonal bounce from pent up demand following a cold winter.) 

Complicating matters for the Fed is the strength of the dollar, the continued rise oil prices which is already leading to stronger inflationary prints, and increases in wages which will lead to concerns about an overheating economy. Such will put the Fed in a “box” with respect to both being “data dependent” as well as maintaining some semblance of “independence.”

In other words, while they may be “patient” for the moment, that doesn’t mean their position won’t change. As noted in their minutes:

“Most participants indicated that they did not expect the recent weakness in spending to persist beyond the first quarter.

“Several participants noted that their views of the appropriate target range for the federal funds rate could shift in either direction based on incoming data and other developments. Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year”

Furthermore, as I noted in this past weekend’s missive, the Fed has already been dropping hints (since the March meeting) about further rates hikes in 2019 and 2020.

“Cleveland Fed President Loretta Mester:

‘Could we be done with policy rate increases this cycle? It is possible, but if the economy performs along the lines I think is the most likely case…the fed-funds rate may need to move a bit higher than current levels.’

Philadelphia Fed President Patrick Harker:

‘I continue to be inwait-and-see modewith expectations of at most, one hike for 2019 and one for 2020.”

Those comments don’t align with a Fed eager to sit on the sidelines, reduce rates, or begin to inject further stimulus.

However, while markets rallied on the idea the Fed will stay pat, for now, this still doesn’t alleviate the problems we noted previously:

  • Yes, the Fed isn’t hiking rates, but they aren’t reducing them either.
  • Yes, the Fed isn’t reducing their balance sheet any more after September, but they aren’t increasing it either.
  • While economic growth outside of China remains weak, the year-over-year credit expansion in China IS slowing.
  • Employment growth is slowing and will continue to weaken
  • There is no massive disaster currently to spur a surge in government spending and reconstruction.
  • There isn’t another stimulus package like tax cuts to fuel a boost in corporate earnings
  • With the deficit already pushing $1 Trillion, there will only be an incremental boost from additional deficit spending this year. 
  • Unfortunately, it is also just a function of time until a recession occurs.

Most importantly, even if the Federal Reserve does begin to reverse course and inject liquidity, the effectiveness of those actions will likely not have the same effect.


Because the economic backdrop is not what it was a decade ago. The table below compares a variety of financial and economic factors from January of 2009 to January 2019.

The critical point here is that QE and rate reductions have the MOST effect when the economy, markets, and investors have been ‘blown out,’ deviations from the ‘norm’ are negatively extended, confidence is hugely negative.

In other words, there is nowhere to go but up.”

Unfortunately, the Fed is trapped between the data and their “need to do something” to keep the asset prices inflated to support economic growth.

But that may not be enough as the bond market is already sniffing out the problems. Back to Peter Bookvar:

“The stock market is assuming…things will improve in Q2 and throughout the second half. The bond market has a less-optimistic take on that, saying that the data is weak, and we’re going to reflect that right now in lower yields and inversions within the yield curve.”

Currently, 5 out of 10 yield curves we track (50%) are now inverted. Such is the highest risk of a recessionary onset as we have seen since 2007.

For Boockvar’s part, the fixed-income market is the indicator to watch.

“The bond market is going to be right. We’re in a slowdown that’s not just temporary, and I think that’s something that’s going to last throughout the year.”

He is right.

While we are maintaining our equity exposure currently, we have also hedged those long-positions with gold and gold mining stocks, a heavier weighting than normal in cash, and have recalibrated the duration and credit risk in our bond holdings to account for the inversion.

This is simply because the “risks” continue to outweigh the reward for the markets currently. As Doug Kass recently noted:

  • “Negative or near zero interest rates represent conditions that understandably exist immediately following a deep recession, not 10-years after. 
  • Fewer Tools Left in the Policy Shed as the Fed ends the tightening cycle with the absolute and real Federal Funds rate several hundred basis points lower than any economic cycle in history. 
  • Debt Is a Governor to Growth and debt that is not self-funding is future consumption brought forward. 
  • Deficit and Demographic Threats combined with a Fed balance sheet, which is four times normal, and slowing population growth, diminish intermediate to longer-term economic and profit growth prospects. Such is not supportive of higher valuations or asset prices. 
  • No Country Is an Economic Island and the lack of coordination between the super economic powers in the world will likely exacerbate worldwide economic risks.
  • The Misallocation of Resources Causes Bubbles and low interest rates which we have experienced for years have always – in every cycle – been a source of ‘mischief’ and a misallocation of resources. The only question is ‘when’ something breaks it will ripple through the financial markets like a tidal wave. (Think about the proliferation of ‘covenant-lite’ loans.)”


While the Fed has successfully “jawboned” the markets recently to keep asset prices stable and positive, there will come a point where “verbal liquidity” simply isn’t enough. The fact that economic cycles will eventually complete seems to be lost on the Fed. As Mike Shedlock noted:

The weakness of inflation pressures given a strong job market and accelerating output last year has puzzled Fed officials. At last month’s meeting, they discussed reasons that inflation might have been more muted, including the prospect that the estimated level of unemployment rate consistent with stable prices is lower than previously thought.

Instead of wondering why inflation is weak, they ought to consider the absurdity of their models.

Stocks are priced beyond perfection, housing prices are so high no one can afford them, and the entire inflation expectations model they use is ridiculous.”

He is right about the Fed’s models and their reliance on low interest rates. Charlie McElligott discussed the three most important points about low interest rates (h/t Zerohedge)

  1. Low interest rates are (ultimately) deflationary, sustaining zombie-firms in a “liquidity-trap,” which weigh on overall economic performance while also weakening investment.  
  1. Low interest rates and QE are deflationary as you incentivize mal-investment and blow perpetual speculative-asset bubbles, which (ultimately) correct and drive deleveraging—thus the ‘balance sheet recession.’ 
  1. As there is still a lot of debt-related “scar tissue,” you can’t push credit on a string. This then leads to quick “muscle memory” returns to a defensive posture: “If there is no return on capital, capital should not be deployed.” 

Here are the most important takeaways from all of this:

  1. Despite an expected uptick in economic growth in Q2, look for weaker economic growth through the end of this year and into 2020.
  2. Employment is set to weaken markedly over the next 12-24 months. 
  3. Wage growth gains will also reverse as tightness in the labor force eases.
  4. Inflationary pressures will remain non-existent as debt, disruption, and demographic forces continue to suppress economic growth. 
  5. Go back to #1.

This is the cycle we are likely locked into currently and will continue to play out over the next several quarters. The markets are misreading what the Fed is really saying and investors will ultimately pay the price.

Each week we produce a chart book of the major financial markets to review whether the markets, as a whole, warrant higher levels of equity risk in portfolios or not. Stocks, as a whole, tend to rise and fall with the overall market. Therefore, if we get the short-term trend of the market right, our portfolios should perform respectively.


There are three primary components to each chart:

  • 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 have a tendency of working better than when below the zero line.

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

S&P 500 Index

  • As we discussed two weeks ago, the rally above, and retest of support at 280 sets up a test of all-time highs. That happened last week as expected and we are no watching to see if it can hold.
  • SPY is extremely overbought, so a test and failure at the highs will not be surprising.
  • Note the “buy” signal in the lower panel is at a level which has always denoted at least short-term market tops. So currently risk outweighs further reward.
  • Short-Term Positioning: Bullish
    • Last Week: Hold full weight position
    • This Week: Hold, Take profits
    • Stop-loss moved up to $280
  • Long-Term Positioning: Neutral

Dow Jones Industrial Average

  • Like SPY, DIA also broke above resistance at previously which now sets the market up for a test of all-time highs.
  • As with SPY above, and QQQ below, a test of highs in next few days will not be surprising. However, a failure at those levels, as stated will also not be a surprise.
  • Market is extremely overbought and the current buy signal is extremely extended.
  • Short-Term Positioning: Neutral
    • Last Week: Hold 1/2 of position
    • This Week: Hold 1/2 of position
    • Stop-loss moved up to $255
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • As noted last week, we stated QQQ would test all-time highs this past week. It did.
  • With the market and the underlying “buy signal” extremely stretched to the highest levels we have seen in several years, an initial failure at highs would not be surprising.
  • Short-Term Positioning: Bullish
    • Last Week: Currently holding full position.
    • This Week: Hold position
    • Stop-loss moved up to $175
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • Recent rally continues to stall at the 200-dma, and has established a downtrend with a lower high on the bounce and the break of previous support at the Oct-Nov lows.
  • Currently on a modest “buy” signal and not completely overbought, it is now or never for small-caps to join the broader market rally.
  • Small-caps have reversed their oversold condition and did rally into the downtrend line on Friday.
  • Short-Term Positioning: Bearish
    • Last Week: No Holding
    • This Week: No Holding
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • Last week, MDY finally took on a more bullish tone by breaking higher and pushing into overhead resistance well above the 200-dma.
  • Mid-caps are on a buy signal, however, that signal is reaching more extended levels with the market getting back to more extreme overbought levels.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position – but a buying opportunity on a pullback to support may be approaching.
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM recently broke above its consolidation range and pushed into resistance of the lows of the February 2018 sell-off. The backdrop remains bullish for emerging markets currently.
  • However, both the current “buy” signal and the market itself are extremely overbought. Look for a pullback to support at the tops of the previous consolidation which works off some of the overbought condition to add to holdings.
  • Short-Term Positioning: Bullish
    • Last Week: Hold current position.
    • This Week: Hold current position.
    • Stop-loss moved up to $43
  • Long-Term Positioning: Neutral

