Monthly Archives: February 2019

Technical Value Scorecard Report For The Week of 6-18-21

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

Commentary 6-18-21

  • The outperformance of the deflationary sectors like technology and healthcare continued this past week. The best performing sector versus the S&P 500 was technology which beat the S&P 500 index by 1.56%, healthcare followed, beating the index by 1.05%. Materials, transportation stocks, and financials are now three of the four most oversold sectors relative to the S&P 500. As a result of the strong sector rotation, the inflation index is now decently oversold versus the deflation index, as shown in the first set of relative graphs in the upper right chart.
  • Realestate, which was grossly overbought last week, came back to earth this past week as we suspected. It still sits over 2 standard deviations from its 200 dma so caution remains the theme.
  • Continuing on the same dominant theme, the NASDAQ and TLT (long UST bonds) are now the most overbought factors/indexes, while the Dow and Momentum, which now has a lot more exposure to inflationary stocks, are the most oversold. The scatter plot in the bottom right of the first series of graphs shows the correlation of scores and excess returns is very strong, which is a little surprising given the volatility and strong rotational shifts throughout the week. The slope of the regression line steepened, telling us the excess return differences between under and outperformers was larger than the prior week.
  • From an absolute perspective, the same themes discussed above hold true. Over the past week, the S&P 500 went from decently overbought to closer to fair value. It still remains overbought and our proprietary cash flow model just turned to a sell signal so caution is warranted.
  • In both sets of graphs, utilities and staples, two sectors that should do better in a deflationary push, remain at fair value. If the rotation continues over the next few weeks, we should expect those two sectors to outperform on a relative basis versus the market and most other sectors.
  • The transportation sector (XTN) may be due for a bounce as it is now almost three standard deviations from its 50 dma. On the downside, its next line of support is the 200 dma, which is still almost 1 standard deviation, or 11% away.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

You Can’t Create Permanent Inflation From Artificial Growth

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Much like “Humpty Dumpty,” despite the Fed’s best efforts, you can’t create permanent inflation from artificial growth.

Currently, depending on whether you are “bullish” or “bearish,” there is much angst over the prospect of higher inflation. If you are bullish, higher inflation is a reflection of surging economic growth. If you are bearish, higher inflation leads to rising costs and higher rates. However, we need a better definition of what inflation is.

“In order to understand the effects of inflation it is helpful to understand that inflation is not a general rise in prices as such, but an increase in the supply of money which then sets in motion a general increase in the prices of goods and services in terms of money.” – The Mises Institute

The chart below shows the annual percentage change of M2 money supply and CPI. As Mises sets out, the surge in M2 should lead to a rise in “prices” over the next year.

There is little argument that we see a rise in prices in everything from food to housing and automobiles. The question we must answer is whether it is “sustainable” or “transitory” inflation?

Market Reach 4500, Technically Speaking: Yardeni – The Market Will Soon Reach 4500

Sustainable Inflation Requires Organic Growth

Sustainable, demand-driven inflation, requires sustainable wages to support higher prices. Due to the artificial stimulus, retails sales are 20% higher than pre-pandemic norms while employment is 10-million jobs lower.

As discussed previously, there is a high correlation between inflation and economic growth, wages, and rates.

Unless jobs come roaring back with a subsequent surge in wages, the artificially driven “demand” feeding into inflation will reverse.

Bonds Are Right

As discussed in “Why Bonds Are Right,” there is an even higher correlation between interest rates and the economic composite of inflation, wages, and economic growth. To wit:

“As shown, the correlation between rates and the economic composite suggests that current expectations of sustained economic expansion and rising inflation are overly optimistic. At current rates, economic growth will likely very quickly return to sub-2% growth by 2022.”

Bonds Overvalued, #MacroView: No, Bonds Aren’t Overvalued. They’re A Warning Sign.

The reason that rates are discounting the current “economic growth” story is that artificial stimulus does not create sustainable organic economic activity.

“This is because bubble activities cannot stand on their own feet; they require support from increases in money supply that divert to them real savings from wealth generators. Also, note again that a major cause behind the possible decline in the pool of real savings is unprecedented increases in money supply and massive government spending. While the pool of real savings is still growing, the massive money supply increase is likely to be followed by an upward trend in the growth rate of the prices of goods and services. This could start early next year. Once the pool of real savings starts to decline, however—because of massive monetary pumping and reckless fiscal policies—various bubble activities are will plunge. This, in turn, is likely to result in a large decline in economic activity and in the money supply.” – Mises Institute

As stimulus fades from the system, that decline in money supply is only one of several reasons that “deflation” will resurface.

Market Reach 4500, Technically Speaking: Yardeni – The Market Will Soon Reach 4500

Monetary & Fiscal Policy Is Deflationary

The Federal Reserve and the Government have failed to grasp that monetary and fiscal policy is “deflationary” when “debt” is required to fund it.

How do we know this? Monetary velocity tells the story.

What is “monetary velocity?” 

“The velocity of money is important for measuring the rate at which money in circulation is used for purchasing goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

With each monetary policy intervention, the velocity of money has slowed along with the breadth and strength of economic activity.

While in theory, “printing money” should lead to increased economic activity and inflation, such has not been the case.

A better way to look at this is through the veil of money” theory.

If money is a commodity, more of it should lead to less purchasing power, resulting in inflation. However, this theory began to fail as Governments attempted to adjust interest rates rather than maintain a gold standard.

Crossing The Rubicon

As shown, beginning in 2000, the “money supply” as a percentage of GDP has exploded higher. The “surge” in economic activity is due to “reopening” from an artificial “shutdown.” Therefore, the growth is only returning to the long-term downtrend. As shown by the attendant trendlines, increasing the money supply has not led to either more sustainable economic growth rates or inflation. It has been quite the opposite.

However, it isn’t just the expansion of the Fed’s balance sheet that undermines the strength of the economy. For instance, it is also the ongoing suppression of interest rates to try and stimulate economic activity. In 2000, the Fed “crossed the Rubicon,” whereby lowering interest rates did not stimulate economic activity. Therefore, the continued increase in the “debt burden” detracted from it.

Similarly, we can illustrate the last point by comparing monetary velocity to the deficit.

As a result, monetary velocity increases when the deficit reverses to a surplus. Such allows revenues to move into productive investments rather than debt service.

The problem for the Fed is the misunderstanding of the derivation of organic economic inflation

Market Reach 4500, Technically Speaking: Yardeni – The Market Will Soon Reach 4500

6-More Reasons Deflation Is A Bigger Threat

Previously, Mish Shedlock discussed Dr. Lacy Hunt’s views on inflation, or rather why deflation remains a more significant threat.

  • Inflation is a lagging indicator. Low inflation occurred after each of the past four recessions. The average lag was almost fifteen quarters from the end of each. (See Table Below)
  • Productivity rebounds in recoveries and vigorously so in the aftermath of deep recessionsThe pattern in productivity is quite apparent after the deep recessions ending in 1949, 1958, and 1982 (Table 2 Below). Productivity rebounded by an average of 4.8% in the year after each of these recessions. Unit labor costs remained unchanged as the rise in productivity held them down.
  • Restoration of supply chains will be disinflationary. Low-cost producers in Asia and elsewhere could not deliver as much product into the United States and other relatively higher-cost countries. Such allowed U.S. producers to gain market share. As immunizations increase, supply chains will gradually get restored, removing that benefit.
  • Accelerated technological advancement will lower costs. Another restraint on inflation is that the pandemic significantly accelerated the implementation of technology. The sharp shift will serve as a restraint on inflation. Much of the technology substitutes machines for people.
  • Eye-popping economic growth numbers vastly overstate the presumed significance of their result. Many businesses failed in the recession of 2020, much more so than usual. Furthermore, survivors and new firms will take over that market share, which gets reflected in GDP. However, the costs of the failures won’t be.
  • The two main structural impediments to traditional U.S. and global economic growth are massive debt overhang and deteriorating demographics, both having worsened as a consequence of 2020.

To summarize, the long-term risk to current outlooks remains the “3-Ds:”

  • Deflationary Trends
  • Demographics; and,
  • Debt

Market Reach 4500, Technically Speaking: Yardeni – The Market Will Soon Reach 4500

Conclusion

With this in mind, the debt problem remains a massive risk. If rates rise, the negative impact on an indebted economy quickly depresses activity. More importantly, the decline in monetary velocity shows deflation is a persistent threat.

Treasury&Risk clearly explained the reasoning:

“It is hard to overstate the degree to which psychology drives an economy’s shift to deflation. When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers all change their primary orientation from expansion to conservation.

  • Creditors become more conservative, and slow their lending.
  • Potential debtors become more conservative, and borrow less or not at all.
  • Investors become more conservative, they commit less money to debt investments.
  • Producers become more conservative and reduce expansion plans.
  • Consumers become more conservative, and save more and spend less.

These behaviors reduce the velocity of money, which puts downward pressure on prices. Money velocity has already been slowing for years, a classic warning sign that deflation is impending. Now, thanks to the virus-related lockdowns, money velocity has begun to collapse. As widespread pessimism takes hold, expect it to fall even further.”

There are no real options for the Federal Reserve unless they are willing to allow the system to reset painfully.

Unfortunately, we now have a decade of experience of watching monetary experiments only succeed in creating a massive “wealth gap.” 

Most telling is the current economists’ inability to realize the problem is trying to “cure a debt problem with more debt.”

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

Unfortunately, deflation remains the most significant threat as permanent growth doesn’t come from an artificial stimulus.

#WhatYouMissed On RIA This Week: 06-18-21

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What You Missed On RIA This Week Ending 06-18-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



Video Of The Week

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

Video Of The Week For 06-18-21 – The Fed Meeting, Rates & Taper.


Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 06-18-21

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

See you next week!

Is “Running Hot” Inflation Wise and Humane?

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Is “Running Hot” Inflation Wise and Humane?

  • “To me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target.” – Janet Yellen
  • To me, the weather is perfect when it’s 75 degrees.”

Both statements have some truth to them but severely lack context.

Even if it is 75 degrees, can I call it a perfect day if a hurricane is bearing down with torrential downpours and 150 miles per hour winds?

Letting inflation rise “above target” may have some benefit, but the rate at which incomes are changing versus inflation and its effect on confidence is far from inconsequential.

Yellen’s comments align with most Fed members who wish to see inflation run “hot.”

In this article, we explore the consumer’s plight and whether letting inflation run “hot” is a wise and humane way to keep the economic recovery rolling.

What’s Supporting the Economic Recovery

The robust economic recovery is in part the result of nearly $5 trillion in deficit spending.

To grasp how the government supported the economy, consider the graph below. The orange line is total personal income. After the second set of direct payments to citizens went out in March, personal income was 25% more than before the Pandemic.  The blue line shows organic income, or that earned solely through employers. The difference, the gray area, is payments from the government, known as transfer payments. These direct benefits represented nearly a third of income on multiple occasions over the last year. 

Personal consumption represents nearly two-thirds of economic activity (GDP). Over the last six months, consumption was significantly boosted by stimulus programs. Further, the government allowing forbearance of rent, mortgage, student loan, and utility payments provided many with additional money to spend.

Resulting from surging income and reduced liabilities, retail sales are running about 15% above the trend of the prior decade. For historical recessionary context, consider retail sales fell by about 13% from its trend during the 2008 recession.

With the economy reopening quickly, the government is handing the recovery baton to consumers. As such, the strength of wages and employment, the means with which we consume, are critical if the recovery is to continue without enormous support from Uncle Sam.  

Atlanta Fed Wage Tracker

The data and graphs in this section and other informative data are from the Atlanta Fed Wage Tracker website.

When wages rise, consumers feel more confident in their financial standing and are more willing to spend. Consumer confidence is vital for the continuation of economic recovery. The data and graphs highlight recent wage trends allowing us to gauge potential changes in consumer confidence as we advance.

The first graph below shows wage growth was running in a 3.5-4.0% range for a few years before 2020. Since the Pandemic, wage growth has been gradually declining.

Despite declining wage growth in 2020, wage growth outpaced CPI by around 2%, as shown below. That was because inflation was running at a below-average 1.3% rate. Unfortunately, the real (after inflation) wage growth from 2020 was erased. In 2021 CPI is running at a 5.4% annualized rate, dwarfing wage growth.  

The following graph shows wage growth declined in 2020 for all categories except paid hourly workers. The trend continues in 2021 as all classifications are falling. 

The takeaway from the graphs above is that wage growth is falling, and inflation is picking up. As a result, as shown in the first bar chart, real wages are falling by about 2% this year.

Chart 3 below shows the percentage of those not receiving pay raises has been up ticking since 2020, after trending lower for the prior decade. Median wage growth is also falling, like the average wage growth shown above.

Chart 2 below shows that average wage growth is falling at all income levels.

Lastly, we add one more important consideration. The series of graphs above solely focus on those with jobs. Left out of the data are nearly 10 million people who have lost jobs in the last year and a half.

Taking Off the Training Wheels

Like riding a bike for the first time, confidence is imperative once your teacher lets go and pushes you forward. Confidence, along with balance, allows the rider to peddle forward and at increasing speeds. New bike riders often lack confidence in their abilities and fall many times before speeding ahead.

The government is weaning consumers from critical support at a rapid rate. There are no more direct checks, unemployment benefits are expiring, and forbearance rules are ending. Consumers must start peddling at a fast pace to keep the economy going. Like riding a bike, confidence will play a vital role if the handoff from the government is to be successful. 