International Markets

  • As I noted last week, the recent rally finally pushed above the 200-dma and into a series of previous bottoms which are now acting as resistance to a further advance.
  • The rally this week establishes a bullish trend for International markets. However, the downtrend from all-time highs remains and EFA is not back to extremely overbought levels.
  • While a “buy signal” has been triggered, EFA it also remains extremely overbought in the short-term.
  • Short-Term Positioning: Neutral
    • Last Week: Hold 1/2 position
    • This Week: Looking to add second 1/2 on a small correction that works off overbought conditions.
    • Stop-loss moved up to $64
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • The rally in oil has gotten way ahead of itself in the face of building supplies.
  • With Oil extremely overbought in the short-term, there is decent risk of a short-term reversion to work off some of the extreme overbought condition.
  • Oil has triggered a buy signal, but remains extremely overbought. This is a good opportunity to scalp some profits and reduce risk currently.
  • Short-Term Positioning: Neutral
    • Last Week: After taking profits, hold 1/2 position
    • This Week: Hold 1/2 position, look for a correction that holds the 50% retracement to add to holdings.
    • Stop-loss adjusted to $57.50
  • Long-Term Positioning: Bearish


  • For fourth time in the last several weeks, Gold is testing critical support at the 61.8% retracement level of the previous decline. GLD is back to oversold but the “buy” signal is fading.
  • If Gold breaks support at $121, close out positions for now and wait for a better entry point. After adding to our position, gold hasn’t done much at this juncture.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position moved up to $121
  • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • As we discussed two weeks ago, bonds had gotten EXTREMELY overbought and a pullback was likely. That pullback process has continued for a second week.
  • Currently on a buy-signal (bottom panel), bonds have once again swung from oversold to overbought and are working to hold support at $122 and work off some of the short-term overbought condition.
  • If support holds between $122 bonds can be added to portfolios. However, given the current backdrop and complacency of the equity markets, our guess is we could well see TLT trade between $118 and $122.
  • Strong support at the 720-dma (2-years) (green dashed line) which is currently $118.
  • Short-Term Positioning: Bullish
    • Last Week: Trimmed 1/4th of holdings to take profits.
    • This Week: Hold current positions and look to add exposure if support holds.
    • Stop-loss adjusted to $122
  • Long-Term Positioning: Bullish

  • Market Review – Market Climbs Above 2900
  • Make Stock Buybacks Illegal?
  • Sector & Market Analysis
  • 401k Plan Manager

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Markets Climb Above 2900, All-Time Highs Next Stop?

Over the last couple of weeks, we have been discussing the market’s advance from the lows and why retesting old highs was quite probable. To wit:

“The markets are close to registering a ‘golden cross.’ This is some of that technical ‘voodoo’ where the 50-day moving average (dma) crosses above the longer-term 200-dma. This ‘cross’ provides substantial support for stocks at that level and limits downside risk to some degree in the short-term.”

As I penned on Monday for our RIA PRO subscribers (Try it FREE for 30-days and get access to daily trading ideas on the markets, sectors, portfolio positions and long-short idea list):

As we discussed last week, the rally above, and retest of support at 280 sets up a test of all-time highs. I expect that will occur early next week. SPY is extremely overbought, so a test and failure at the highs will not be surprising.

  • Short-Term Positioning: Bullish
  • Last Week: Previously increased sizing to full weight.
  • This Week: Hold
  • Stop-loss moved up to $280″

More importantly, on Friday, the markets broke above short-term resistance and the psychological barrier of 2900. This will likely get the bulls all excited over the weekend to make an attempt for all-time highs. 

While the bullish bias is definitely behind investors currently, there are concerns relative to the current risk/reward backdrop. 

As shown in the chart above, the market is not only back to more extreme overbought levels, it is also close to registering a short-term sell signal. With prices now compressed into a very tight range, the risk of a downside break has risen. Drew Zimmerman from Polar Futures Group also made some very astute observations on Friday.

“Is it the middle of April or the middle of August? The weekly trading volume of shares on the US indices and the number of futures contracts that traded this week was the lowest since last summer and among the lowest weekly levels of the past several years. This low volume has reduced price volatility with the VIX index trading back to down to levels not seen since the beginning of October last year before the equity price decline started. Even the volatility in the G7 currencies is the lowest it has been since the middle of 2014!

So, it’s quiet out there….what does that mean? Equity markets are only a couple of percentage points from all-time highs, things must be good! The central banks have done their job, they have all gone back to accommodative policy stances, and China easing more aggressively. We have gone from worries of a global slowdown to not worrying at all because the central banks have our back, and in that environment taking more risk pays. The central banks must know what is best right?

However, when we see broad markets get this quiet, it usually means we are about to get a rude surprise. When things coil up, it is common to see some explosive moves. Given the very low level of volatility, it may be an opportune time to buy some protection.”

We agree with the last statement. This is supported by the extreme level of the current “buy” signal as shown in the shaded orange bar graph in the chart below. These rare extreme extensions occur at extremes of sell-offs and rallies. 

As stated, we definitely agree and as such are maintaining our current equity exposure, with an overweight positioning in cash and fixed income. While this allocation structure is currently providing some performance drag, it is also greatly reducing overall portfolio volatility which we think we will be well rewarded for over the next four to six months.

This is generally where someone with a reading disability sends me an email:

“But you are always bearish”

On December 21st I wrote:

“The market has not been this oversold at any point in the last 20-years, on a monthly basis, as shown in the chart below.

The other bit of good cheer for the bulls is that unlike the previous two starts to more protracted bear markets, the long-term monthly uptrend has not been broken, yet. As noted above, the market is sitting on that uptrend support line which began in 2009.

At this point, the risk/reward for traders is clearly sided to the bulls…for now.”

So, for the reading impaired:

We are carrying reduced equity long positions, we are overweight cash, and fixed income because the deeply oversold condition which previously existed has been entirely reversed. This has occurred at a time where the earnings and economic backdrop are deteriorating, not improving. 

Simply, the risk/reward setup is no longer as favorable as it was in December.

Make Stock Buybacks Illegal?

“Few topics prompt as powerful (and violent) a response from financial professionals as what the role of financial buybacks is in determining stock prices.

One group, largely those bulls who after a decade of central bank manipulation still believe that markets are efficient and unrigged, argue that stock buybacks have no impact on stock prices.

The other group, those who actually understand that if there is a trillion dollars in price indiscriminate stock bids is the single most effective way to boost stock prices, know that corporate buybacks, which until not too long ago were banned, and which over the past decade emerged as the single biggest source of stock purchases, are one of the two most important factors behind the all time highs in the stock market (the other being the Fed, whose policies have allowed companies to issue debt with record low yields, allowing them to fund these trillions in buybacks).”Zerohedge, April 4, 2019

It is an interesting debate. 

What makes this debate particularly notable, and as noted above, most people don’t remember that share repurchases were banned for decades prior to President Reagan in 1982. 

So, why were they banned in the first place? Via Vox:

“Buybacks were illegal throughout most of the 20th century because they were considered a form of stock market manipulation. But in 1982, the Securities and Exchange Commission passed rule 10b-18, which created a legal process for buybacks and opened the floodgates for companies to start repurchasing their stock en masse.”

This isn’t the first time we have reversed policy previously put into place to avert Wall Street from taking advantage of the market to fill their own coffers.

The Crash of 1929

Leading up to the crash of 1929, banks, which were entrusted with people’s life savings, were on both sides of the investment game. They loaned money to investors to speculate with, and they were speculating in the markets themselves. What could possibly go wrong?

“Stocks are now at a permanently high plateau” – Dr. Irving Fisher, 1929

Following the crash, the SEC was formed to “police” the financial markets and protect investors from the predatory practices of Wall Street and the Banks. Part of that process was the passage of the Glass-Steagall act in 1933 to separate banking and brokerage activities in order to build a wall between the source of funds (bank deposits) and the use of funds (speculative investment.) 

For nearly 70-years the markets functioned properly. However, in 1999, Congress repealed Glass-Steagall under tremendous pressure from the major banks who lobbied heavily to gain access to the massive revenue being generated from the “” mania.

It didn’t take long.

Just seven short years later, the world came apart in the biggest crisis/recession since the “Great Depression.” Not surprisingly, at the very center of the financial and economic destruction, were the major banks taking advantage of the investing public once again.  


“History may not repeat, but it often rhymes.” – Mark Twain

As noted, for decades stock buybacks were banned due to the problem of potential market manipulation. It is important to remember that regulations are NEVER passed in ADVANCE of a problem, they are always imposed in RESPONSE to a problem.

What Are We Talking About?

Like stock splits, share repurchases in and of themselves are not necessarily a bad thing, they are just the least best use of cash. Instead of using cash to expand production, increase sales, acquire competitors, or buy into new products or services, the cash is used to reduce the outstanding share count and artificially inflate earnings per share. Here is a simple example:

  • Company A earns $1 / share and there are 10 / shares outstanding. 
  • Earnings Per Share (EPS) = $0.10/share.
  • Company A uses all of its cash to buy back 5 shares of stock.
  • Next year, Company A earns $0.20/share ($1 / 5 shares)
  • Stock price rises because EPS jumped by 100%.
  • However, since the company used all of its cash to buy back the shares, they had nothing left to grow their business.
  • The next year Company A still earns $1/share and EPS remains at $0.20/share.
  • Stock price falls because of 0% growth over the year. 

This is a bit of an extreme example but shows the point that share repurchases have a limited, one-time effect, on the company. This is why once a company engages in share repurchases they are inevitably trapped into continuing to repurchase shares to keep asset prices elevated. Share repurchases divert ever-increasing amounts of cash from productive investments and takes away from longer-term profit and growth.

As we just discussed last week, since the recessionary lows, much of the rise in “profitability” has come from a variety of 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 is directly connected to a consumption-based economy, has remained muted. 

The reality is that stock buybacks create an illusion of profitability. Such activities do not spur economic growth or generate real wealth for shareholders, but it does provide the basis for with which to keep Wall Street satisfied and stock option compensated executives happy.

Don’t believe me?

In 1982, according to the Economic Policy Institute, the average CEO earned 50 times the average production worker. Today, the CEO Pay Ratio’s increased to 144 times the average worker with most of the gains a result of stock options and awards.

As shown in the chart below, clearly profits aren’t being shared with “working class stiffs.” 

Tax Cuts For Corporations

As I wrote in early 2018. while it was widely believed that tax cuts would lead to rising capital investment, higher wages, and economic growth, it went exactly where we said it would. To wit:

“Not surprisingly, our guess that corporations would utilize the benefits of ‘tax cuts’ to boost bottom line earnings rather than increase wages has turned out to be true. As noted by Axios, in just the first two months of this year companies have already announced over $173 BILLION in stock buybacks. This is ‘financial engineering gone mad'” 

Share buybacks are expected to hit another new record by the end of 2019.

Let’s clear up a myth used to support the benefit of stock buybacks:

“Share repurchases aren’t bad. It is simply the company returning money to shareholders.”

Here is the issue:

Share buybacks only return money to those individuals who sell their stock. This is an open market transaction. For example, when Apple (AAPL) buys back some of their outstanding stock, the only people who receive any capital from the buyback are those who sold their shares.

So, who are the ones mostly selling their shares?

As noted above, it’s the insiders, of course, as changes in compensation structures since the turn of the century has become heavily dependent on stock issuance. Insiders regularly liquidate shares which were “given” to them as part of their overall compensation structure to convert them into actual wealth. As the Financial Times recently penned:

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

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

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

What is clear, is that the misuse and abuse of share buybacks to manipulate earnings and reward insiders has become problematic. As John Authers recently pointed out:

“For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.”

In other words, between the Federal Reserve injecting a massive amount of liquidity into the financial markets, and corporations buying back their own shares, there have been effectively no other real buyers in the market. 

Don’t Have Cash, Use Debt

The other problem with the share repurchases is that is has increasingly been done with the use of leverage. The ongoing suppression of interest rates by the Federal Reserve led to an explosion of debt issued by corporations. Much of the debt was not used for mergers, acquisitions or capital expenditures but for the funding of share repurchases and dividend issuance. 

Furthermore, with 62% of investment grade debt maturing over the next five years, there are a lot of companies that are going to wish they didn’t buy back so much stock. This debt load will become problematic if rates rise markedly, further deterioration in credit quality locks companies out of refinancing, or if there is a recessionary drag which forces liquidation of debt. This is something Dallas Fed President Robert Kaplan warned about:

U.S. nonfinancial corporate debt consists mostly of bonds and loans. This category of debt, as a percentage of gross domestic product, is now higher than in the prior peak reached at the end of 2008.

A number of studies have concluded this level of credit could ‘potentially amplify the severity of a recession,’

The lowest level of investment-grade debt, BBB bonds, has grown from $800 million to $2.7 trillion by year-end 2018. High-yield debt has grown from $700 million to $1.1 trillion over the same period. This trend has been accompanied by more relaxed bond and loan covenants, he added.

This was recently noted by the Bank of International Settlements. 

“If, on the heels of economic weakness, enough issuers were abruptly downgraded from BBB to junk status, mutual funds and, more broadly, other market participants with investment grade mandates could be forced to offload large amounts of bonds quickly. While attractive to investors that seek a targeted risk exposure, rating-based investment mandates can lead to fire sales.”

Make Stock Buybacks Illegal?

Now that you understand the background, and who share buybacks actually benefit, you can understand the reasoning behind wanting to ban them once again. 

While share repurchases by themselves may indeed seem somewhat harmless, it is when they are coupled with accounting gimmicks, and massive levels of debt to fund them, in which they become problematic. This issue was noted by Michael Lebowitz:

“While the financial media cheers buybacks and the SEC, the enabler of such abuse idly watches, we continue to harp on the topic. It is vital, not only for investors but the public-at-large, to understand the tremendous harm already caused by buybacks and the potential for further harm down the road.”

However, there are significant consequences in resetting the system. 

“Eliminating buybacks would immediately force firms to shift corporate cash spending priorities, impact stock market fundamentals, and alter the supply/demand balance for shares… The potential restriction on buybacks would likely have five implications for the US equity market: (1) slow EPS growth; (2) boost cash spending on dividends, M&A, and debt paydown; (3) widen trading ranges; (4) reduce demand for shares; and (5) lower company valuations.” – David Kostin, Goldman Sachs

If you are a short-term stock market bull, you will probably not want that. However, as my friend Doug Kass notes there are long-term benefits to reforming the system and putting corporations back onto a more “economically friendly” level: 

My plan is simple.

Make buybacks illegal.

Allow companies to dividend out cash tax-free, like a buyback. This keeps companies out of the market and prevents them from manipulating their own stock, which often benefits company insiders who are selling.

Then the decision of what to do with corporate cash becomes more pure.

It no longer will be a choice of trying to prop up a stock versus spending it on the business. 

Companies will still be left to do with their own cash what they want. 

This is the other big problem, the fact that dividends are taxed, but buybacks are not.

That doesn’t make too much sense to me.”

In the end, the S.E.C. will move to once again ban stock buybacks as they did once before.

Unfortunately, it will be in response to (not to mention the pressure of public outrage) the next financial crisis that devastates a vast majority of the U.S. economy. 

But that is just the way the system works.

See you next week. 

Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

S&P 500 Tear Sheet

Performance Analysis

ETF Model Relative Performance Analysis

Sector & Market Analysis:

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


Looking at sectors on a “relative performance” basis to the S&P 500 we have seen some rotations in leadership over the last week.

Improving – Energy, Materials

With the pick up in oil prices, the Energy sector has performed better as of late. Last week, energy finally broke above its 200-dma but is still lagging many other sectors of the market. Current, with oil prices very overbought, look for a pullback in energy shares soon. Take profits for now, and if the sector can hold support we can increase our holdings accordingly. Materials have surged over the last couple of weeks on hopes of a “trade war” resolution. With the sector extremely overbought, take profits, rebalance risk, and tighten up stops. 

Current Positions: 1/2 Position in XLE, XLB

Outperforming – Technology, Industrials, Discretionary

Discretionary and Technology broke out to new all-time highs last week, and continue to push higher this past week as well. While participation continues to become more concentrated in a smaller number of sectors, the bullish bias persists for now with 50-dma’s above 200-dma’s and momentum trending positively. These sectors are all overbought, so take some profits, rebalance portfolios, raise stops but remain long for now

Current Positions: XLI, XLY, XLK – Stops moved from 200 to 50-dma’s.

Weakening – Real Estate, Utilities, Communications

Despite the “bullish” bias, the more defensive sectors of the markets, namely Utilities and Real Estate, have continued to attract buyers. While Utilities recently corrected a small bit, Real Estate has not. Both sectors remain very extended and overbought. Communications has become much more bullishly biased as of late after successfully testing its 200-dma and the 50-dma crossing above the 200-dma. With the sector extremely overbought look for a correction which does not violate support to add to portfolios. 

Current Position: XLU

Lagging – Healthcare, Staples, Financials

Staples recently had a very small correction which was not enough to resolve its overbought condition. However, Staples are testing previous highs as money continues to chase defensive sectors of the market. Financials, which has been struggling as of late due to the inversion of the yield curve, perked up this past week and finally broke out of its consolidation with better than expected earnings from JPM on Friday.  With the performance of Financials is improving, it may attract more buyers over the next couple of weeks as it has underperformed the bulk of the rally from the December lows. Healthcare continues to struggle with repeated calls from political candidates for “Government sponsored health care.” This is very unlikely to happen, and Healthcare is likely setting up to gain from a rotation from offense to defense in the market. This is the only sector that oversold and currently sitting on support. 