The University of Michigan Consumer Sentiment survey, shown below, is improving but shows confidence is not what it was.

The Atlanta Fed graphs show wages are shrinking on a real basis. Recent BLS data confirms the message. Real average weekly and hourly earnings fell 2.2% and 2.8%, respectively on a year-over-year basis.

Is now the time for the Fed to promote policies that effectively reduce wages via inflation? We find it hard to believe consumers will be gung-ho about spending when their wages do not go as far as they used to.  

Back to Janet Yellen’s quote. Is more inflation wise at such a precarious spot in the recovery? To paraphrase, is damaging consumer sentiment in our best interest?

Is Inflation Humane?

As far as her characterization of more inflation being humane, we have choice words for Mrs. Yellen.

In Two Pins Threatening Multiple Asset Bubbles, we quantified how low-wage workers are more affected by rising inflation. To wit: “Only accounting for food and housing, two necessities, the lowest income classes saw their annual expenses rise by 6.05%. The highest income classes saw their expenses rise by 2.10%.”  

There is nothing humane about reducing purchasing power for a large majority of citizens. What can we possibly hope to gain by reducing the economic standing of the many for the benefit of a few? Further, growing wealth inequality does not bolster confidence, quite the opposite in fact.

Summary

The Atlanta Fed and BLS show wages are failing to keep up with inflation. While nominal economic data may improve due to the effects of higher prices, inflation-adjusted data, which is the reality we all live by, does not benefit.

It is now common to hear people complain about sharply rising prices. Social and traditional media fan the flames as they increasingly bring inflation to light.  While some consumers may take inflation with a grain of salt, many others are likely to become more frugal.

Consumer confidence is vital to keep recovery rolling.

So, with proper context, do you believe more inflation is wise or humane?

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

Technically Speaking: Slowly At First, Then All At Once

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Bull markets always seem to end the same – slowly at first, then all at once.

My recent discussion on why March 2020 was a “correction” and not a “bear market” sparked much debate over the somewhat arbitrary 20% rule.

“Price is nothing more than a reflection of the ‘psychology’ of market participants. A potential mistake in evaluating ‘bull’ or ‘bear’ markets is using a ‘20% advance or decline’ to distinguish between them.”

Wall Street loves to label stuff.  When markets are rising, it’s a “bull market.” Conversely, falling prices are a “bear market.” 

Interestingly, while there are some “rules of thumb” for falling prices such as:

  • A “correction” gets defined as a decline of more than 10% in the market.
  • A “bear market” is a decline of more than 20%.

There are no such definitions for rising prices. Instead, rising prices are always “bullish.”

It’s all a bit arbitrary and rather pointless.

The Reason We Invest

It is essential to understand what a “bull” or “bear” market is as investors.

  • A “bull market” is when prices are generally rising over an extended period.
  • A “bear market” is when prices are generally falling over an extended period.

Here is another significant definition for you.

Investing is the process of placing “savings” at “risk” with the expectation of a future return greater than the rate of inflation over a given time frame.

Read that again.

Investing is NOT about beating some random benchmark index that requires taking on an excessive amount of capital risk to achieve. Instead, our goal should be to grow our hard-earned savings at a rate sufficient to protect the purchasing power of those savings in the future as “safely” as possible.

As pension funds have found out, counting on 7% annualized returns to make up for a shortfall in savings leaves individuals in a vastly underfunded retirement situation. Moreover, making up lost savings is not the same as increasing savings towards a future required goal.

Nonetheless, when it comes to investing, Bob Farrell’s Rule #10 is the most relevant:

“Bull markets are more fun than bear markets.” 

Of this, there is no argument.

However, understanding the difference between a “bull” and a “bear” market is critical to capital preservation and appreciation when the change occurs.

Defining Bull & Bear Markets

So, what defines a “bull” versus a “bear” market.

Let’s start by looking at the S&P 500.

Bull and bear markets are evident with the benefit of hindsight.

The problem, for individuals, always comes back to “psychology” concerning our investing practices. During rising or “bullish,” markets, the psychology of “greed” keeps individuals invested longer and entices them into taking on substantially more risk than realized. “Bearish,” or declining, markets do precisely the opposite as “fear” overtakes the investment process.

Most importantly, it is difficult to know “when” the markets have changed from bullish to bearish. Over the last decade, several significant corrections have certainly looked like the beginning of turning from a “bull” to a “bear” market. Yet, after a short-term corrective process, the upward trend of the market resumed.

So, while it is evident that missing a bear market is incredibly important to long-term investing success, it is impossible to know when the markets have changed.

Or is it?

The next couple of charts will build off of the weekly price chart above.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Identifying The Trend

“In the short run, the market is a voting machine but in the long run it is a weighing machine” – Benjamin Graham

In the short term, which is from a few weeks to a couple of years, the market is simply a “voting machine” as investors scramble to chase what is “popular.” Then, as prices rise, they “panic buy” everything due to the “Fear Of Missing Out or F.O.M.O.” Then, they “panic sell” everything when prices fall. However, these are just the wiggles along the longer-term path.

In the long-term, the markets “weigh” the substance of the underlying cash flows and value. Thus, during bull market trends, investors become overly optimistic about the future bid-up prices beyond the practical aspects of the underlying value. The opposite is also true, as “nothing has value” during bear markets. Such is why markets “trend” over time. Eventually, excesses in valuations, in both directions, get reverted to, and beyond, the long-term means.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

While the long-term picture is relatively straightforward, valuations still don’t do much in terms of telling us “when” the change is occurring.

Change Starts Slowly, Then All At Once

“Tops are a process and bottoms are an event” – Doug Kass

During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market, prices trade below that moving average.

The keyword is TREND. 

The chart below which compares the market to the 75-week moving average. During “bullish trends,” the market tends to trade above the long-term moving average and below it during “bearish trends.”

Since 2009, there are four occasions where the long-term moving average was violated but did not lead to a longer-term change in the trend.

  • The first was in 2011, as the U.S. was dealing with a potential debt-ceiling default and a downgrade of the U.S. debt rating. Fed Chairman Ben Bernanke started the second round of quantitative easing (QE), flooding the markets with liquidity.
  • The second came in late-2015 and early-2016 as the Federal Reserve started lifting interest rates combined with the threat of Britain leaving the European Union (Brexit). Given the U.S. Federal Reserve had already committed to tightening monetary policy, the ECB stepped in with their version of QE.
  • The third came at the end of 2018 as the Fed again tapered its balance sheet and hiked rates. The market decline quickly reversed the Fed’s stance.
  • Finally, the “pandemic shut-down” of the economy led to a price reversion in the market. The Fed intervened with massive liquidity injections and the start of QE-4.

Each of these declines only gets classified as “corrections.” The market did not sustain the break of the long-term trend, valuations did not revert, and psychology remained bullish. 

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Still A Bull Market

Today, Central Banks globally continue their monetary injection programs, rate policies remain at zero, and global economic growth is weak. Moreover, with stock valuations at historically extreme levels, the value currently ascribed to future earnings growth almost guarantees low future returns.

As discussed previously:

Like a rubber band stretched too far – it must get relaxed in order to stretch again. The same applies to stock prices that are anchored to their moving averages. Trends that get overextended in one direction, or the other, always return to their long-term average. Even during a strong uptrend or strong downtrend, prices often move back (revert) to a long-term moving average.”

The chart below shows the deviation in the market price above and below the 75-week moving average. Historically, as prices approach 200-points above the long-term moving average, corrections ensued. Thus, the difference between a “bull market” and a “bear market” is when the deviations occur BELOW the long-term moving average consistently. 

Since 2017, with the globally coordinated interventions of Central Banks, those deviations have started exceeding levels not seen previously. As of the end of May, the index was nearly 800 points above the long-term average or 4x the normal warning level. 

We can see the magnitude of the current deviation by switching to percentage deviations. Historically, 10% deviations have preceded corrections and bear markets. Currently, that deviation is 22.5% above the long-term mean.

Notably, the decline below the long-term average reversed quickly, keeping the “bull market” trend intact.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Conclusion

Understanding that change is occurring is what is essential. But, unfortunately, the reason investors “get trapped” in bear markets is that when they realize what is happening, it is far too late to do anything about it.

Bull markets are lure investors into believing “this time is different.” When the topping process begins, that slow, arduous affair gets met with continued reasons why the “bull market will continue.”  The problem comes when it eventually doesn’t. As noted, “bear markets” are swift and brutal attacks on investor capital.

As Ben Graham wrote in 1959:

“‘The more it changes, the more it’s the same thing.’ I have always thought this motto applied to the stock market better than anywhere else. Now the really important part of the proverb is the phrase, ‘the more it changes.’

The economic world has changed radically and will change even more. Most people think now that the essential nature of the stock market has been undergoing a corresponding change. But if my cliché is sound, then the stock market will continue to be essentially what it always was in the past, a place where a big bull market is inevitably followed by a big bear market.

In other words, a place where today’s free lunches are paid for doubly tomorrow. In the light of recent experience, I think the present level of the stock market is an extremely dangerous one.”

Pay attention to the market. The action this year is very reminiscent of previous market topping processes. Tops are hard to identify during the process as “change happens slowly.” The mainstream media, economists, and Wall Street will dismiss pickup in volatility as simply a corrective process. But when the topping process completes, it will seem as if the change occurred “all at once.”

Viking Analytics: Weekly Gamma Band Update 6/14/2021

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

Gamma Band Update

The S&P 500 (SPX) again closed the week above the Gamma Flip level, and in our view is prepared to trade with low volatility through the key mid-year option expiration on June 18th as long as price remains above the gamma flip level.  If SPX value falls below the gamma flip and 20 day moving average, we would then expect to see increasing volatility.

Our daily Gamma Band model[1] maintained a 100% allocation to SPX last week. When the daily price closes below “Gamma Flip” (currently near 4,205), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below the lower gamma level (currently near 3,995), the model will reduce the SPX allocation to zero.

Investors who keep an eye on various gamma-related levels are more aware when market volatility is expected to increase.  One application of Gamma Bands is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report. With stocks continuing to extend historically high valuations, risk management tools are more important than ever to manage the next drawdown, whenever it comes.

A sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

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


Fed Starting Campaign To Taper Its Asset Purchases

image_printPRINTER FRIENDLY VERSION

Over the last couple of months, the Fed started its campaign to prepare markets for a “taper” of its asset purchases.

Michael Lebowitz noted that Jerome Powell repeatedly affirmed the Fed “isn’t even thinking about thinking about tapering.”

“As Chairman of the Fed, his opinions take precedence over those from other Fed members. Regardless, other Fed members are not entirely on the same page as Powell.” – Lebowitz

As CNBC noted, the voices of other Fed members are becoming more prominent.

“Comments by Fed officials in the past several weeks suggest the issue of tapering looks likely to be discussed as soon as the Federal Open Markets Committee meeting next week. The Fed may be on track to begin asset reductions later this year or early next year.

At least five Fed officials have publicly commented on the likelihood of those discussions in recent weeks. Those include Patrick Harker, Robert Kaplan, Fed Vice Chair Randal Quarles and Cleveland Fed President Loretta Mester.”

Talking Taper

Here are some of the comments:

  • Bullard: the U.S. may be getting close to the point where the pandemic is over. 
  • Lael Brainard: “Vulnerabilities associated with elevated risk appetite are rising.” The combination of stretched valuations with very high levels of corporate indebtedness bears watching because of the potential to amplify the effects of a repricing event.”
  • Robert Kaplan: “The Fed should start talking about tapering bond-buying soon.” & “I am beginning to feel differently regarding the advantages and drawbacks of the Fed’s QE purchases.”
  • Eric Rosengren: “The mortgage market probably doesn’t need as much support now.“
  • Mester: “As the economy continues to improve, and we see it in the data, we are getting closer to our goals. We’re going to have discussions about our stance on policy overall. Such includes our asset purchase programs and including our interest rates,”

Fed members use these“trial balloons” to prepare the markets for a “policy shift.” However, as discussed previously, the Fed walks a very tight rope with monetary policy. Moving too quickly would have potentially disastrous results on the financial markets.

Not Just Fed Members

Once you get beyond hints from Fed members, there are other issues. The robust recovery, financial institutions, and money markets are encountering QE-related problems.

“Banks are struggling to digest the reserves they receive when the Fed purchases assets from them. As a result, their ongoing ability to facilitate additional amounts of QE is increasingly becoming problematic.

Zoltan Pozsar, credit analyst and Fed expert at Credit Suisse, summed the situation as follows:

(The) use of the (reverse repurchase program RRP) facility has never been this high outside of quarter-end turns. The fact that the use of the facility is this high on a sunny day mid-quarter means banks don’t have the balance sheet to warehouse any more reserves at current spread levels.’

Secondly, the Fed is struggling with the recent reduction of Treasury balances held at the Fed. As a result, the Treasury is issuing fewer short-term bonds. Such results in a scarcity of money market securities and collateral supporting derivatives. Consequently, short-term interest rates are starting to go negative.

The two problems make it progressively more challenging to maintain the pace of QE and keep rates from going negative.”

Importantly, there is a limit to how many bonds the Federal Reserve can lift out of the market. As stated, there are already problems on the short end of the curve. Furthermore, their purchases of mortgage-backed bonds have created another housing price escalation on the longer end.