Current Positions: XLF, XLV, XLP 

Market By Market

Small-Cap and Mid Cap – Small Cap stocks continue to lag the rest of the market and remain confined within the context of a broader downtrend. While small caps are challenging their 200-dma, a break above that level will make small-caps are more compelling play. Conversely, Mid-Caps are performing much better as of late and have broken out of its consolidation over the last couple of months. With the 50-dma crossing above the 200-dma, look for a pullback towards the 50-dma to increase exposure to Mid-caps. 

Current Position: None

Emerging, International & Total International Markets 

Emerging Markets continue to perform better as of late but are extremely overbought in the short-term. We are looking for a pullback which holds support to increase our holdings in that market. 

Major International & Total International shares also are performing much better despite global economic weakness. This is probably misplaced optimism but nonetheless the technical backdrop has improved enough to warrant adding a position on a pullback that holds support and works off some of the extreme overbought condition. 

Stops should remain tight at the running 50-dma which is also previous support. 

Current Position: 1/2 position in EEM

Dividends, Market, and Equal Weight – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with respect to economic growth and inflation. Currently, the short-term bullish trend is positive and our core positions are providing the “base” around which we overweight/underweight our allocations based on our outlook. 

Core holdings remain currently at target portfolio weights but all three of our core positions are grossly overbought. A correction is coming, it is now just a function of time. 

Current Position: RSP, VYM, IVV

Gold – Gold continues to perform poorly despite concerns over the Fed, policy, and monetary policy. With gold building a bearish wedge below the 50-dma, the critical support level of $121 must be honored. Gold is very oversold in the short-term so any market sell-off in the next week will likely see gold bounce. Gold must get above $123.50 to make an attempt at higher levels. 

Current Position: GDX (Gold Miners), IAU (Gold)


The 10-year treasury popped up to 2.54% on Friday on rising inflationary pressures in recent reports. This is going to put the Fed into a very uncomfortable position of not raising the Fed Funds rate if prices and wages continue to advance. However, rates are simply bouncing back from a very oversold condition after the plunge from last November. This is setting up a very nice entry point to add additional bond exposure in the months ahead as we move into the summer months. Look for rates to touch 2.6% as a point to begin adding exposure to portfolios. There is a potential for rates to climb as high as 2.85%, but that move is quite unlikely in the current economic environment.

Current Positions: DBLTX, SHY, TFLO, GSY

High Yield Bonds, representative of the “risk on” chase for the markets, have continued to rally this past week and are now egregiously overbought. Take profits and rebalance risk accordingly. International bonds, which are also high credit risk, have been consolidating over the last couple of weeks, but remain very overbought currently which doesn’t over a high reward/risk entry point. 

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

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

Portfolio/Client Update:

No actions this past week were needed. 

As we noted last week, there is currently little concern about the markets despite economic weakness popping up just about everywhere. For now, the market remains glued to headlines on trade, China stimulus, and the Fed. This will turn out to be ill-advised in the months ahead, but for now it remains “Party on Garth.” 

With our near term buy signals in place, we continue to let our equity holdings ride the wave of the market and are looking to opportunistically take on opportunities as they present themselves. With earnings season now underway there will be bid under stocks as companies “beat” drastically lowered “expectations.”  

So, for now, we are patient. 

  • New clients: We continue to onboard clients and move into specified models accordingly. 
  • Equity Model: We rebalanced all positions in the portfolio, with the exception of Boeing (BA), reducing overweight positions and adding to underweight positions. 
  • ETF Model: No changes. – Reviewing for rebalancing as needed.

Note for new clients:

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


A Conservative Strategy For Long-Term Investors

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


Don’t Let Your Emotions Take Control Of You

Bull markets have a tendency to suck the most investors in at the point to inflict the most possible pain. 

That is the point we are currently at in the markets today. After a recovery rally from the lows many investors are now back to where they were in January of last year. The rally also tends to make investors forget the pain the endured during the previous decline. 

If you feel like you “must get back into the market now,” you are probably allowing your emotions to get the better of you. This is why most investors tend to repeatedly buy tops and sell bottoms. 

This market rally will stall. It will correct, and it will provide you a much better risk-reward entry point to increase equity exposure. Don’t allow short-term market movements to deviate you from your long-term investing goals.

Chasing performance is the absolute best way to destroy your investing outcome. 

As noted last week, we now have both “buy” signals now in place which suggests that target allocations move to 100% equity exposure. However, with the market EXTREMELY overbought on a short-term basis and pushing up against longer-term trend lines, it will require patience to wait for a correction to increase exposure into. 

In the meantime, we can prepare for this opportunity by continuing our actions we have recommended over the last several weeks. 

  • If you are overweight equities – take some profits and reduce portfolio risk on the equity side of the allocation. However, hold the bulk of your positions for now and let them run with the market.
  • If you are underweight equities or at target – remain where you are until the market gives us a better opportunity to increase exposure to target levels.

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

Exciting News – the 401k Plan Manager is “Going Live”

We are making a “LIVE” version of the 401-k allocation model which will soon be available to RIA PRO subscribers. You will be able to compare your portfolio to our live model, see changes live, receive live alerts to model changes, and much more. 

This service will also be made available to companies for employees. If would like to offer our service to your employees at a deeply discounted corporate rate please contact me.

Stay tuned for more details over the next couple of weeks.

Current 401-k Allocation Model

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

401k Choice Matching List

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




A week ago, I wrote an article discussing how the options markets can provide clues to future price direction and/or volatility in the crude oil market.  In particular, we addressed the question, “how can a trader spot these option clues in advance?”

This morning, we got a signal which may indicate volatility is in the cards again for crude oil.

As crude oil has continued its upward advance from late December, call sellers have become increasingly off-sides with their hedging and position taking. In fact, our measure of sentiment in the options market is now off the charts in the 99th percentile. Simply, all investors appear to be on the bullish side of the boat.   

We recently saw a similar situation play out in the natural gas market. When the level of market neutral gamma spiked out of its recent trading range (or it becomes incalculable), natural gas experienced a short squeeze and rallied substantially.

Current NYMEX crude oil options expire next Tuesday, April 16th.  While today’s level of neutral gamma is in range, we have forecasted that the level of market neutral gamma will spike on Sunday night – unless market conditions change.  This forecasted spike is shown in the graph below (blue line).


What Does it Mean?

The safest conclusion to arrive at is to expect volatility ahead.  The market may experience a form of a short squeeze as options traders scurry to cover their off-sides net short.  Or, the market will correct lower towards our calculated Price Magnet in the low $60 range.  Based on our research, we would not be surprised to see a $5 move in either direction by the end of next week. 

I look forward to any feedback on these concepts in general, or the oil market in particular.

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech. You can see more of his work at:

Once again, we are faced with a rally nobody likes and everybody thinks it ready to roll over and die. After all, the “mucky-mucks” in the “gubmint,” and I mean well beyond the “Tweeter-in-Chief,” cannot help themselves in stepping on their own junk. We just saw tariffs threatened on Europe. The guacamole supply is safe for the next year. And the investigation that just won’t die fired its latest salvo at the state level. Everyone is dug in, too.

You have to admit, the memes lately are awesome!

But maybe that is a good thing. Remember, when Washington is gridlocked, the stock market seems to do better.

Now let’s leave the land of make-believe and look at what the markets are really telling us.

Let’s just list them, bullet-wise, mainly because I am still healing from a doctor-inflicted boo-boo and am too tired for effective prose. Prozac, maybe. Ketel One, definitely.

  • The rally that began in December is still intact.
  • The NYSE advance-decline line hit another new high Friday before Boeing screwed the pooch.
  • The bullish percent index and stocks above their 50- and 200-day averages look strong.
  • The Dow Transports finally took out the falling trendline from last year’s peak.

  • The lagging Russell 2000 small caps finally moved higher from a flag formation.
  • The ratio of discretionary to staples had a mini-upside breakout.
  • The offense-defense index (discretionary and tech to staples and healthcare) remains in a strong rising trend.
  • The yield curve is not inverted, despite the panic last month over the 3-month yield rising above the 10-year yield – for about two days. Who looks at that, anyway?
  • The Euro Stoxx-50 index just missed a 52-week high. Yes, most of Europe is lagging but this is a little bit of contrary evidence.
  • The emerging markets ETF (EEM) just broke out from a rectangle pattern embedded in a rising market. In other words, a bullish continuation pattern.
  • FANGs and BAITs, for the most part, are in nice rising trends. BAITs are the Chinese FANGs and are comprised of Baidu, Alibaba, IQ, and Tencent.
  • Oil is in a secret rally. Shhh…..

Invariably, investors who disregard where they stand in cycles are bound to suffer serious consequences” – Howard Marks

If you believe, as we do, that the current economic cycle is likely at a similar point as 2006/07, then you should consider heeding the warning of the charts we are about to show you.

The current economic cycle stretching from the market peak of 2006/07 to today started with euphoria in the housing markets and investors taking a general indifference towards risk-taking. In 2008, reality caught up with the financial markets and desperation fueled sharp drawdowns, punishing many risky assets. The recovery that began in 2009 has been increasingly fueled by investor enthusiasm. While the stock market gets the headlines, this fervor has been every bit as evident in the junk bond sector of the corporate fixed- income markets.

Has This Cycle Reached Its Tail illustrated how investor sentiment and economic activity has evolved, or cycled, over the last 12 years. We recommend reading it as additional background for this article.

The Popularity of Junk

Junk debt or non-investment grade securities also known as high yield debt will be referred to as “junk” for the remainder of this article. They are defined as corporate debt with a credit rating below the investment grade threshold (BBB-/Baa3), otherwise known as “triple B.”

Historically, buyers of junk debt were credit specialists due to the need for an in-depth understanding of the accounting and financial statements of companies that bear a larger risk of default. Extensive analysis was required to determine if the higher yield offered by those securities was enough to cushion the elevated risk of default. The following questions are just a small sample of those a junk investor would want to answer:

  • Will the company’s cash flow be sufficient to make the payments on the debt?
  • If not, what collateral does the company have to support bond holders?
  • What is the total recovery value of plant, property and other capital represented by the company?
  • Does the yield on the junk bond offer a reasonable margin of safety to justify an investment?   

Since the financial crisis, the profile of the typical junk investor has changed markedly. Gone are the days when the aforementioned specialized analysts, akin to accountants, were the predominant investors. New investors, many of whom lack the skills to properly evaluate such investments, have entered the high yield debt arena to boost their returns. We believe that many such investors are ill-prepared for the risk and volatility that tend to be associated with non-investment grade bonds when the economic cycle turns.

The advent of exchange-traded funds (ETF’s) has made investing in junk-rated debt much easier and more popular. It has opened the asset class to a larger number of investors that have traditionally avoided the sector or simply did not have access due to investment restrictions. ETF’s have turned the junk market into another passive tool for the masses.

The combination of investors’ desperate need for yield along with the ease of investing in junk has pushed spreads and yields to very low levels as shown below. While a yield of 6.40% may seem appealing versus Treasury bonds yielding little more than the rate of inflation, consider that junk yields do not factor in losses due to default. Junk default rates reached double digits during each of the last three recessions. A repeat of those default rates would easily wipe out years of returns. Even in a best-case scenario, an annual 2.5-3.5% default rate would significantly reduce the realized yield. The graph below charts yields and option-adjusted spread (OAS).

OAS measures the spread, or additional yield, one expects to receive versus investing in a like maturity, “risk-free” U.S. Treasury bond. It is important to note that spread is but one measure investors must consider when evaluating prospective investments. For example, even if OAS remains unchanged while Treasury yields increase 300bps, the yield on the junk bond also increases 300bps and produces an approximate 15% price decline assuming a 5-year duration.

Junk Debt Spreads (OAS) and Economic Data

Economic activity and corporate profits are well -correlated. Given the tenuous nature of companies in junk status, profits and cash flows are typically extremely sensitive to economic activity. The following graphs illustrate current valuations and guide where spreads may go under certain economic environments. The label R² in the graph is a statistical measure that calculates the amount of variance of one factor based on the other factor. The R², of .58 in the graph below, means that 58% of the change in OAS is due to changes in real GDP.

In the scatter plot below, each dot represents the respective intersection of OAS and GDP for each quarterly period. Currently, as indicated by the red triangle, OAS spreads are approximately 175 basis points too low (expensive) given the current level of GDP. More importantly, the general upward slope of the curve denotes that weaker economic activity tends to result in wider spreads. For instance, we should expect OAS to widen to 10% if a recession with -2.00% growth were to occur.

The following are scatter plots of OAS as contrasted with PMI (business confidence/plans) and Jobless Claims (labor market).  The current OAS versus the dotted trend line is fair given the current level of PMI and Jobless Claims. However, if the economy slows down resulting in weaker PMI and rising jobless claims, we should expect a much higher OAS. Note both graphs have a significant R².

As discussed earlier, frothy equity markets and junk spreads have rewarded investors since the financial crisis. The scatter plot below compares OAS to CAPE10 valuations. A return to an average CAPE (16) should result in an OAS of nearly 10. Assuming that such an event was to occur, an investor with a five-year junk bond could lose almost 30% in the price of the bond assuming no default. Default would harm the investor much more.

We finish up with a similar graph as we presented in Has This Cycle Reached Its Tail. A special thank you to Neil Howe for the idea behind the graph below.

The graph, using two year averages compares the U.S. Treasury yield curve and junk OAS. The yield curve serves as a proxy for the economic cycle. The cycle started with the blue triangle which is the average yield curve and OAS for 2006 and 2007. As the cycle peaked and the financial crisis occurred, the yield curve widened, and junk OAS increased significantly. Starting in 2009, recovery took hold resulting in a flattening yield curve and lower junk OAS. The current one month point denoted by the red dot shows that we have come full circle to where the cycle began over ten years ago.

Trade Idea

Given the unrewarding risk-return profile of junk bonds, we recommend investors consider reallocating from junk to investment grade corporates, mortgages or U.S. Treasuries. For those more aggressive investors, we recommend a paired trade whereby one shorts the liquid ETF’s (HYG/JNK) and purchases an equal combination of investment grade corporates (LQD) and U.S. Treasuries (IEI).

Had one put on the paired trade mentioned above in 2014, when junk yields were at similar levels, and held the trade for two years, the total return over the holding period was 16.75%. Similarly, such a trade established in January of 2007 and held for two years would have resulted in an approximate total return of nearly 38.85%.

Investment return data used in pair trade analysis courtesy of BofA Merrill Lynch US high yield and Corporate Master Total Return Indexes. Treasury data from Barclays.


Junk debt is highly correlated with economic activity and stock market returns. When potential default rates are considered with signs that the economic cycle is turning, and extreme equity valuations, investors should be highly attuned to risks. This is not to say junk bond holders will suffer, but it should raise concern about the amount of risk being taken for a marginal return at best.

If you have owned junk debt for the last few years, congratulations. You earned a return greater than those provided by more conservative fixed-income investments. That said, we strongly recommend a critical assessment of the trade. Math and historical precedence argue that the upside to holding junk debt is quite limited, especially when compared to investment grade corporate bonds that offer similar returns and expose the investor to much less credit risk.

At RIA Advisors, we have sold the vast majority of our junk bond holdings over the last month. We are concerned that the minimal spread over Treasuries does not nearly compensate our clients enough for the real risk that the current economic cycle is coming to an end.

George Soros is about as close to a household name as it gets for a hedge fund manager. He’s legendary for his billions, “breaking” the Bank of England, and is even an alleged mastermind of left-wing, political conspiracy theories. For me, though, Mr. Soros’s theory of reflexivity is his most impressive achievement. Introduced in his book, The Alchemy of Finance, I simply see reflexivity everywhere. In fact, we might be in the midst of a reflexive event of epic proportions as we speak.

While I didn’t find The Alchemy of Finance to be much of a read, I was blown away by Mr. Soros’s theory of reflexivity. More commonly accepted today, it was truly groundbreaking and highly controversial at the time of its publishing in 1987. In a lot of ways, I’m not surprised that it took a philosophically-minded person to stand so boldly against the over-zealous mathematicians who seemingly commandeered economics. Reflexivity is far from a neat and tidy theory. However, its potential explanatory power appears greater than others’.

What Is Reflexivity?

Reflexivity is simply a theory of feedback loops. While Mr. Soros contemplates a wider applicability, he contends that the behavior of market participants today impacts tomorrow’s outcomes. It flies firmly in the face of the Efficient Market Hypothesis (EMH) and the related theory of rational expectations which dominate modern financial thought. According to these orthodoxies, market prices reflect all current and known information; trading is futile. Occurrences of booms and busts run contrary to EMH yet they are commonplace throughout history. Reflexivity, in my opinion, offers a more plausible alternative explanation.

“I contend that financial markets are always wrong in the sense that they operate with a prevailing bias, but the bias can actually validate itself by influencing not only market prices but also the so-called fundamentals that market prices are supposed to reflect.”

George Soros, The Alchemy of Finance

Reflexivity as a model for market behavior is more widely accepted today. More commonly referred to as complexity theory, complex adaptive system analysis, or some other variant, it is both growing as a field of study as well as in stature. (Please note that for the remainder of this article I will use “reflexivity” to refer to these collective views.) To be sure, there are still plenty of EMH holdouts. Institutional inertia and its mathematical neatness keep it entrenched. Reflexivity requires messy abstraction and accepting unknowns. Surely EMH has utility as an approximation for market behavior, but it fails as anything more. I find reflexivity to meet such demands, though putting it into practice is anything but easy.