Once the Fed starts to try and lift off the “gas pedal,” the inflation of assets supported by the monetary policy will slow.

In other words, the “clock starts ticking” when the Fed reverses course.

Taper Starts The Clock

As discussed previously, there is a correlation between expanding the Fed’s balance sheet and the S&P 500 index. Whether the correlation is due to liquidity moving into assets through leverage or just the “psychology” of the “Fed Put,” the result is the same.

Therefore, it should also not be surprising that when the Fed starts “tapering” their bond purchases, the market tends to witness increased volatility. The grey shaded bars in the chart below show when the balance sheet is either flat or contracting.

The risk of a market correction rises further when the Fed is both tapering its balance sheet and increasing the overnight lending rate. The negative impact of tighter monetary policy on asset prices is of no surprise.

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

Bonds As A Risk Hedge

Understanding that volatility is a risk once the Fed starts to “taper,” the question is how to “hedge” that risk?

The easy answer is to reduce the equity exposure that suffers the most from a volatility spike. But, as discussed recently in “Warning Signs Of A Correction,” there is an advantage of just having a more significant holding of cash.

“If we reduce risk and the market continues to rise, we can increase risk exposures. Yes, we sacrifice some short-term performance. However, if we reduce risk and the market declines sharply, we not only protect capital during the decline but have the liquidity to deploy at lower price levels.”

Another way to hedge portfolio risk is to buy Treasury bonds.

Ironically, while the Fed states that their goal with “QE” is to suppress interest rates, historically, Treasury rates increase as investors move from “risk-off” to “risk-on” trades. As Michael illustrates.

“The graph below shows the yield on ten-year UST notes rose during each QE period and fell upon its conclusion. As circled, yields fell precipitously when the Fed reversed QE via Quantitative Tightening (QT).”

taper, Taper Is Coming: Got Bonds?

“Ten-year yields tend to rise about 1% from the start of QE to peak yield levels during QE. Equally important, yields tend to fall toward the end of QE.”

Again, just as investors shift from bonds into stocks when “QE” is increasing, the opposite is true when investors sense the Fed is beginning to reduce accommodation.

“Currently, yields are close to their cycle highs. If we believe the Fed is nearing tapering, yields could be peaking. Based on prior QE taper experiences, a yield decline of 1% may be in store for the next six months to a year if the Fed tapers.”

taper, Taper Is Coming: Got Bonds?

Conclusion

With inflation running hot, housing prices significantly elevated, and multiple signs of excess speculative risk in the market, it is not surprising the Fed is talking about “tapering” asset purchases.

Will their actions create a “volatility event” in the market? No one knows for sure, but history over the last decade suggests it will.

While the Fed may be starting to “think about thinking about tapering,” all we are suggesting is that you may want to start “thinking about risk management.” 

I could be wrong.

Hopefully, I am.

But isn’t it worth having a plan in place just in case I’m not?

“Strategy without tactics is the longest path to victory; tactics without strategy is the noise before defeat.” – Sun Tzu, The Art of War

Reviewing Market Signals As Warnings Increase

image_printPRINTER FRIENDLY VERSION


In this 06-11-21 issue of “Reviewing Market Signals As Warnings Increase.

  • Reviewing Market Signals
  • Warnings Increase
  • Bonds Say Deflation Is A Risk
  • Portfolio Positioning
  • #MacroView: Rates, Dollar & The 2021 Outlook
  • Sector & Market Analysis
  • 401k Plan Manager

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


Are you worried about the potential for a market correction, a surge in inflation, or are you unsure how to invest for your retirement? We can help. If you are not yet a client and would like to discuss your portfolio construction, please schedule a time to meet with one of our advisors below.


Reviewing Market Signals

Over the last several weeks, we discussed evaluating the recent “buy” signal and concerns about a potential summer correction. We will review that bit of history and discuss our reduction of equity exposures this past week. 

May 7th:

“The uptick in money flows did allow us to add some exposure to portfolios in holdings we took profits in previously. Overall, the market trend remains bullish, so there is no need to be overly defensive. Just a regular process of tweaking risk and managing exposures is all that portfolios require for now.”

May 14th – things didn’t work out as planned:

“Well, that follow-through failed to occur. Not only did the “buy signal” not trigger, but the market also broke down through the previous consolidation range. The last exposure we took on is now pressuring the portfolio momentarily, but we should benefit from the turn if we are correct.”

May 21st – the rally gets underway:

“We do expect a counter-trend rally due to the liquidations occurring by institutional investors over the previous few weeks. We will hold exposures at current levels for now. However, instead of looking for a more extended rally into mid-summer, we suspect this rally will be fairly short-lived.”

That week we also began to build the case for a 5-10% correction by mid-summer.

“The risk of a more significant drawdown outweighs the reward longer-term, but we are willing to trade short-term opportunities.”  

Jumping ahead, last week, the signals returned to overbought short-term conditions.

“The good news is that we did indeed get the rally we were expecting. The not-so-good news is that the rally already consumed a majority of the ‘buy signal.’ Such does not mean the market is about to correct; it does suggest that upside remains limited near term.”

Market Struggles At Highs As Signals Peak

While the market did hit all-time highs this week, it was a feeble rally. Both Thursday and Friday saw the market drop into the red intraday only to be saved by end-of-day buying. Unfortunately, as shown, money flows continued to decline until there was “distribution” as the market hit highs. Such is not a sign of confidence the “highs” will stick.

On a weekly chart, the picture improves somewhat with the “buy signal” still intact. However, it is just barely the case, and if we get selling pressure next week, it will trigger a “sell.”

As discussed previously, we set our expectations for a 5-10% correction between mid-June and July. With that window approaching and signals very close to triggering “sells” on both a daily and weekly basis, we used the rally this week to lighten our equity exposure and raise cash levels. (See the portfolio update below.)

For now, the bullish trend remains intact. Therefore, there is no need to get overly defensive at this juncture. However, being excessively complacent and not applying some risk management to portfolios will leave you flat-footed when the correction does come.

Investors are exceedingly exuberant about markets once again, with numerous analysts suggesting nothing but “blue skies” ahead.

Maybe. But there are plenty of warnings that suggest “carrying an umbrella” may come in handy.



Warning Signals Increase

In our “Warning Signs Ahead,” we discussed several concerns of a correction in the coming weeks. Importantly, as noted then, we are only discussing the potential for a short-term correction. As is often the case, some tend to extrapolate such commentary to mean a “crash” is coming. Such is not the case currently, but it does not mean a deeper correction is not possible.

Currently, complacency has reached more extreme levels. As noted last week, the 15-day moving average of VIX, on an inverted scale, suggests a correction is likely.

Warning Signs Correction, Technically Speaking: Warning Signs A Correction Is Ahead

“The market may have one last push higher over the next several weeks. Such will take the VIX even lower and complete the VIX wedge pattern. That pattern has been evident in the last three 10% or greater corrections. By this measure, the correction should begin somewhere around July 21st – August 10th.” – Jim Colquitt

Morgan Stanley‘s market timing indicator is also at levels typically associated with market downturns. Just for reference, the current reading is the most “bearish” on record.

Warning Signs Correction, Technically Speaking: Warning Signs A Correction Is Ahead

We covered several other indicators, all suggesting that risk has become elevated. Moreover, given the length of the current advance without a correction, the risk of such has increased.

More Signs

Furthermore, during the past week, we saw other indicators suggesting that market upside is likely limited short-term. For example, Sentiment Trader made an excellent observation of the recent rotation from large to small-caps.

“Over the past few weeks, there has been a remarkable rotation under the surface. On May 12, only 31% of stocks in the Russell 2000 were holding above their 50-day moving averages. In the Info-Tech sector, only 25% of stocks were above their averages. Both have seen participation more than double since then, while the S&P 500 has stagnated internally, as pointed out by the esteemed Liz Ann Sonders.”

As noted above, one of the common themes has been numerous bullish commentators suggesting the market is about to run to new highs. However, given the confluence of warning signals and “stagnation” of the advance, the bearish view is such action usually appears near market peaks. Sentiment Trader provided some historical evidence.

“Looking at available history, bears have the more compelling evidence on their side, depending on the index and the time frame. The table below shows the S&P 500’s future returns when its percentage of members above the 50-day average rises less than 12.5% over a multi-week period while the percentage of members above their averages in Small-Caps and Tech rises more than 25%.”

Again, given the more extreme conditions seen in not only our current short-term “money-flow” signals but numerous other indications, the risk of a short-term correction seems a realistic probability.

Does such mean that a “correction” must occur? No. However, as noted last week, we prefer to err to the side of our analysis and discipline. By the time a correction appears, it is often too late to mitigate the damage effectively.

Bonds Say Deflation Is The Risk

Despite a sharp year-over-year increase in the latest CPI report, the bond market suggests deflation remains the more considerable risk. As shown in the chart below, the latest CPI and “Core CPI” surged sharply. I also included a “consumer inflation gauge,” which excludes healthcare and home prices. (For most individuals, these two costs are fixed by a mortgage payment and health insurance.)

Interestingly, the “bond market” continues to suggest deflation is the more significant threat as we are currently at the largest deviation between annual CPI and rates since 1980.

This model suggests the market agrees with the Fed’s view that inflation is transitory and is pricing in sub-2% inflation and economic growth. Furthermore, over the next two quarters, the year-over-year rate of change will slow (the “base effect”) as the economic “shutdown” is removed from the calculation.

As discussed in Friday’s #MacroView report “The Dollar, Rates & 2021 Outlook,” deflation is set to return.

“Contrary to the conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year-end and will undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.” – Dr. Lacy Hunt

Furthermore, given real wages are not keeping up with the actual “cost of living” increases, the “stimulus” effect is fading, and the pull-forward of consumption is mostly complete, we most likely have seen the peak of economic and earnings growth.

We remained concerned about a repricing of risk over the next few months.

Portfolio Update

On Thursday, we did begin reducing our exposures slightly in 60/40 equity and ETF portfolios. (Chart via RIAPRO.net)

As shown, we are still 53% long equity exposure but are down from nearly 70% from the recent market lows. Part of the cash exposure comes from our bond portfolio due to shortening duration to offset short-term interest rate risk. We did begin increasing bond duration a couple of weeks ago.

The reason for showing you the allocation is that you don’t assume that just because we are warning of a potential correction, we are not sitting 100% in cash. I suggest that with our “sell signals” approaching, it is time to start taking some action essential to portfolio risk management.

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

We may very well be a little early in our actions which could equate to short-term portfolio underperformance. However, there is minimal risk in “risk management.” In the long term, the results of avoiding periods of severe capital loss will outweigh missed short-term gains.

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 92.88 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 86.42 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

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


Weekly Stock Screens

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

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

S&P 500 Growth Screen

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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

This past week, the daily “buy signal” continued to get more oversold, with the weekly signal very close to triggering a “sell” signal. Consequently, we are taking some pre-emptive actions to reduce portfolio risk by rebalancing holdings across the models.

We still expect a mild correction of 5% or so during the summer, which will “feel worse” than it is. However, the goal will be to use that correction to rebalance equity risk back to target levels for the remainder of the year. Notably, the current rebalancing gives us increased cash levels to make opportunistic buys during the next corrective phase.

As noted in the main body of this week’s missive, the inflation surge seen this past week is a function of the “base effect” from the “shutdown” last year. As a result, we expect to see inflation and economic growth numbers fade over the next quarter as the base effect gets removed from the calculation.

This roll-off of the base effect will also lead to a surge in deflationary headwinds leading to weaker earnings growth into year-end. We expect to see a resurgence of the “deflation” trade as that occurs, which will benefit Technology, Healthcare, Staples, and Utilities. You will notice we have already started making adjustments in these areas.

However, at the moment, there are no “big red flags” that suggest we become significantly more active. But, should they appear, we assure you we will take action as needed.

Portfolio Changes

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

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

“As discussed over the last few weeks in our weekly newsletter, we are coming upon the confluence of daily and weekly signals turning negative for a wide swath of sectors, stocks, and broad indexes. As such, we are reducing our net exposure by 3.5% to 53% in both models. At the same time, we are adding to a few sectors/stocks that have positive technical outlooks.” – 06/10/21

Equity Model:

  • AAPL – reduce by 1/2%
  • ABBV – increase by 1% 
  • ADBE – reduce by 1/2% 
  • ALB – reduce 1 1/2% 
  • FANG – reduce 1/2% 
  • CVS – increase by 1/2% 
  • GOLD – increase by +1 
  • JNJ – increase by 1/2% 
  • MSFT – reduce by 1/2% 
  • PSA – reduce by 1/2% 
  • RTX – reduce by 1/2%
  • UNP – sell 100% of the position.
  • UPS – increase by 1% 
  • V – reduce by 1/2% 

Sector Model:

  • XLV – increase by 2% of the portfolio. 
  • XLK – reduce by 2.5% 
  • LIT – decrease by 1% 
  • IYT – reduce by 1/2% 
  • XLB – reduce by 1/2% 
  • XLE – reduce by 1/2% 
  • XLF – decrease by 1% 
  • XLI – reduce by 1/2% 
  • XLU – increase by 1% 

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

Have a great week!

Technical Value Scorecard Report For The Week of 6-11-21

image_printPRINTER FRIENDLY VERSION

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

Commentary 6-11-21

  • One of the key themes this past week is the increasing investor buy-in to the Fed’s expectation that inflation will be transitory. Despite a 5% annual inflation print Thursday, bond yields fell and the deflationary sectors outperformed inflationary sectors. This can be seen in the sector charts below, as technology and health care, for example, shifted to the left over the last week. Note also that financials and materials are now both slightly oversold after being decently overbought last week and for many months prior. Both sectors underperformed the S&P by about 2.5%. The energy sector bucked the trend, rising 5.6% versus the S&P, on the back of oil prices eclipsing $70/barrel.
  • The deflationary trend can also be seen in the top right relative fixed income graphs. Our inflation/deflation index fell back toward fair value. Further, the Treasury yield curve flattened, as can be seen by TLT (20yr bonds) improving markedly versus IEI (5-7yr notes). We have discussed the Fed paring back on MBS purchases and the market seems to be concerned as well. MBB continues to weaken versus IEI.
  • The relative factor/index graphs also show gravitation toward deflationary indexes. Equal weighted S&P (RSP) and value versus growth, both underperformed, while the NASDAQ (QQQ) is now slightly above fair value.
  • On an absolute basis (second set of graphs) we see similar rotations. Real estate and energy remain overbought, but materials, financials, industrials, and transportation shifted right.
  • Most of the factors/indexes are overbought and rose further above fair value over the past week. The S&P 500 is also overbought and approaching prior high water marks that usually result in consolidation or a sell-off. This coincides with our daily and weekly proprietary cash flow models which are in the process of turning to sell signals.
  • We reduced our exposure to XLRE (real estate) on Thursday as it is grossly overbought. XLRE is nearly 3 standard deviations above its 200 dma and 2.5 above its 50 day. We should also keep our eye on many other sectors, as shown in the third table, which are approaching 2 standard deviations.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

#MacroView: Rates, The Dollar & The 2021 Outlook

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As we move into the second half of 2021, interest rates and the dollar continue to shape the outlook.

Of course, much of the debate focuses on whether rates and the dollar continue to miss the bigger picture. For example, just recently, Jim Bianco tweeted a critical point.

However, while I very much respect his opinion, I am not sure I entirely agree. Such is where the analysis of rates and the dollar suggests a different story.

The Inflation Premise

We previously discussed that inflation might indeed be more transitory given the drivers of increased prices were artificial. (i.e., stimulus, semi-conductor shortages, and pandemic-related shutdowns.) To wit:

“Inflation is and remains an always ‘transient’ factor in the economy. As shown, there is a high correlation between economic growth and inflation. As such, given the economy will quickly return to sub-2% growth over the next 24-months, inflation pressures will also subside.” 

China Yields Deflationary 05-28-21, China, Yields, And The Coming Deflationary Impulse 05-28-21

“Significantly, given the economy is roughly comprised of 70% consumption, sharp spikes in inflation slows consumption (higher prices lead to less quantity), thereby slowing economic growth. Such is particularly when inflation impacts things the bottom 80% of the population, which live paycheck-to-paycheck primarily, consume the most.”

However, another important factor behind inflationary pressures is an individual’s actions. As noted last week by Société Générale’s Albert Edwards:

“Surveys suggest that inflation fears have become investors’ number one concern. But why look at it that way? We could equally say it is investors’ own bullishness on the strength of this economic cycle that is driving prices sharply higher in the most cyclically exposed equity sectors and industrial commodities.”

Bloomberg’s John Authers discussed the same, noting a “reflexivity” to investors’ belief in rising inflation.

“In inflation, as in many other areas of economic life, perceptions can form reality, and that is certainly true of inflation. The University of Michigan monthly survey of consumers’ expectations perennially shows shoppers foreseeing more inflation than will in fact arrive. The important factor here is the direction of travel. If they are more worried about inflation, they will do more to guard against it, which will tend to push up prices.”

Psychological Inflation & China

Such is an important point, as Albert notes:

“When investors pile into commodities as an investment vehicle to benefit from rising inflation, they create substantial upstream cost pressures. Beyond the cascading effect of upstream commodity price pressures, headline CPIs are also quickly impacted as food and energy prices rip higher.”

In other words, investors cause inflation by their actions. However, this is where Albert keys in on another critical driver of inflation.

“In addition to this, the observation by investors that industrial commodity prices are rising only serves to reaffirm their belief about cyclical strength and rising inflation, most especially ‘Dr. Copper.” Many investors see copper as extremely sensitive to economic conditions.

The circular, or as George Soros terms it, ‘reflexive’ nature of financial markets makes them extremely vulnerable to being whipsawed. Yet because of the current extreme momentum, it would take a very heavy weight of evidence to convince this market to reverse direction.

We continue to highlight that commodity prices are at high risk of a major reversal because of the steep downturn in the Chinese Credit Impulse. We have highlighted this before and we are not alone. Julien Bittel of Pictet Asset Management posted the following chart.”

China Yields Deflationary 05-28-21, China, Yields, And The Coming Deflationary Impulse 05-28-21

“When commodity prices do start to fall, expect a major reversal in inflation sentiment. Furthermore, expect momentum to become as self-reinforcing and reflexive on the way down just as it was on the way up.”

As we discussed previously, this is something the bond market already expects.

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

What Rates Are Saying About Inflation

While investors expect surging inflation, the bond market continues to price in weaker future economic growth. As noted in “No, Bonds Aren’t Over-Valued.”

“The correlation between rates and the economic composite suggests that current expectations of sustained economic expansion and rising inflation are overly optimistic. At current rates, economic growth will likely very quickly return to sub-2% growth by 2022.”

Note: The “economic composite” is a compilation of inflation (CPI), economic growth (GDP), and wages.

China Yields Deflationary 05-28-21, China, Yields, And The Coming Deflationary Impulse 05-28-21

There is a fundamental reason why the bond market is pricing in deflation currently.

“The correlation should be surprising given that lending rates get adjusted to future impacts on capital.

  • Equity investors expect that as economic growth and inflationary pressures increase, the value of their invested capital will increase to compensate for higher costs.
  • Bond investors have a fixed rate of return. Therefore, the fixed return rate is tied to forward expectations. Otherwise, capital is damaged due to inflation and lost opportunity costs. 

As shown, the correlation between rates and the economic composite suggests that current expectations of sustained economic expansion and rising inflation are overly optimistic. At current rates, economic growth will likely very quickly return to sub-2% growth by 2022.”

The Fed Will Push Deflation

The problem for the Federal Reserve is that the fiscal and monetary stimulus imputed into the economy is “dis-inflationary.” 

“Contrary to the conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year end and will undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.” – Dr. Lacy Hunt

The point here is that while economic growth may be booming momentarily, inflation, which is destructive when not paired with rising wages, will be transient. Given the massive surge in prices for homes, autos, and food, the reversal will cause a substantial disinflationary drag on economic growth.

The most considerable risk is a divergence among Fed policymakers which possibly leads to a policy mistake of tapering too quickly or even hiking rates. 

The majority of the inflation and economic growth pressures are artificial, stemming from the stimulus injections over the last year. However, with those inputs fading as year-over-year comparisons become more challenging, the “deflationary” impact could be more significant than expected.

There is also one other point about the Fed tapering the purchases. As shown in the chart below, rates rise during phases of QE as money rotates from bonds to stocks for the “risk-on” trade. The opposite occurs when they start to taper, suggesting a decline in rates if “taper talk” increases.

China Yields Deflationary 05-28-21, China, Yields, And The Coming Deflationary Impulse 05-28-21

The Story Of The Dollar

While many view the US Dollar as a proxy for economic strength, there is very little correlation between the currency on a short-term basis. However, as shown below, there is a long-term trend of the dollar’s value as compared to economic growth. In other words, the value of the dollar does reflect economic strength over the longer term.

Currently, the U.S. dollar is weakening as the Government is flooding the system with liquidity. Now, the money supply is spiking, but given the relative surge in debt, the injections fail to spur an increase in monetary velocity.

With the US dollar breaking down to the lowest level since 2014 and trading below its 2-year moving average, the risk of the dollar retrenching to “Financial Crisis” lows is not out of the question.

The massive increase in the US budget deficit as a percent of GDP also suggests that “deflationary” pressures weigh both on economic growth and the dollar. As Bryce Coward of Gavekal recently noted:

“The ballooning budget deficit suggests a level of 70 or 80 on the US dollar index over the coming years would not be out of the realm of possibilities. That would equate to a further decline of 11% to 22% from here. If the US dollar drops below $90 such would have fairly large ramifications for equities.”

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

The Fed May Be Right For The Wrong Reason

With double-digit rates of change in essential items like transportation (going back to work), food, goods and services, and energy, the impact on disposable incomes will come much quicker than expected. If we strip out “housing and healthcare,” which are fixed budget items (mortgage and insurance payments), we see that “household” inflation is pushing 5.86% annualized.

Such is particularly problematic when wages aren’t keeping up with inflation.

Inflation transitory 04-30-21, All Inflation Is Transitory. The Fed Will Be Late Again. 04-30-21

The Fed is probably right. Inflation will be transitory, but for all the wrong reasons.

Conclusion

There is a significant difference between a “recovery” and an “expansion.” One is durable and sustainable; the other is not.

Those expecting a significant surge in inflation will likely be disappointed for the one reason which seems to get mostly overlooked.

“If the economy was growing organically, which would create stronger rates of wage growth and inflation, then there would be no need for zero interest rates, continued monetary interventions by the Federal Reserve, or deficit spending from the Government.”

The obvious problem is that not all “spending” is equal. Pulling forward consumption through stimulus is indeed short-term inflationary but long-term deflationary. Since 1980, there has been a shift in the economy’s fiscal makeup from productive to non-productive investment. 

As we have pointed out previously, you can not overstate the impact of psychology on an economy’s shift to “deflation.” When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers change their primary orientation from expansion to conservation.

  • Creditors become more conservative and slow their lending.
  • Potential debtors become more conservative and borrow less or not at all.
  • Investors become more conservative, and they commit less money to debt investments.
  • Producers become more conservative and reduce expansion plans.
  • Consumers become more conservative, and save more, and spend less.

As we have been witnessing since the turn of the century, these behaviors reduce the velocity of money. Consequently, the decline in velocity puts downward pressure on prices. Given the massive increases in debt and deficits, the deflationary drag continues to increase as stimulus fades from the system.

Likely, the dollar and rates already figured this out.

#WhatYouMissed On RIA This Week: 06-11-21

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What You Missed On RIA This Week Ending 06-11-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



Video Of The Week

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

Video Of The Week For 06-11-21Mid-Year Market Outlook


Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 06-11-21

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

See you next week!

Two Pins Threatening Multiple Asset Bubbles- Part II

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Part One of this article showed how growing wealth inequality might pressure the Fed to taper QE and/or raise interest rates. Given the indirect market liquidity resulting from the Fed’s stimulus, a reduction is likely a headwind for many asset prices.

In this follow up we discuss another proverbial needle looking for asset bubbles; Financial Stability.

Financial “Stability” Blindness

Fed members are not as open about their desire for higher asset prices as general price inflation. Instead, they often cloak support for rising asset prices with the term financial stability. Based on many Fed statements, financial conditions are stable when equity prices are rising and unstable when falling.

The reality is financial stability, as it relates to markets, is based on valuations and liquidity, not the direction of prices. Markets are most stable when their prices fairly reflect fundamental conditions. As they stray from fair value, prices inherently become more unstable.

Today’s extremely high equity valuations and historically tight credit spreads are signs of bubbles. Unfortunately, most often, such periods are followed by market instability. Not only do price corrections roil investors, but they also hamper financial conditions across the economy.

The reason the Fed promotes higher asset prices is the so-called trickle-down effect. Effectively, they believe rising asset prices benefit economic activity and the welfare of the nation’s citizens. As we will discuss, such a policy is flawed. The Fed wants to boost economic growth with rising asset prices. But to do so today, they must ignore asset bubbles that are forming from excessive monetary policy. The cartoon below is a somewhat accurate portrayal of the flaws of trickle-down policies.

On May 5, 2021, Fed President Williams stated: “I don’t see those higher asset valuations, say, in the stock market or the housing market as being a significant risk for financial stability right now,”

It’s really hard to spot bubbles with any confidence before they burst.”- Neel Kashkari Minneapolis Fed

Who Benefits From Trickle Down “Financial Stability”?

In addition to eventual financial instability resulting from asset bubbles, the other problem is they do not benefit all citizens equally. As shown below, the share of equity holdings by the top 1% has grown significantly in the last 20 years. Moreover, the last 20 years mark extended periods of excessive monetary stimulus.  

The lowest income class has average expenditures of nearly $38,000 versus income after taxes of $25,000. This figure is skewed by a few wealthier people with low incomes and high savings. However, a large majority of households in this bucket must spend every dime they make. For the majority, this leaves them with near-zero to save and invest.

The highest income class only consumes 53% of their income on average. Accordingly, they are left with almost half of their income to save and invest.

QE and historically low-interest rates greatly benefit asset prices. As a result, the wealthier benefit much more from rising asset prices than the poor. The graph below, courtesy of Lohman Econometrics, shows the correlation between global central bank assets and global asset values.

As we stated in part one, politicians wanting to win over voters will likely have to deal with the wealth inequality problem. One possible way for them to scapegoat the issue is to question the Fed on their financial stability policy.

Defining Excessive Policy

Investors should never accept a rate of interest below the rate of inflation. Such a condition called negative real yields is often due to an overly aggressive central bank.