“The crux of the debate boils down to whether we should consider investors to be rational, well informed, and homogeneous—the backbone of standard capital markets theory—or potentially irrational, operating with incomplete information, and relying on varying decision rules. The latter characteristics are part and parcel of a relatively newly articulated phenomenon that researchers at the Santa Fe Institute and elsewhere call complex adaptive systems”.

Michael J. Mauboussin, Revisiting Market Efficiency: The Stock Market as a Complex Adaptive System

According to Michael Mauboussin’s research, reflexivity addresses a number of key shortfalls that underpin the EMH (further detailed here). First, it better explains the “fat tails” of return distributions (i.e. booms and busts). EMH assumes returns are normally distributed which is unsupported by the data. Reflexivity also demonstrates how returns can persistent under certain conditions rather than follow the “random walk” of EMH. It similarly shows how diversity of investor opinions can change over time, and why most portfolio managers underperform the market, yet some prove to be exceptional. Here, EMH turns a blind eye.

After familiarizing myself more with reflexivity, I simply see instances of if everywhere.

I See Reflexivity In Bitcoin

Bitcoin’s value is inextricably linked to its use. The more people who transact over the Bitcoin network, the greater its value should be. After all, you need bitcoin tokens to use it. This means buying and selling bitcoin as needed. Thus, we can see the establishment of a feedback loop between the value of bitcoin and the amount of users it garners.

The fixed amount of bitcoins and early phase of its adoption created ripe conditions for speculation. Reflexivity can shed some light on its bubble and subsequent bust.

I See Reflexivity In Momentum

Momentum is a market phenomenon where the best performing assets continue to outperform and “losers” continue to underperform. According to EMH momentum cannot exist. Yet, scores of academic research validate its existence—so much so, that momentum is a commonplace “factor” in quantitative investment strategies.

In practice, momentum strategies buy winners and sells losers. Thus, it can create a self-reinforcing loop. Not only do inflows into such strategies help perpetuate their success, but so too does periodic rebalancing. In fact, the same can be said for market-cap-weighted passive investment strategies.

I See Reflexivity In The “Fed Put”

The “Fed Put” originates back to the days when Alan Greenspan ran the Federal Reserve (Fed) in the 1990s and 2000s. Originally dubbed the Greenspan Put, it refers to a theory that monetary policy is most influenced by stock market performance rather than macro-economic factors. The Fed (re)acts to support the stock market—and in particular to (try to) prevent its decline—rather than promote its duel mandate. While denied by the Fed, a number of research papers (such as this and this) have shown it exists.

“We find that the explanatory power of negative stock returns for changes in the Federal funds target is stronger than that of almost all of the 38 macro variables covered by Bloomberg.”

Anna Cieslak and Annette Vissing-Jorgensen, The Economics of the Fed Put

Many traders try to anticipate the Fed’s actions¬—rightly or wrongly so. Since monetary policy can influence (short term) market behavior and the stock market’s performance can influence monetary policy, a reflexive relationship is established. The Fed takes its cues from the stock market, and the stock market looks to the Fed; it’s “turtles all the way down” so to speak.

I See Reflexivity In Credit Markets

Companies (and people) default when they can’t pay their bills. They lack liquidity. Rarely does this happen by accident. Access to credit can forestall the day of reckoning and give an entity time to get through its rough patch. However, the greater the liquidity need, the greater the risk of default and the less keen lenders will be to extend credit. Furthermore, lending terms become increasingly punitive with financial distress. Creditors will demand higher rates and restrict operating flexibility. While these provide lenders with important protections, they can hamper the entity’s ability to repay its loans, perversely increasing default risk. Hence credit markets contain a reflexive quality.

Is The Yield Curve Reflexive?

Recently, the U.S. treasury (UST) yield curve inverted. The yield on the 3-month UST bill exceeded that of the 10-year bond. This is a rare occurrence and typically only precedes a recession. In fact, a yield curve inversion has arguably been the most reliable recessionary economic indicator since the 1960s.

The UST yield curve just recently inverted ever so slightly.

It’s important to note that causality has yet to be established for this relationship. To be sure there are theories. Most entail some version of the Fed raising interest rates by too much. Today, however, historical causes might be irrelevant. Our knowledge of such events creates the possibility for reflexivity.

The predictive power of the yield curve is common knowledge. Might the mere occurrence of an inversion self-fulfill into a recession? Will investors, armed with the historical record, react to the prospect of a recession and create a sell-off in the markets?

In my view, this is one of the most interesting questions we investors face today. If you were (are) a fund manager how would (does) this affect your investment decisions? Think of the career risk for the manager who loses money ignoring such a potentially potent signal. After all, who in their right mind would fault you for erring on the side of caution?

Now, let’s take this one step further. Consider the Fed’s proven sensitively to equity market declines. On one hand, the markets might soften; on the other central banks will likely react. How will these potentially opposing forces resolve?

So, What Are You Going To Do About It? No, Seriously!

Reflexivity is both a fascinating yet nascent area of study. I simply see it everywhere I look. While reflexivity contains much explanatory power for market phenomena, incorporating it into an investment process is far from straightforward. It takes a truly gifted mind to do so. Strong first principles and reliable data collection tools are required. Mastery of induction and deduction are prerequisites.

Unfortunately, there’s no neat answer to the current riddle of the yield curve inversion. Only time will reveal its message. As Mr. Soros identified over thirty years ago, the outcome might be dependent upon our collective actions. If reflexivity applies, then it is we who hold the answer today. Thus, the question becomes: What are you going to do about it?

Written by Lance Roberts and Michael Lebowitz, CFA of Real Investment Advice

CHAPTER 12 – 181 Lines of Wisdom

Over the last 30-years, I have endeavored to learn from my own mistakes and, trust me, I have paid plenty of “stupid-tax” along the way. However, it is only from making mistakes, that we learn how to become a better investor, advisor or portfolio manager.

You have now read our opinions on buy and hold. Before we conclude we thought you should hear the views of investing legends.

The following is a listing of investing tips, axioms and market wisdom from some of the great investors of our time. Importantly, as you review this invaluable knowlege, compare how these investing legends approach investing as compared to your methodologies, those of your advisor, or what you are told daily by the media.

Can you spot what’s missing?

Bob Farrell’s 10-Investing Lessons

  1. Markets tend to return to the mean over time.
  2. Excesses in one direction will lead to an opposite excess in the other direction.
  3. There are no new eras – excesses are never permanent.
  4. Exponential rising and falling markets usually go further than you think.
  5. The public buys the most at the top and the least at the bottom.
  6. Fear and greed are stronger than long-term resolve.
  7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chips.
  8. Bear markets have three stages.
  9. When all the experts and forecasts agree – something else is going to happen.
  10. Bull markets are more fun than bear markets.

12 Market Wisdoms From Gerald Loeb

  1. The most important single factor in shaping security markets is public psychology.
  2. To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.
  3. Accepting losses is the most important single investment device to insure safety of capital.
  4. The difference between the investor who year in and year out procures for himself a final net profit, and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.
  5. One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages.
  6. There is a saying, “A picture is worth a thousand words.” One might paraphrase this by saying a profit is worth more than endless alibis or explanations. . . prices and trends are really the best and simplest “indicators” you can find.
  7. Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed.
  8. Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.-
  9. In addition to many other contributing factors of inflation or deflation, a very great factor is the psychological. The fact that people think prices are going to advance or decline very much contributes to their movement, and the very momentum of the trend itself tends to perpetuate itself.
  10. Most people, especially investors, try to get a certain percentage return, and actually secure a minus yield when properly calculated over the years. Speculators risk less and have a better chance of getting something, in my opinion.
  11. I feel all relevant factors, important and otherwise, are registered in the market’s behavior, and, in addition, the action of the market itself can be expected under most circumstances to stimulate buying or selling in a manner consistent enough to allow reasonably accurate forecasting of news in advance of its actual occurrence.
  12. You don’t need analysts in a bull market, and you don’t want them in a bear market

Jesse Livermore’s Trading Rules Written in 1940

  1. Nothing new ever occurs in the business of speculating or investing in securities and commodities.
  2. Money cannot consistently be made trading every day or every week during the year.
  3. Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion.
  4. Markets are never wrong – opinions often are.
  5. The real money made in speculating has been in commitments showing in profit right from the start.
  6. As long as a stock is acting right, and the market is right, do not be in a hurry to take profits.
  7. One should never permit speculative ventures to run into investments.
  8. The money lost by speculation alone is small compared with the gigantic sums lost by so-called investors who have let their investments ride.
  9. Never buy a stock because it has had a big decline from its previous high.
  10. Never sell a stock because it seems high-priced.
  11. I become a buyer as soon as a stock makes a new high on its movement after having had a normal reaction.
  12. Never average losses.
  13. The human side of every person is the greatest enemy of the average investor or speculator.
  14. Wishful thinking must be banished.
  15. Big movements take time to develop.
  16. It is not good to be too curious about all the reasons behind price movements.
  17. It is much easier to watch a few than many.
  18. If you cannot make money out of the leading active issues, you are not going to make money out of the stock market as a whole.
  19. The leaders of today may not be the leaders of two years from now.
  20. Do not become completely bearish or bullish on the whole market because one stock in some particular group has plainly reversed its course from the general trend.
  21. Few people ever make money on tips. Beware of inside information. If there was easy money lying around, no one would be forcing it into your pocket.