The yellow shading in the graph below highlights negative real yields have been the norm for the better part of the last 15+ years. The chart also shows the percentage of wealth owned by the top 10% (green dotted line) accelerated during the negative real yield era. Their gains came at the expense of the bottom 90% (blue dotted line).

Rising House Prices

The Fed is purchasing $40 billion in mortgages a month. As a result, mortgage rates and spreads are at or near historic lows. The benefit of lower mortgage rates is greater affordability for buyers. While that helps everyone, low rates also drive up home prices.  Per the Case-Shiller 20 City Composite Home Price Index, home prices are up nearly 17% since the Fed started buying mortgages in early 2020.

As an aside, higher prices often result in higher rent payments. As shown below, we are just starting to see rent prices pick up following the surge in home prices.

Who benefits more from rising home prices, the wealthy or the poor? Who tends to rent more, the wealthy or the poor? Fed policy directly supports the housing market, and its benefits are overwhelmingly bestowed upon the wealthy.

Jerome Powell acknowledged the surge in home prices in his latest press conference but quickly refuted the blame. Oddly, he had no intelligent answer for why the Fed is buying $40 billion worth of mortgages monthly and driving mortgage rates lower, ergo prices higher.   

Tapering MBS QE

The pressure on the Fed to decrease their support of the mortgage market is heating up. Even the Fed seems to recognize it.

Boston Fed President Rosengren said, “the mortgage market probably doesn’t need as much support now.” Similar to comments from Dallas Fed President Kaplan, it seems Rosengren is indirectly pushing for a tapering of MBS-QE.

There is little doubt, more pressure on the Fed will arise from the media and politicians if home prices continue to soar. We would not be surprised if the Fed begins to taper MBS purchases as early as the June 15-16, 2021 FOMC meeting.

A Ray of Honesty at the Fed

The potential sources of financial instability are soaring real estate valuations and broad asset market valuations. On May 6, 2021, Fed Governor Lael Brainard, the board’s financial stability committee head, spoke with brutal honesty about financial markets and financial stability. To wit:

“Vulnerabilities associated with elevated risk appetite are rising.” “The combination of stretched valuation with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event.”

In no uncertain words, Brainard cautions financial stability is at risk. Since her comments, there has been nary a whisper from Fed members on financial stability.

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

Summary- The View from the Fed

The Fed did not understand the escalating level of financial instability leading to the Great Depression, Dot-Com bust (2000), Financial Crisis (2008), and other more minor financial crises. Do you think they will this time?

Unlike those periods, rising wealth inequality resulting from surging asset prices is making front-page news. The media is picking up on inequality which will undoubtedly lead politicians to act. The Fed may likely be in their sightlines. As discussed in Part One, rising wealth inequality, driven by inflation and/or “financial stability,” are potential needles waiting to pop the Fed-driven asset bubbles.

We end with a quote from Stanley Druckenmiller- “I don’t think there’s been any greater engine of inequality than the Federal Reserve Bank of the United States the last 11 years.”

Technically Speaking: Warning Signs A Correction Is Ahead

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After a decent rally from the recent lows, there are multiple warning signs a correction approaches.

Over the last few weeks, we discussed the rising risk of a correction between 5-10%, most likely this summer. Such drawdowns are historically very common within any given year of an ongoing bull market. As Sentiment Trader recently noted, we are now in one of the more extended periods without such an occurrence.

Market Hits Highs 06-04-21, Market Hits All-Time Highs As Money Flows Peak 06-04-21

Of course, as is always the case, amid a bullish advance, it is easy to become complacent as prices rise.

Before we go any further, it is essential to clarify we are discussing only the potential for a short-term correction. As is often the case, some tend to extrapolate such to mean I am saying a “crash” is coming, and you should be all in cash. Such an extreme move is ill-advised without a significant weight of evidence.

However, there is reason to be cautious in the near term.

Suppressed Volatility

As I stated, during a “bullish advance,” investors become incredibly complacent. That “complacency” leads to excessive speculative risk-taking. We see clear evidence of that activity in various “risk-on” asset classes from Cryptocurrencies, to SPAC’s, to “Meme Stocks.”

A measure of speculative excess is the Volatility Index (VIX). The chart below is from my colleague Jim Colquitt of Armor ETF’s.

The top pane is the 15-day moving average of VIX, which is on an inverted scale. The bottom pane is the S&P 500 index.

“The market may have one last push higher over the next several weeks. Such will take the VIX even lower and complete the VIX wedge pattern. That pattern has been evident in the last three 10% or greater corrections. By this measure, the correction should begin somewhere around July 21st – August 10th.” – Jim Colquitt

As they say, “timing is everything.” While a July-August time frame is entirely possible, a June-July correction is just as likely. What is essential, as we will discuss momentarily, is understanding that risk is prevalent.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Market Exuberance Stretched Again

It isn’t just complacency that is suggestive of a short-term market correction. There are numerous others as well.

As my friend Daniel Lacalle recently posted, Morgan Stanley’s market timing indicator is at levels that have typically coincided with market downturns. Just for reference, the current reading is the most “bearish” on record.

Furthermore, a host of other indicators posted by @Not_Jim_Cramer also suggests there are reasons for concern about a correction.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Inflationary Warning

Lastly, this note from Tom Bowley caught my eye on Saturday.

“The S&P 500 reached a high on Friday of 4233.45, narrowly eclipsing the all-time high close of 4232.60 from May 7th. Unfortunately for the bulls, selling in the final few minutes ruined the breakout attempt. This false breakout, ever so slight, could be quite ominous for next week and there’s one MAJOR reason why. Inflation data.

That May 7th all-time high came just days before the shocking April CPI data was released on May 12th. Now here we are back at the high again. As the late Yogi Berra might say, “it’s deja vu all over again!” I don’t believe inflation to be a problem, but just the possibility of it could trigger scary headlines and encourage selling in the week ahead.”Tom Bowley, Stockcharts

The chart below shows the differential between the annual rates of change of the Producer Price Index (PPI) and the Consumer Price Index (CPI.) It should not be surprising that when PPI surges well ahead of CPI, equity markets tend to run into problems. Such is because this shows producers are unable to pass the inflation along to their customers. Consequently, this leads to reduced earnings and a repricing of risk assets.

Tom goes on to state inflation will not be a problem longer-term correctly. However, in the near term, the surge in inflation will weigh on outlooks, creating corrective actions.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

The Problem With Technicals

I want to reiterate a point from the most recent newsletter:

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

Therefore, we must treat each signal with the same respect and adjust risk accordingly. The opportunity costs of doing so are minimal.

If we reduce risk and the market continues to rise, we can increase risk exposures. Yes, we sacrifice some short-term performance. However, if we reduce risk and the market declines sharply, we not only protect capital during the decline but have the liquidity to deploy at lower price levels.

Such is the problem with “buy and hold” strategies. Yes, you will perform in line with the market, but given that you didn’t “sell high,” there is no cash available with which to “buy low” in the future.

With that stated, here is the most significant problem of technical analysis. All of the warnings noted above suggest there is a risk of a correction in the near term. However, technical analysis does not differentiate between a 5% pullback, a 10% correction, or a “bear market.”

You will only find that out once it begins, and such is why risk management is essential.

“Risk management is much like driving a car. If there is a blind spot ahead, and you don’t tap on the brakes to control your speed, you are unlikely to avoid the hazard ahead. Yes, tapping on the brakes to provide more control over the car will slow your arrival time to your destination. However, being late is a much better option than not getting there at all.” 

Just A Warning

Again, I am not implying, suggesting, or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given, that is the time when individuals should perform some essential portfolio risk management such as:

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

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

While I agree you can not “time the markets,” you can “manage risk” to improve your long-term outcomes. 

Viking Analytics: Weekly Gamma Band Update 6/07/2021

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

Gamma Band Update

The S&P 500 (SPX) again closed the week above the Gamma Flip level, and in our view is prepared to trade with declining volatility through the key mid-year option expiration on June 18th as long as the price remains above the gamma flip level.  If SPX value falls below the gamma flip and 20-day moving average, we would then expect to see increased volatility.

Our daily Gamma Band model[1] maintained a 100% allocation to SPX last week. When the daily price closes below “Gamma Flip” (currently near 4,185), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below the lower gamma level (currently near 3,960), the model will reduce the SPX allocation to zero.

Investors who keep an eye on various gamma-related levels are more aware of when market volatility is expected to increase.  One application of Gamma Bands is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report. With stocks continuing to extend historically high valuations, risk management tools are more important than ever to manage the next drawdown, whenever it comes.

A sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

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


Have Stocks Already Priced In The “Economic Boom?”

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The media is buzzing with claims of an “Economic Boom” in 2021. While the economy will most certainly grow in 2021, the question is how much is already “baked in?”

“The economy has entered a period of supercharged growth. Instead of fizzling, it could potentially remain stronger than it was during the pre-pandemic era into 2023.

Economists now expect the second quarter to grow at a pace of 10%, and they expect growth for 2021 to be north of 6.5%. In the past decade, there have been few quarters gross domestic product grew at even 3%.” – CNBC

The premise is that strong “pent up” demand will sustain the economic recovery over the next few years.

However, since market lows in 2020, the market surge has not only recouped all of those losses but has rocketed to all-time highs on expectations of surging earnings growth.

The question: How much has gotten priced in?

A Return To Normalcy

Just recently, Liz Ann Sonders wrote a piece for Advisor Perspectives. To wit:

“Vaccines and herd immunity continue to bring COVID cases down, and the economic reopening continues to kick into a higher gear. Such is what the data is starting to show. Across economic metrics, from the gross domestic product (GDP) to retail sales and job growth, boom conditions are evident.”

She is correct in her statement. However, there is a difference between an “economic boom” and a “recovery.” As shown in the chart of GDP growth below, the U.S. has already experienced a very sharp “economic recovery” from the recessionary lows. (I have included estimates for the rest of 2020, which shows a return to trend growth.)

The following chart shows the economic recovery against the massive dumps of liquidity pumped into the economy. (Estimates run through the end of 2021 using economist’s assumptions.)

Can’t Recoup Losses

Certain areas of the economy, like airlines, hotels, and cruise ships, have yet to recover to pre-pandemic levels. However, those industries only make up a relatively small amount of overall economic activity. Furthermore, these industries will continue to struggle for some time as individuals will not take “two vacations” this year since they missed last year. That activity is now forever lost.

Yes, the economy will recover most likely to pre-pandemic levels this year due to stimulus injections, but as discussed previously, what then?

“The biggest problem with more stimulus is the increase in the debt required to fund it. There is no historical precedent, anywhere globally, that shows increased debt levels lead to more robust economic growth rates or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.”

stimulus organic growth, #MacroView: Why Stimulus Doesn’t Lead To Organic Growth

Just as it is with investing, getting “back to even” is not the same thing as “organic growth.”

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

The Second Derivative

What is shown above is the “second derivative” effect of growth.

“In calculus, the second derivative, or the second-order derivative, of a function f is the derivative of the derivative of f.” – Wikipedia.

In English, the “second derivative” measures how the rate of change of a quantity is itself changing. Since we measure GDP growth on an annual rate of change basis, the larger the economy grows, the lower the rate of change will be. Here is a simplistic example go GDP growth:

In year 1, GDP = $1. In the second year, GDP grows to $2. The annual rate of change is 100%. However, in year 3, even though the economy grows to $3, the annual rate of change falls to just 50%.

Given the long-term historical correlation between economic growth, corporate earnings, and annualized returns, the reversion to trend growth has implications for investors. As Liz notes:

“Using three broad ranges for GDP growth historically, the lowest range (when the economy is barely growing or in recession) is accompanied by the highest annualized stock market performance. GDP is only slightly back into positive territory on an annualized basis. However, the strong growth expected in the second quarter will push GDP into the highest zone. At that level, stocks have historically posted a negative annualized return.”

The reason is that once economic growth reaches higher levels, stocks have climbed to levels incorporating those expectations. In other words, when things are as “good as they can get,” stocks begin to reprice for slower future growth rates.

That is the phase we are at currently.

How Much Pent Up Demand Is There Anyway

The main driver of the expected recovery from a “recessionary” low stems from the question of how much “pent up” demand currently exists?

If we look at durable goods as an example, such would suggest that much of the demand for long-lasting products got pulled forward by consumers over the last 12-months.

Of course, if we broaden that measure to retails sales which make up ~40% of the personal consumption expenditures (PCE) index, we see much the same.

Given PCE, which comprises nearly 70% of GDP, has already recovered much of pandemic-related decline, how much “pent up” demand remains.

However, wage growth outside of personal transfer payments (i.e., stimulus) hasn’t recovered. It is impossible to sustain higher rates of economic growth without wage growth.

Importantly, as we saw in January and February following the $900 billion stimulus bill passage, there was a short-lived surge of activity. However, once individuals spent the money, activity quickly faded. We saw the same with retail sales in April following the American Rescue Plan, which sent out $1400 checks.

After the $1400 checks get spent, what will be the driver for continued consumption at previous rates? Further, given the impact of a larger economy (as it recovers), the rate of change will decline markedly in the months to come.

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

Earnings Growth Inflection

“Earnings growth has a high correlation to stock market performance, but with time lags that are less well-understood. We are about halfway through the first quarter S&P 500 earnings season and so far, the results are exceptionally strong.” – Liz Ann Sonders

That is correct, and given the high correlation between earnings and market returns, we come back to the same question. Has the advance in the market accounted for the rebound in earnings? More importantly, what happens when that growth reverses?

“Relative to last year’s second-quarter plunge of nearly -31% year-over-year, expectations are that S&P 500 earnings will be up more than 46% in this year’s first quarter. The second quarter will boast a whopping 60% increase. Such should be the inflection point in terms of the year-over-year growth rate.” – Liz Ann Sonders

The problem is the S&P rose to levels that earnings growth will have difficulty supporting, particularly as the stimulus fades from the system. As with economic growth, the 2nd derivative of earnings growth is now a headwind for the markets.

Problem Pulling Forward Sales, The Problem Of Pulling Forward Sales & Revenue

Such is also the problem of “pulling forward sales.”

Conclusion

Notably, the outsized growth of the market reflects repetitive interventions into the financial markets by the Fed. Those interventions detached financial asset growth from their long-term correlation to GDP growth, where corporate revenue comes from. Historically, when the S&P 500 becomes separated from economic growth, a reversion occurred.

Problem Pulling Forward Sales, The Problem Of Pulling Forward Sales & Revenue

Currently, analysts are expecting earnings to surge well above economic growth rates. However, the flaw in the analysis is the assumption earnings growth will continue its current trend.

While there will be an economic recovery to pre-pandemic levels, a recovery is very different from an expansion.

As Liz concludes:

“Optimism is extremely elevated. Such is certainly justified by stock market behavior over the past year and recent economic releases. But some curbing of enthusiasm may be warranted given the history of the stock market as an uncanny ‘sniffer-outer’ of economic inflection points.”

As she goes on to point out, this is not a time for FOMO-driven investment decision-making. The reality is that the supports that drove the economic recovery will not support an ongoing economic expansion. One is self-sustaining organic growth from productive activity, and the other is not.

The risk of disappointment is high. And so are the costs of being “wilfully blind” to the dangers.

Market Hits All-Time Highs As Money Flows Peak

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In this 06-04-21 issue of “Market Hits All-Time Highs As Money Flows Peak.

  • Market Review And Update
  • Risk Of A Summer Sell-Off
  • The Lack Of Value In Value
  • Portfolio Positioning
  • #MacroView: Yellen’s Push To Offshore Labor
  • Sector & Market Analysis
  • 401k Plan Manager

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



Catch Up On What You Missed Last Week


Market Review & Update

Over the last few week’s we discussed the ongoing “buy signals” suggesting the market could retest all-time highs. That occurred this week. However, as stated last week:

The good news is that we did indeed get the rally we were expecting. The not-so-good news is that the rally already consumed a majority of the ‘buy signal.’ Such does not mean the market is about to correct; it does suggest that upside remains limited near term.”

As shown in the bottom panel, the RIA PRO “Money Flow” signal is now into overbought territory. While the markets could undoubtedly break out to new highs next week, the upside remains limited. Such is due to the weekly signal, which is very close to triggering. 

“Our more significant concern remains the weekly “sell signal.” Historically, these weekly signals typically denote periods of more significant volatility swings or corrections. The biggest correction risk comes when the daily and weekly signals align.”

I will lay out the case for a summer “sell-off” momentarily, but let me recap what these signals do and don’t mean.

Technical Analysis In A Mania

On Friday, I received an email asking an essential question:

“I  enjoyed your piece this week on Sell Signals Are Useless In A Mania. I am starting to believe the Fed has achieved a ‘Permanently High Plateau’ for asset prices because there seems to be nothing to derail the endless risk appetite for any asset. However, in the futile exercise of trying to stay disciplined I don’t want to abandon valuations and technicals.”

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

Therefore, we must treat each signal with the same respect and adjust risk accordingly. The opportunity costs of doing so are minimal.

If we reduce risk and the market continues to rise, we can quickly increase our exposures. Yes, we sacrifice some short-term performance. However, if we reduce risk and the market declines sharply, we not only protect our capital during the decline but have the cash to deploy at lower price levels.

Such is the biggest problem with “buy and hold” strategies. Yes, you will perform in line with the market, but given that you didn’t “sell high,” there is no cash available with which to “buy low” in the future.

While I agree you can not “time the markets,” you can “manage risk” to improve your long-term outcomes. 

Santa Claus Broad Wall, Technically Speaking: Will “Santa Claus” Visit “Broad & Wall”

Risk Of A Summer Selloff

Over the last three weeks, we have discussed that while we had added exposure to portfolios in anticipation of a short-term rally, we still expect a more significant correction this summer. There are several reasons for this.

The first is that a 5% correction is likely one or more times in any given year. Given the last correction was in the summer of 2020, such makes the current stretch of a low volatility advance one of the longer ones on record.

Fed Taper 05-21-21, Bulls Buy Stocks, As Fed Starts Talk Of Taper 05-21-21

Secondly, as noted by Variant Perception recently, the market has been tracking the post-correction/bear market rally analog. Such also suggests a pause given the strength of the rally from the previous lows.

Lastly, money flows into stocks may have peaked after a massive surge in inflows over the last 9-months. As shown by Bespoke:

All of these signposts suggest a risk of a correction in the near term. However, as stated above, technical analysis does not differentiate between a 5% pullback, a 10% correction, and a 20% decline.

You will only find that out once it begins.

Risk management is much like driving a car. If there is a blind spot ahead, and you don’t tap on the brakes to control your speed, you are unlikely to avoid the hazard ahead.

Yes, tapping on the brakes to provide more control over the car will slow your arrival time to your destination. However, being late is a much better option than not getting there at all. 

Risk Is Evident 

A recent note from Doug Kass summed up the current market environment well.

Stocks and bonds are richly priced. It makes no sense to say, as many do, that equities are inexpensive against an overpriced asset class (fixed income). Most traditional metrics indicate that stocks are at least in the 95th percentile – a non-trivial amount of indicators of valuation are in the 99th percentile.”

Even using always overly estimated forward earnings, valuations remain extremely rich, suggesting lower returns in the future.

Of course, such DOES NOT mean the market is about to crash, and you should hide in cash. However, the elevation in valuations, combined with the chase in “Meme” stocks like AMC, and cryptocurrencies are just the latest manifestations of risk-taking by investors.

A look at small-capitalization companies (which are the riskiest of stocks) and their deviation from long-term means also is representative of “speculation”  (The 200-week moving average has been consistent support for small-caps since 2008. The current deviation is unprecedented.)

Even with the expected surge in earnings, the Russell 2000 index is still trading at more the 28x earnings based on estimates 2-years into the future. Such means that expected returns over the next 24-months for small-cap stocks are now close to zero.

Then there is the problem with “value” stocks.

The Lack Of Value In Value

Over the years, “value” has been the cornerstone of investing. The reason is that during “bear markets,” the speculative excesses get wrung out, and investors search for “value” as a store of safety. The problem is that since there hasn’t been an actual “bear market” since 2008, there is relatively little value in “value stocks.”

“The popular and ‘cool guys,’ value stocks, are now extended. That (arguably) includes banks, industrials and ‘opening’ stocks.” – Doug Kass

An excellent example is the Momentum ETF (MTUM) that switched from growth stocks to value stocks. The same is occurring in other factor-based ETFs. For instance, the two top holdings of IWN, the iShares Russell 2000 Value ETF, are GameStop (GME) and AMC Entertainment (AMC) which are about as far from value as one can imagine.

The problem will be whether the “economic expansion” will allow earnings growth to justify current valuations. However, three massive rounds of stimulus “pulled forward” several years of sales, which will become problematic as economic growth slows.

As noted, there is little “value” in the “value trade. As discussed in “The Astonishing Lack Of Value:”

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

However, today, such is no longer the case. Items such as patents, licenses, human capital, etc., now make up a significant portion of a company’s “value.” These types of assets are hard to value and more difficult to liquidate.

So, how many NON-FINANCIAL companies in the S&P 500 currently have a price-to-book ratio below 1.5x? How about 18.

See the problem?

Portfolio Update

With our weekly “sell” signal now triggered on the S&P 500, and the daily signals back to very overbought levels, we liquidated the rest of our QQQ index trading position. The sell locked in the recent gains and raised our cash levels to buffer our overall portfolio allocations.

The rest of the portfolio remains balanced between the “inflation” and “deflation” trade to lower overall volatility. The “barbell” approach to the reopening trade has worked well given the rapid rotations between the two “schools” over the last few months.

We certainly don’t profess to have all the answers, but there is no argument we will see robust short-term growth and rising inflationary pressures. Such suggests the “value trade” may persist for a while longer. Those sectors remain energy, financials, industrials, and materials for now.

However, we also continue to add to “deflationary” holdings opportunistically as economic growth will return to its 2%ish long-term trend. Technology, Staples, and Healthcare remain increasingly recession-proof due to the changing workforce, demographic trends, and living standards.

We are firm believers in “value investing.”  However, after years of artificial interventions, accounting gimmicks, share buybacks, and massive balance sheet leveraging, there is little “real” value in the markets currently.

Given that the markets have not reset, speculators are now simply chasing whatever is moving higher. For now, we have to continue to navigate markets for what they are rather than what we “hope” they could be.

We suspect that this year could wind up disappointing both economists and investors alike.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 84.70 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 90.99 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

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


Weekly Stock Screens

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

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

S&P 500 Growth Screen

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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

With the daily “buy signal” getting back to an oversold condition, we took our remaining profits in the QQQ index trading position. Such raised our current cash levels to buffer portfolios against an expected decline this summer.

We still expect a mild correction of 5% or so during the summer, which will “feel worse” than it is. The goal will be to use that correction to rebalance equity risk for the remainder of the year.

The goal is to continue to manage risk accordingly. With the weekly “sell” signal triggered on the S&P 500 index, we will reduce risk further as needed to maintain the current outperformance over the benchmark index.

One of the biggest challenges ahead will be the shift back into longer-duration bonds as economic growth slows later this year. Likely, we will not get much of a signal before yields drop sharply. We monitor bonds closely as we hold an extremely short duration in our bond allocations. This short duration limits our ability to hedge risk currently.

However, at the moment, there are no “big red flags” that suggest we become significantly more active. But, should they appear, we assure you we will take action as needed.

Portfolio Changes

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

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

“We closed out the remainder of our QQQ position as our indicators are now aligning for the next sell signal. We should begin to see technology underperform relative to the broad index over the next couple of weeks.” – 06/03/21

Both Models

  • Sell 100% of remaining position in QQQ

“With our “money flow” buy signal now getting fairly elevated we trimmed off another 1% of our QQQ position this morning in both models. We will likely exit the entire position by the end of the week.

In the Equity model, we also reduce Ford (F) by 1.5% (down to 2% of the portfolio) to take profits after a strong price surge last week.” – 06/01/21

Equity Model

  • Reduce QQQ from 3% to 2% of the portfolio.
  • Reduce F to 2% of the portfolio.

ETF Model

  • Reduce QQQ from 3% to 2% of the portfolio.

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

Have a great week!

Technical Value Scorecard Report For The Week of 6-4-21

image_printPRINTER FRIENDLY VERSION

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

Commentary 6-4-21

  • As you will notice, we re-formatted the relative and absolute graphs to make them easier to read. First, the scores are now in a bar chart format and sorted from most overbought to most oversold. In general, a score above 80% warrants caution, as it usually leads to a relative or absolute consolidation or decline. Likewise, a score below -80% often signals a buying opportunity. Based on client feedback, we now provide last week’s score as well, to provide a gauge of the recent trend. The relative and absolute scores, taken in conjunction with other technical, fundamental, and economic assessments, provide a solid basis for investment decisions.
  • The Relative-Sector graphs show the real estate sector is very overbought, after beating the S&P 500 by over 3% last week and nearly 6% over the last four weeks. Real estate is now 1.98, 2.24, and 2.60 standard deviations above its 20, 50, and 200 dmas. Readings at or above 2% are hard to maintain and often result in a pullback or consolidation. If you are over-allocated to the sector or want to reduce exposure in general, you should consider taking some profits. Longer-term XLRE tends to outperform the S&P 500 when the Fed is not buying assets. XLRE’s recent performance may be providing an early warning that the tapering of QE is coming.
  • The next three most overbought sectors are those that benefit most from rising inflation expectations- energy, financials, and materials. Despite the inflationary push last week, staples went from slightly oversold to slightly overbought. This was likely a function of investors seeking safety in the down market. Utilities, another lower beta sector in which investors gravitate toward in down markets, also outperformed the market. However, its score remains somewhat deeply in oversold territory.
  • The third table below shows the performance of each sector over multiple time frames. XLK and XLY are sectors that have performed poorly versus the S&P, but may be showing signs of improving. Conversely, XLB and XLF, while outperforming are now more in line with the S&P 500. Energy is not showing signs of slowing down as the price of crude oil approaches $70/barrel. It is too early to tell, but the changes in some of the aforementioned sector over/under performances may be an early indication the relation trade may be slowing.
  • The scatter plot in the bottom right of the relative graphs shows a continued high statistical correlation between each sector’s scores and their excess returns versus the S&P 500. This provides confidence in the results.
  • The relative factor/index graph paints a similar picture as the relative sector graphs. The inflationary biased sectors like the equal-weighted S&P (RSP), value, and small-cap are the most overbought, albeit not at cautionary levels. The score on the inflation/deflation gauge (top right relative graph) based on 8 sectors/factors inched upward but is far from overbought.
  • On the absolute graphs, real estate is also the most overbought sector, followed by the inflationary sectors for the most part. The factor/index absolute graphs and the S&P (bottom right) show the market remains overbought but not to a concerning degree. Our proprietary daily and weekly money flow indicators are likely to trigger sell signals shortly so caution is warranted.
  • Despite the inflationary push last week, TIPs lost ground to nominal bonds (TLT) as shown in the upper right in the second set of graphs.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

#MacroView: Yellen & The Big Push To Offshore US Labor

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Janet Yellen’s latest commitment to support the Biden progressive agenda from higher taxes to unionization, will not lead to increased economic prosperity. Instead, it will lead to more outsourcing and offshoring of U.S. Labor. Such was evident in two recent comments.