21 Rules Of Paul Tudor Jones

  1. When you are trading size, you have to get out when the market lets you out, not when you want to get out.
  2. Never play macho with the market and don’t over trade.
  3. If I have positions going against me, I get out; if they are going for me, I keep them.
  4. I will keep cutting my position size down as I have losing trades.
  5. Don’t ever average losers.
  6. Decrease your trading volume when you are trading poorly; increase your volume when you are trading well.
  7. Never trade in situations you don’t have control.
  8. If you have a losing position that is making you uncomfortable, get out. Because you can always get back in.
  9. Don’t be too concerned about where you got into a position.
  10. The most important rule of trading is to play great defense, not offense.
  11. Don’t be a hero. Don’t have an ego.
  12. I consider myself a premier market opportunist.
  13. I believe the very best money is to be made at market turns.
  14. Everything gets destroyed a hundred times faster than it is built up.
  15. Markets move sharply when they move.
  16. When I trade, I don’t just use a price stop, I also use a time stop.
  17. Don’t focus on making money; focus on protecting what you have.
  18. You always want to be with whatever the predominant trend is.
  19. My metric for everything I look at is the 200-day moving average of closing prices.
  20. At the end of the day, your job is to buy what goes up and to sell what goes down so really who gives a damn about PE’s?
  21. I look for opportunities with tremendously skewed reward-risk opportunities.

 Bernard Baruch’s 10 Investing Rules

  1. Don’t speculate unless you can make it a full-time job.
  2. Beware of barbers, beauticians, waiters — of anyone — bringing gifts of “inside” information or “tips.”
  3. Before you buy a security, find out everything you can about the company, its management, and competitors, its earnings and possibilities for growth.
  4. Don’t try to buy at the bottom and sell at the top. This can’t be done — except by liars.
  5. Learn how to take your losses quickly and cleanly. Don’t expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.
  6. Don’t buy too many different securities. Better have only a few investments which can be watched.
  7. Make a periodic reappraisal of all your investments to see whether changing developments have altered their prospects.
  8. Study your tax position to know when you can sell to greatest advantage.
  9. Always keep a good part of your capital in a cash reserve. Never invest all your funds.
  10. Don’t try to be a jack of all investments. Stick to the field you know best.

 James P. Arthur Huprich’s Market Truisms And Axioms

  1. Commandment #1: “Thou Shall Not Trade Against the Trend.”
  2. Portfolios heavy with underperforming stocks rarely outperform the stock market!
  3. There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.
  4. Sell when you can, not when you have to.
  5. Bulls make money, bears make money, and “pigs” get slaughtered.
  6. We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.
  7. Understanding mass psychology is just as important as understanding fundamentals and economics.
  8. Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.
  9. Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.
  10. When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”
  11. Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.
  12. Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.
  13. When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.
  14. As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.
  15. Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.
  16. Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first.
  17. Don’t average trading losses, meaning don’t put “good” money after “bad.” Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.
  18. Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don’t need to trade.
  19. Wishful thinking can be detrimental to your financial wealth.
  20. Don’t make investment or trading decisions based on tips. Tips are something you leave for good service.
  21. Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.
  22. Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.
  23. Said another way, “It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”
  24. Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.
  25. As many participants have come to realize from 1999 to 2010, during which the S&P 500 has made no upside progress, you can lose money even in the “best companies” if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a “mixed” fundamental opinion.
  26. To the best of your ability, try to keep your priorities in line. Don’t let the “greed factor” that Wall Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.
  27. Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

James Montier’s 7 Immutable Laws Of Investing

  1. Always insist on a margin of safety
  2. This time is never different
  3. Be patient and wait for the fat pitch
  4. Be contrarian
  5. Risk is the permanent loss of capital, never a number
  6. Be leery of leverage
  7. Never invest in something you don’t understand

10-Trading Rules From Todd Harrison

  1. Respect price action but never defer to it.
  2. Discipline always trumps conviction. Following a set discipline removes the emotional bias of conviction.
  3. Opportunities are made up far easier than lost capital.
  4. Emotion is the enemy of trading.
  5. It’s far better to “zig” when others “zag.”
  6. Be adaptive to the market. Failure to adapt leads to extinction.
  7. Maximize reward relative to the risk taken.
  8. Perception is reality in the marketplace.
  9. When “unsure” – trade small or not at all.
  10. Don’t let bad trades turn into investments.

25-Trading Rules From Jim Cramer

  1. Bulls, Bears Make Money, Pigs Get Slaughtered
  2. It’s OK to Pay the Taxes
  3. Don’t Buy All at Once
  4. Buy Damaged Stocks, Not Damaged Companies
  5. Diversify to Control Risk
  6. Do Your Stock Homework
  7. No One Made a Dime by Panicking
  8. Buy Best-of-Breed Companies
  9. Defend Some Stocks, Not All
  10. Bad Buys Won’t Become Takeovers
  11. Don’t Own Too Many Names
  12. Cash Is for Winners
  13. No Woulda, Shoulda, Couldas
  14. Expect, Don’t Fear Corrections
  15. Don’t Forget Bonds
  16. Never Subsidize Losers With Winners
  17. Check Hope at the Door
  18. Be Flexible
  19. When the Chiefs Retreat, So Should You
  20. Giving Up on Value Is a Sin
  21. Be a TV Critic
  22. Wait 30 Days After Preannouncements
  23. Beware of Wall Street Hype
  24. Explain Your Picks
  25. There’s Always a Bull Market

10-Rules From Richard Bernstein

  1. Income is as important as are capital gains. Because most investors ignore income opportunities, income may be more important than are capital gains.
  2.  Most stock market indicators have never actually been tested. Most don’t work.
  3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.
  4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.
  5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.
  6. Balance sheets are generally more important than are income or cash flow statements.
  7. Investors should focus strongly on GAAP accounting, and should pay little attention to “pro forma” or “unaudited” financial statements.
  8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.
  9. Investors should research financial history as much as possible.
  10. Leverage gives the illusion of wealth. Saving is wealth.

David Rosenberg’s 13-Rules For Economists

  1. In order for an economic forecast to be relevant, it must be combined with a market call.
  2. Never be a slave to the data – they are no substitutes for astute observation of the big picture.
  3. The consensus rarely gets it right and almost always errs on the side of optimism – except at the bottom.
  4. Fall in love with your partner, not your forecast.
  5. No two cycles are ever the same.
  6. Never hide behind your model.
  7. Always seek out corroborating evidence
  8. Have respect for what the markets are telling you.
  9. Be constantly aware with your forecast horizon – many clients live in the short run.
  10. Of all the market forecasters, Mr. Bond gets it right most often.
  11. Highlight the risks to your forecasts.
  12. Get the US consumer right and everything else will take care of itself.
  13. Expansions are more fun than recessions (straight from Bob Farrell’s quiver!).

Our Own Investing Rules

  1. Cut losers short and let winner’s run(Be a scale-up buyer into strength.)
  2. Set goals and be actionable. (Without specific goals, trades become arbitrary and increase overall portfolio risk.)
  3. Emotionally driven decisions void the investment process.  (Buy high/sell low)
  4. Follow the trend. (80% of portfolio performance is determined by the long-term, monthly, trend. While a “rising tide lifts all boats,” the opposite is also true.)
  5. Never let a “trading opportunity” turn into a long-term investment. (Refer to rule #1. All initial purchases are “trades,” until your investment thesis is proved correct.)
  6. An investment discipline does not work if it is not followed.
  7. “Losing money” is part of the investment process. (If you are not prepared to take losses when they occur, you should not be investing.)
  8. The odds of success improve greatly when the fundamental analysis is confirmed by the technical price action. (This applies to both bull and bear markets)
  9. Never, under any circumstances, add to a losing position. (As Paul Tudor Jones once quipped: “Only losers add to losers.”)
  10. Market are either “bullish” or “bearish.” During a “bull market” be only long or neutral. During a “bear market”be only neutral or short. (Bull and Bear markets are determined by their long-term trend as shown in the chart below.)
  11. When markets are trading at, or near, extremes do the opposite of the “herd.”
  12. Do more of what works and less of what doesn’t. (Traditional rebalancing takes money from winners and adds it to losers. Rebalance by reducing losers and adding to winners.)
  13. “Buy” and “Sell” signals are only useful if they are implemented. (Managing a portfolio without a “buy/sell” discipline is designed to fail.)
  14. Strive to be a .700 “at bat” player. (No strategy works 100% of the time. However, being consistent, controlling errors, and capitalizing on opportunity is what wins games.)
  15. Manage risk and volatility. (Controlling the variables that lead to investment mistakes is what generates returns as a byproduct.)

But, did you spot what was missing?

Every day Wall Street and the financial media push the narrative of passive investing, indexing and “buy and hold.” Yet while these methods are good for Wall Street, as it keeps your money invested at all times for a fee, it is not necessarily good for your future investment outcomes. 