“With corporate taxes at a historical low of one percent of GDP, we believe the corporate sector can contribute to this effort by bearing its fair share: we propose simply to return the corporate tax toward historical norms.”

And;

“Workers, particularly lower-wage earners, have seen wage growth stagnate over several decades, despite overall rising productivity and national income. There are several contributors to this troubling trend, but one important factor is an erosion in labor’s bargaining power.”

In theory, there is nothing wrong with either of these two statements. Why not have corporations pay more in tax and push companies to unionize.

In reality, however, if Janet Yellen and Joe Biden get their wish, it would lead to a sharp increase in the offshoring of manufacturing and employment.

Let’s dig into both of these issues.

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

Increase Corporate Tax Rates

Increasing corporate tax rates certainly seems like an easy task. However, the negative impacts of increasing taxes on the primary suppliers of employment will likely outweigh the revenue increase. 

Let’s start by understanding some of the most basic facts.

In the U.S. there are roughly 30.7 million businesses. Of those, 81% have ZERO employees. Such is important to understand because many of these “businesses” are set up for tax shelters and estate planning purposes.

The remaining 19% employee 100% of all non-governmental workers.

Importantly, when Yellen suggests we raise taxes on corporations, she is primarily talking about the roughly 10,000 major corporations in the U.S. However, 50% of all jobs are created by firms with fewer than 500 employees, and almost 90% by firms with less than 1000.

While Yellen is suggesting we go after those “evil corporations,” she is only talking about a fraction of the businesses that employ workers. However, the impact of higher taxes, unionization, etc., impact all businesses and hurts the small business owners that employ the most workers the most. 

Such was a point made by the Chamber of Commerce in response to Janet Yellen’s statement:

“The data and the evidence are clear: the proposed tax increases would greatly disadvantage U.S. businesses and harm American workers, and now is certainly not the time to erect new barriers to economic recovery.” – Suzanne Clark, CEO/President US Chamber of Commerce

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

Unionization Is A Barrier To Employment

As we discussed recently, the cost of operating a business is increasing. For small businesses which already struggle to remain profitable, increasing the cost of “labor” is problematic. The cost of a “union shop” costs nearly 1/3rd more to operate than a “non-union” shop.

Research indicates that the cost of running a unionized operation is 25% to 35% greater than for a non-unionized one, and this figure does not reflect any negotiated changes in unionized employee wages or benefits.

The administrative budgets of the unionized plants were 30% higher. In addition to obvious increased costs, there are those that affect morale, creativity, and resiliency. Ultimately, an organization’s profit margin can decline. Productivity appears to be lower in unionized environments.” – Adams, Nash, Haskell & Sheridan

Increased costs of labor are the primary reason why companies look to “offshore.”  To wit:

“The two main reasons that organizations decide to outsource are to reduce costs and to have the ability to focus on core business goals and planning. But the research shows a shift in industry thinking. Outsourcing is not just about saving money anymore. It’s seen as a critical tool in innovation.” – Deloitte

Of course, the companies that are outsourcing labor are the industries with the highest wage-paying jobs.

“The primary industries for outsourcing are Consumer & Industrial Products, Financial Services, Life Sciences & Healthcare, and Technology, Media & Telecomm. There has also been a growing increase in outsourcing from industries such as Real Estate, Facilities Management and Procurement.”

That leaves the lower-wage paying jobs in the U.S. which are being automated to further save costs.

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

The Carrier Reality

A great example of trying to “onshore” jobs came during the early days of the Trump administration.

Pay attention to the details.

The deal made with Carrier Industries, which makes heating, air conditioning, and refrigerator parts, meant roughly 1,000 workers would keep their jobs in Indiana. However, in exchange for keeping those jobs in Indiana, Carrier received $7 million in tax credits and other incentives which fell to the taxpayers of Indiana. Carrier also invested $16 million in its Indianapolis plant.

According to Carrier, they would have saved $65 million a year by moving operations to Mexico. 

So, how do tax credits and company investment of $16 million equalize the disparity of costs?

For that answer let’s go to an interview with Greg Hayes, the CEO of Carrier: (Transcript courtesy of Business Insider)

JIM CRAMER: What’s good about Mexico? What’s good about going there? And obviously what’s good about staying here?

GREG HAYES: So what’s good about Mexico? We have a very talented workforce in Mexico. Wages are obviously significantly lower. About 80% lower on average. But absenteeism runs about 1%. Turnover runs about 2%. Very, very dedicated workforce.

JIM CRAMER: Versus America? Much higher.

GREG HAYES: Much higher. And I think that’s just part of these — the jobs, again, are not jobs on an assembly line that people really find all that attractive over the long term. Now I’ve got some very long service employees who do a wonderful job for us. And we like the fact that they’re dedicated to UTC, but I would tell you the key here, Jim, is not to be trained for the job today. Our focus is how do you train people for the jobs of tomorrow?

Entitlement Is A Problem

While foreign countries have cheaper labor (not demanding $15/hr) they also have a more dedicated workforce. To wit:

GREG HAYES: The assembly lines in Indiana — I mean, great people, great people. But the skill set to do those jobs is very different than what it takes to assemble a jet engine.

There are several problems that should be readily evident with American workers:

  • We believe we are entitled to higher wages, benefits, time off, support, bonuses, health care, etc. 
  • Our skill set, and dedication to the job, lags that of other countries. 
  • We now believe “blue-collar” work is degrading. 

As we discussed in “The Adverse Consequences Of $15/min Wage:”

“Increasing the cost of employing low-wage workers generally leads employers to reduce the size of their workforce. The effects on employment cause changes in prices and different labor and capital types.

By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers.

Higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices. Those higher prices, in turn, lead consumers to purchase fewer goods and services. The employers consequently produce fewer goods and services, reducing their employment of low-wage and higher-wage workers.”

Here is the most important point:

When the cost of employing low-wage workers goes up, the relative cost of hiring higher-wage workers or investing in machines and technology goes down.”

While U.S. workers believe they are entitled to higher wages, employment is ultimately driven by competition, costs, and relative skills.

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

Yellen’s Prescription Won’t Work

So, as I asked earlier, how do you equalize the cost of saving $65 million annually by moving a plant to Mexico in exchange for $7 million in one-time tax credit and incentives?

That is where the $16 million investment came in.

In order to justify keeping the Indiana plant open, the company injected $16 million to drive down the cost of production and reduce the operating gap between the US and Mexico.

GREG HAYES: Right. Well, and again, if you think about what we talked about last week, we’re going to make a $16 million investment in that factory in Indianapolis to automate to drive the cost down so that we can continue to be competitive. Now is it as cheap as moving to Mexico with a lower cost of labor? No. But we will make that plant competitive just because we’ll make the capital investments there.

JIM CRAMER: Right.

GREG HAYES: But what that ultimately means is there will be fewer jobs.

While the idea of higher corporate taxes and unionization sounds great in theory, businesses operate from a position of profitability.

However, Yellen’s prescription of unionization and taxes won’t reduce the employment, wage, or wealth gap. Instead, those policies will only create incentives for businesses to fight back by passing on costs, reducing labor, increasing automation, and offshoring labor.

#WhatYouMissed On RIA This Week: 06-04-21

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What You Missed On RIA This Week Ending 06-04-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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Video Of The Week

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

Video Of The Week For 06-04-21Mid-Year Market Outlook


Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 06-04-21

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

See you next week!

Three Ways To Teach Your Kids To Invest Smart.

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Three ways to teach your kids to invest “smart” is something I take to heart because even though she’s 22 years old, I still assist my daughter in navigating the financial landscape.

When I was a boy, my paternal grandfather – a depression-era blue-collar sort  – repeatedly advised me to invest smart, not stupid. Fidelity Investments’ recent move to allow 13-17-year-olds to open accounts and trade stocks and ETFs helped me realize how they may be the ‘grandpa’ of today where kids are left confused and on their own to handle a critical moment.

I give credit to grandpa for the inspiration, but candidly, he never really explained himself. How do I see it? There were snippets of driveby words, and occasionally, wisdom spilled out with them. Strange how much I looked forward to these moments because at least he was paying attention to me! And the greater the flow of homemade wine, so the volume of the education. After downing grandpa’s brew, I get the volume thing.

(We have lots of Financial Guides here)

Invest smart, not stupid, was heavy in the lesson rotation.

It entertains me to recall grandma nodding positively in the background, although I don’t think she knew what gramps was talking about. Perhaps investing smart sounded good to her because she was what I consider a good investor. Grandpa, not so much. He maintained most of the family’s investment dollars in certificates of deposit.  His stock investing was relegated to penny stocks, all losers usually touted by friends and family as the ‘next big thing.’

Invest smart, not stupid, can be whatever you want it to be!

Over the years, I took his cryptic words to heart and formed my own definitions. Invest smart, not stupid became sort of a voice in my head, especially during times of distress and euphoria. When emotions are strong and fueled with money, the words take on a personal, greater resonance. 

Overall, it could be a positive for teens to maintain their own brokerage accounts. However, if left with little guidance about investing smart, not stupid, it’s almost like placing them on Main Street in a western town unarmed against the guys in black hats.

A wrong move, one negative experience, can make or break how your kids decide to invest over their lifetimes. That’s why I created the following three ways to teach your kids to invest smart, not stupid, through what I consider stupidly dangerous times.

#1: Are you the proper and responsible pilot?

Kids watch your relationship with money. You don’t think they observe what you do or hear what you say, good or bad, but they do. The foundation of their money scripts is laid by the people closest to them. My parents were horrific with money; we were fraught with financial insecurity. I learned what not to do by observing their debt and spending habits. I wouldn’t have sought them as pilots to assist ‘teen me’ with financial decisions.

In the current environment where exuberance and excessive risk-taking have infiltrated every asset class, the question to self-reflect on is – “Am I the cogent, unemotional voice to help my children invest wisely and for the long term?”

Leave It To Beaver comes to the rescue!

On an episode of Leave It To Beaver (I kid you not), ‘the Beav’ and his brother become interested in stock market investing. Dad suggests a profitable, staid dividend payer – Mayfield Power & Light. Smart-mouthed friend Eddie Haskell recommends the ‘zoomer’ Jett Electric, a penny stock. Well, the boys listen to dad and buy a couple of shares (through dad’s broker) of Mayfield for $25 bucks a share. The thing moves like a slug. Twenty-five cents up. Twenty-five cents down. Flat for days.

Meanwhile, Jett Electric takes off like a rocket which causes the boys to regret their decision leaving dad a bit dismayed how a company with no earnings can do so well. Ward Cleaver is also concerned about the impression his investment selection makes on the boys for the long term – especially when Eddie comes over and rubs it in –  “If you listened to me instead of your father, you’d be in the clover today.”

Ultimately, the brothers ask dad to sell Mayfield and move the proceeds to Jett. You can probably guess what happens next. Jett tanks. Mayfield continues on its merry boring way. Little did Beaver and Wally realize (and the audience until the end), dad had already dumped Jett and repurchased Mayfield. Naturally, the boys are relieved; father saves the day, and Beaver, with admiration in his voice, says – “You must be the smartest man on the planet, dad!” The end. Or is it?

Now, I don’t expect any parent to be a Cleaver. However, if you’re as carried away over Reddit bulletin boards, crypto, and short-term speculation as Eddie, how do you expect to be the proper co-pilot to help your kids navigate the current dangerously euphoric terrain?

Maintain an unemotional head, watchful eye, and explain the difference between gambling thoroughly and investing as best you can.  If this is complicated, set a time for your children to speak with a trusted financial partner. Let them help with the responsibility because flying the investment plane alone is not a good idea.

#2: Teach the kids that investing is always homework first.

Investment decisions, especially the timing, are mostly far from perfect. I mean, ask the Cleavers! An investor can undertake thorough fundamental and technical analysis and still lose. A financial leap of faith happens with every trade initiated. Nevertheless, homework helps place greater odds in an investor’s favor for the longer term. Kids get the concept of homework. Just observe the little ones as they wrestle with their assignments before bed.

You can’t expect kids to undertake investment homework as comprehensively as adults. And candidly, in a roaring bull market, luck and a tailwind can overwhelm the relevance of the exercise. However, as a forever-learning moment goes, it’s important to teach children basic due diligence. Today, with Eddie Haskells everywhere looking to cajole teens into taking their investing advice from Elon Musk tweets, it’s more important than ever that kids embrace homework. But where do you start?

Three basic concepts can go over well. First, gather a list of products the kids like.

Have a conversation about the products and services they enjoy. Which brands are important to them? Certainly, some companies may not trade on the stock exchange; others may not be worth the money. However, the conversation and documentation is an exercise in discovery and ultimately a start to homework.