You will notice that out of 181 lines of investment advice, not one of the greatest investors of the last 100 years have “buy and hold” as a rule.

So, the next time that someone tells you the “only way to invest” is to buy an index and just hold on for the long-term, you just might want to ask yourself what would a “great investor” actually do. More importantly, you should ask yourself, or the person telling you, “WHY?”

The investors listed here are not alone. There are numerous investors and portfolio managers revered for the knowledge and success. While we idolize these individuals for their respective “genius,” we can also save ourselves time and money by learning from their wisdom and their experiences. Their wisdom was NOT inherited, but was birthed out of years of mistakes, miscalculations, and trial-and-error. Most importantly, what separates these individuals from all others was their ability to learn from those mistakes, adapt, and capitalize on that knowledge in the future.

Experience is an expensive commodity to acquire, which is why it is always cheaper to learn from the mistakes of others.

There are only a few basic “truths” of investing and all great investors have learned them over time. We are not preaching alternative strategies, as we hope you learned we are just standing on the shoulders of geniuses.

I hope you will find the lessons as beneficial as I have over the years and incorporate them into your own practices.

During an economic bubble like the late-1990s dot-com bubble or the U.S. housing bubble, frivolous, hubristic investments and business decisions become appealing to many people who are what I call “bubble drunk.” In a bubble, money is flowing, the social mood is euphoric, and asset prices are surging – greed is the dominant emotion and risk is barely an afterthought. In this type of environment, speculation in art and collectibles becomes popular, often leading to an art bubble (for example, Japan’s bubble fueled an art bubble in the late-1980s). Of course, after a tremendous surge, the bubble eventually bursts and speculators are left holding works of art that are worth a fraction of what they paid. For the past several years, there has been an art bubble that has been primarily driven by the Greater China region – here is a recent anecdote reported by Bloomberg:

Millennials snapped up $28 million worth of art inspired by the Simpsons television show, along with skateboarding shoes and cans of spray paint at a Sotheby’s auction in Hong Kong as a new generation of collectors comes of age.

“The auction room suddenly got a lot hipper, with all these cool millennial buyers in hoodies,” said Edie Hu, art advisory specialist at Citi Private Bank in Hong Kong. “Their tastes are very different from their parents, and Sotheby’s is tapping into that.”

The highlight of the 33-lot auction of items belonging to Japanese fashion designer Nigo was a painting by Brooklyn street artist KAWS based on the Beatles’ “Sgt. Pepper’s Lonely Hearts Club Band” album but populated with Simpsons characters. It sold to an unidentified buyer for $14.8 million including fees, a record for the artist and about 15 times the estimate.

A young Chinese buyer with a short back and sides haircut, who was wearing a green army camouflage jacket, shelled out $2.6 million for another KAWS piece called “UNTITLED (KIMPSONS #3).” The work depicts the Simpson family sprawled unconscious on their couch, with the artist’s signature crosses for eyes.

“I am not surprised by the demand, but I am surprised by the final number,” said Max Dolgicer, a New York collector who’s been buying the artist’s work for seven years. “It’s a very fast-moving market.”

Simpsons Art
‘The Kaws Album’, KAWS. Courtesy Sotheby’s.

Young, hip millennials paying jaw-dropping amounts for trendy, lowbrow art is the type of behavior that you see in a bubble. That Simpson’s “art” is tacky and sophomoric – it’s what would pass as art in the year 2505 in the movie Idiocracy, except this is real life. Art from 500 years ago is objectively more beautiful and sophisticated than that Simpsons art, which is just more evidence of the dumbing down of modern culture. These young, hip millennial art buyers in Asia are drunk on easy money – plain and simple. In the next few charts, I will explain why a dangerous bubble is inflating in China and Hong Kong, where the Sotheby’s auction discussed earlier took place.

Since the 2008 global financial crisis, Hong Kong has held its benchmark interest rate at record low levels for a record length of time. These interest rates were far too low for Hong Kong’s economy – this anomalous situation only occurred because Hong Kong was trying to match U.S. interest rates to keep the currency exchange rate between the two countries stable. After 2008, the U.S. was a post-bust economy that was struggling with deflationary pressures – Hong Kong was not. Unfortunately, Hong Kong’s excessively low interest rates have helped to inflate a massive credit and asset bubble.

Hong Kong’s housing prices have quintupled since 2003:

Similarly, total outstanding private sector loans have quintupled since 2003:

Mainland China has also been experiencing a tremendous credit bubble in the past decade that has been artificially boosting economic growth:

Ultra-low interest rates and other stimulative central bank policies are creating bubbles (and stupid decisions) across the globe. These bubbles are everywhere from China to Singapore to Australia to the U.S. to Canada to Western Europe. When asset prices are soaring and cheap credit is flowing, the result is “easy money” that finds its way into art and supercars. Unfortunately, as the Japanese art speculators experienced in the early-1990s, art bubbles always burst. The Chinese are going to be taught this lesson very soon. Even if you don’t live or invest in Asia, you are still tied into the same global economic system, which means that your investments and way of life are at risk.


There are four primary components to each chart:

  • The price chart is contained within the shaded area which represents 2-standard deviations above and below the short-term moving average.  
  • The Over Bought/Over Sold indicator is in orange at the top.
  • The Support/Resistance line (green) is the longer-term moving average which also acts as a trailing stop in many cases.
  • The Buy / Sell is triggered when the green line is above the red line (Buy) or vice-versa (Sell).


GDX – Gold Miners ETF

  • We have owned gold-miners for a while with expectations the Fed will mis-step and drive investors toward safehavens like gold. That likelihood is becoming more likely.
  • Currently on a buy signal, GDX has been running along the 50-dma moving average support. A break above $23 will likely see higher prices.
  • Buy at $23 with an initial target of $25
  • Stop level is $22

GS – Goldman Sachs Group

  • GS is trying to break above the 200-dma with the 50-dma close behind to cross above it.
  • Currently on a “buy” signal and not tremendously overbought, there is upside to the position currently.
  • We added a position to our long-short portfolio at $202
  • We have an initial target for $215-220.
  • Stop-loss is currently $190

EGHT – 8×8, Inc.

  • EGHT is not a fundamental play by any stretch of the imagination, however, for a “trade” there is a decent setup.
  • Just triggering a buy signal and with the 50-dma crossing above the 200-dma, there is upsdie to recent highs.
  • Buy at current levels.
  • Target for trade is $23
  • Stop-loss is $19.50

VLO – Valero Energy Corp.

  • VLO is in technically and fundamentally in a good
  • Having just triggered a buy signal recently, and starting to recover from an oversold condition, the technical setup for a trade is good.
  • Fundamentally, VLO benefits from positive crack spreads and the recent run up in oil prices should bode well for earnings.
  • We took on a position in the long-short portfolio and will add to the position if our thesis plays out.
  • Stop Loss is set at $85

WELL – Welltower, Inc.

  • WELL has consistently tested and bounced off of the running 50-dma.
  • This is a very tight trade with a target of $79-80
  • Buy at current levels.
  • Stop is set at $75


BRK.B – Bershire Hathaway B-Shares

  • With BRK.B in a fairly tight consolidation range, our expectations is that the HNZ debacle from last quarter is not yet behind them.
  • Furthermore, BRK.B has failed to perform with the rally in the market which makes it susceptible if the market declines.
  • Short at current levels.
  • Target for trade is $190
  • Stop-loss is set at $206

WFC – Well Fargo & Co. (AKA “Wiley F$%#@*! Criminals”)

  • WFC continues to erode due to scandal after scandal from their actual criminal activities conducted over the last several years.
  • This is finally started to work its way through their system and customers are moving to other banks. Assets under management are declining and they will likely report a “not so great quarter.” It will be their outlook for redemption which may save the bank in the near term.
  • The recent failure at the 50-dma suggests lower prices in the near-term.
  • Short at current levels
  • Target for trade is $44
  • Stop loss is $50

TSLA – Tesla, Inc.

  • TSLA has continued to struggle with cash burn, production, bad press, and issues with the SEC.
  • There is a high risk of disappointment in this earnings seasons report particularly as auto sales have declined.
  • TSLA continues to struggle in a downtrend of the 50-dma and the $260 level is extremely critical support.
  • However, if the $260 level is broken, the downside will be fast and furious and unshortable at that point.
  • Short at current levels with a stop @290
  • Add to the position on a break below $260
  • Target is initially set at $190

UAA – Under Armour, Inc.

  • UAA has struggled during the entirety of the rally from the December lows.
  • Currently the setup for a short is not great, but there is a decent expectation of an earnings related disappointment particularly if recent retail sales reports are accurate.
  • Short at current levels.
  • Stop is set at $23
  • Target for the trade is $17

VTR – Vertias, Inc.

  • VTR is very close to triggering a “sell” signal and is extremely overbought.
  • After a failure at multiple tops, look for a break below $62 combined with a confirmed sell signal to enter the short.
  • Short below $62
  • Set stops at $64.50
  • Initial target for trade is $60