Building passion around the investing process is important. Begin with a dialogue around brand loyalties (and start at an early age). When I was young, I drove my parents crazy: I always “needed” the latest Mattel’s Hot Wheels car or Hasbro’s G.I. Joe action figure. I would only eat Kellogg’s Frosted Flakes, not the store brand. I had to have the bacon with the Indian profile on the front (I can’t recall the brand).

Sidenote: I don’t suggest parents consider market index or exchange-traded funds. Frankly, kids learn nothing from indexing. The concept is too nebulous, too dispassionate. Teens can’t relate. The consideration of actual companies will enhance their attention. If they’re using the products or see you use them, there is ‘skin in the game’ to keep them engaged.

Second, start homework with the concept of sales.

I’ve found kids relate well to the concept. Whether you’re talking lemonade, girl-scout cookies, or school-related fund drives, children have an uncanny ability to understand that sales are positive and can lead to personal rewards. It’s the same for a business. Generally, the more goods or services sold, the more favorable it is to the stock price over time. It’s not difficult to find a company’s gross and net revenues and year-over-year changes (are they improving or decreasing?).

Third, watch your words!

l will never forget when my uncle, who was a specialist on the New York Stock Exchange floor, explained how I had the ability to own part of a large company. I was hooked. Wait: A poor kid from Brooklyn can own a piece of McDonald’s?

The language used around stock investing is important to help the kids gain a healthy perspective and a sense of pride in their selections and the investment experience overall. The phrase “buying a stock” is confusing compared to “ownership in a company,” which in essence is what you’re trying to help the children embrace.

The concept of “stock” is nebulous for the younger ones to comprehend, so it’s best to keep the language simple. Using words to connect ownership to investing creates a long-term investor mindset. You don’t want the children to focus solely on stock price movement; they should strive to build discipline by focusing on the long-term value of a business – and all because you provided the perspective.

#3. Guide them overall to own quality investments. 

If they’re asking questions about speculative, ethereal fantasy coins, don’t discount the curiosity. There’s also nothing wrong with exposing them as long as the difference between speculating and investing is clearly understood. Create a rule that works for your family. Ask your teen how much he or she is willing to lose. If it isn’t ‘everything,’ then so-called meme stocks and crypto may not fit.

I spoke with a willing mom who needed to brake on how much her 15-year-old daughter wanted to invest in Ethereum. Daughter wanted all her savings in crypto – $500; mom helped her settle on half, which was a good decision as they purchased at $4,100 back in mid-May. As of this writing, Ethereum is $2,628.38.

The other $250 was invested in Hasbro (HAS), the toy and game company, at the same time. Short term, the stock investment is working, and crypto being speculative, has greater gyrations than expected. The difference is mom prepared her daughter for the risk, and instead of being turned off to investing, her teen is not dismayed by the loss and is keeping it in perspective. 

When we teach our kids, we get better too!

Interestingly, many parents find it awkward to discuss stock investing with their children. Some adults don’t feel confident in their abilities to do research. What I’ve discovered is the lessons with kids actually help less confident parents improve their own game and become better stock investors.

Through this period where young people are willing more than ever to invest, it’s important for parents to exhibit their best ‘Ward Cleaver’ and guide them properly so when the next downturn occurs (and it always does), the event doesn’t turn off a new generation to stocks and perhaps even more speculative ventures.

Two Pins Threatening Multiple Asset Bubbles

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Inequality and Financial Stability: Two Pins Threatening Multiple Asset Bubbles

“Powell Says Fed Policies “Absolutely” Don’t Add To Inequality” -Bloomberg May 2020

The headline above is but one of countless times Fed Chairman Powell and his colleagues confidently said their policies do not result in wealth or income inequality. Their political stature and use of complex economic lingo give weight to their opinions in the media. Nevertheless, a deep examination of the Fed’s practices and their consequences leaves us to think otherwise.

In our opinion, the Fed’s contribution to wealth inequality is significant and grossly misunderstood. We have written articles explaining why QE and low interest rates generally benefit the wealthy and harm the poor. This article backs up those prior arguments with quantitative muscle.

Timely for investors, we also draw some lines between wealth inequality and financial stability and their relationship to monetary policy. We think it is becoming increasingly possible wealth inequality, and in particular, the outsized effect inflation has on the poor, could be the needle to pop many asset bubbles. The other possible needle is the Fed’s wanting for financial stability.

**Due to the importance of monetary policy from economic, societal, and market perspectives we are breaking this article into two. We will share part two next week.

Background

More inflation and financial stability (rising asset prices) are two of the three core tenets backing monetary policy. A strong labor market is the third objective. We focus on inflation in this article and financial stability in part II.

In our article Two Percent for the One Percent, we explain why inflation is detrimental to the poor, while rising asset prices (financial stability) primarily benefit the wealthy. The following paragraphs from the article explain:

“With that in mind consider inflation from the standpoint of those living paycheck to paycheck. These citizens are often paid on a bi-weekly basis and spend all of their income throughout the following two weeks. In an inflationary state, one’s purchasing power or the amount of goods and services that can be purchased per dollar declines as time progresses. Said differently, the value of work already completed declines over time.  While the erosion of purchasing power is imperceptible in a low inflation environment, it is real and reduces what little wealth this class of workers earned. Endured over years, it has adverse effects on household wealth.”

“Now let’s focus on the wealthy. A large portion of their earnings are saved and invested, not predominately used to pay rent or put food on the table. While the value of their wealth is also subject to inflation, they offset the negative effects of inflation and increase real wealth by investing in ways that take advantage of rising inflation. Further, the Fed’s historically low-interest-rate policy, which supports 2% inflation, allows the more efficient use of financial leverage to increase wealth.”

The Fed Craves More Inflation

  • If we generated some modest inflation, I think we would consider that a success,” –Neel Kashkari 12/2020
  • If we got 3 percent inflation that would not be so bad.” Charles Evans 1/2021
  • “By committing to achieve inflation outcomes that average 2 percent over time, the Committee would make clear in advance that it would accommodate rather than offset modest upward pressures to inflation in what could be described as a process of opportunistic reflation. This approach will help move inflation expectations back to our 2 percent objective, which is critical to preserve conventional policy space.” – Lael Brainard 2/2020

In no uncertain terms, Fed members make it clear, they want more price inflation. Unfortunately, inflation is not best for everyone. Inflation affects different income classes vastly differently. The disparity is most accentuated with necessities, such as food and housing prices.

Food and Housing Inflation

Spending on food and shelter comprise over 75% of the after-tax income of the lowest income classes but only about 25% for the highest income classes. The graphs below, courtesy of Brett Freeze, compare food and shelter spending across multiple income classes. In each illustration, the bar chart on the left shows the total food or shelter expense as a percent of after-tax income.  The charts to their right are the sub-components expenditures that comprise the total.

Over the last year, the BLS reported food and beverage prices rose at an average annual rate of 8.84%. For a family in the $15,000 – $29,999 income class, total spending would have to rise by 2.07% on average to consume the same amount of goods and services as a year ago. The increase only accounts for higher food prices. For the highest income class, their change was only .67%.

Housing prices, over the same period, rose on average by 7.07%. For a family in the lowest income class, this one expense pushes their total expenses up by 3.98%. The families in the highest income class will pay 1.42% more.

Only accounting for food and housing, two necessities, the lowest income classes saw their annual expenses rise by 6.05%. The highest income classes saw their expenses rise by 2.10%.

Who Can Afford Inflation?

The graph below, courtesy of Congressional Research Service – The U.S. Income Distribution: Trends and Issues, quantifies changes in income by income class. The data allows us to assess if wage inflation can offset price inflation.

As shown, the lowest income group saw incomes rise by 11% over the period spanning 2009-2019. That equates to approximately 1% a year. The highest income group saw their income rise by about 3% a year over the same period.

The current annual increases in food and housing costs will require an additional 6.05% of income for the lowest wage earners to keep their financial position indifferent. Any amount less than that and they fall behind. Keep in mind that does not cover inflation for any other expenditures.

Stimulus checks may fill the immediate gap, but in the long-run inflation makes their financial difficulties worse.

The highest income earners will need to earn 2.10% more in income to cover recent price increases. Fortunately for them, that is below the recent rate of annual income increases.

The data above is further affirmed by the latest BLS employment data released May 7, 2021.  Per the BLS, wages rose 0.3% over the last year versus a 4.2% increase in CPI.

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

Why Investors Should Care

If the prices of food, shelter, and other necessities continue to surge higher without equivalent wage growth, wealth inequality will worsen. This problem represents a coming dilemma for the Fed.

When the media and politicians take notice, they will pressure the Fed on their inflation stance. If the Fed is persuaded or even forced to act, bubbles driven by the latest round of excessive liquidity, are likely to deflate.

Growing wealth inequality may be a needle in search of a bubble.

Part two, coming next week, discusses the other needle looking for a bubble, financial stability.

Technically Speaking: Are “Sell Signals” Useless In “Mania” Markets?

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A recent Bloomberg article made the case that since 2009 “sell signals” are useless during “mania” markets. To wit:

“If you bailed because of Bollinger Bands, ran away from relative strength or took direction from the directional market indicator in 2021, you paid for it.

It’s testament to the straight-up trajectory of stocks that virtually all signals that told investors to do anything but buy have done them a disservice this year. In fact, when applied to the S&P 500, 15 of 22 chart-based indicators tracked by Bloomberg have actually lost money, back-testing data show. And all are doing worse than a simple buy-and-hold strategy, which is up 11%.” – Bloomberg

Note: “Bloomberg’s back-testing model purchases the S&P 500 when an indicator signals a ‘buy’ and holds it until the system generates a ‘sell.’ The index gets sold, and a short position established, until a buy is triggered.”

See, you should “buy and hold” invest, right?

Investing Based On Hindsight

Bloomberg goes on the clarify essential points.

“Of course, few investors employ technical studies in isolation, and even when they do, they rarely rely on a single charting technique to inform decisions. But if anything, the exercise is a reminder of the futility of calling a market top in a year when the journey has basically been a one-way trip.” – Bloomberg

In the short term, which can even include a 12-year bull market cycle, there are periods where “buy and hold” investing outperforms any other form of asset management. The problem is that you only know for sure that “buy and hold” was the proper strategy in hindsight.

Most only have a limited amount of time to invest for retirement for investors, so “getting it right” largely depends on two factors.

  1. When you start your investing process; and
  2. Avoiding major drawdowns

With the vast amount of individuals already vastly under-saved, the current “bear market” cycle will reveal the full extent of the “retirement crisis” silently lurking in the shadows. The Fed, Government bailouts, and low interest rates can’t fix this problem.

Such isn’t just about the “baby boomers,” either. Millennials are haunted by the same problems as their prospects of “economic prosperity” get set back years.

But here is the real problem for “baby boomers.”

Crashes Matter

Financial advisors regularly tell clients that the market grew 6% annually since 1900. Therefore, that is what returns will be in the future. The chart below shows $100,000 invested at 6% annually from 2000 or 2007.

Unfortunately, it didn’t work out that way. 

During the past 20-years, the annual return for stocks has been just 4.96% annualized. Since the peak of 2007, returns have annualized roughly 8.14%. Over the next decade, current valuations suggest average returns will return to 2% or less.

For boomers who start in 2000, whose financial plans assume high return rates to offset a savings shortfall, they are now well short of their retirement goals. For those who started in 2007 they finally got back on track this year. The question is can they keep it?

Unfortunately, investment returns are far worse, as a vast majority of fully-invested individuals in 2007 liquidated out of the market by the end of 2008. It took years before they returned to the market. As such, actual returns are vastly different than what the index suggests.

Here is the sequence of events by age:

  1. 30’s: In 1980, the “baby boomer” generation is working, saving, and investing during the ’80-’90s bull market.
  2. 50’s: From 2000 to 2002, the “Dot.Com” crash cuts investments by 50%.
  3. 53-57: From 2003-2007, the market grows savings back to breakeven.
  4. 57-58:  The 2008 “Financial Crisis” wipes out 100% of the gains of the previous bull market and resets savings values back to 1995 levels.
  5. 58-63: From 2009-2013, financial markets rose, growing savings back to the turn of the century.
  6. 63-71: In 2021, investors finally made some progress towards their retirement goals.

Today, for most individuals heading into retirement, the importance of “mean-reverting events” should not be dismissed.

A Simple Backtest

To successfully invest for the long-term requires the avoidance of the destruction caused by crashes. Such is where even the most basic forms of technical analysis can supplement a good portfolio allocation strategy.

Using Portfolio Visualizer, I show a simplistic backtest of a switching model from stocks (SPY) to bonds (TLT.) 

“Tactical asset allocation model results from Aug 2002 to Apr 2021 for SPDR S&P 500 ETF Trust (SPY) is a function of a 10 calendar month simple moving average and 15 calendar month simple moving average crossover. The tactical asset allocation model is invested in the S&P 500 index when the short moving average is greater than or equal to the long moving average. Otherwise, the portfolio is invested in iShares 20+ Year Treasury Bond ETF (TLT).” 

I used this time frame to capture:

  • The post “Dot.com” crash bull market,
  • The “Financial Crisis” bear market, 
  • And the 12-year Central Bank infused “one-way” bull market.

Portfolio Visualizer illustrates the annual returns and volatility:

Just An Example

Importantly, this is just an example of how technical analysis can improve returns over a “buy and hold” strategy during full-market cycles. During a bull cycle, “buy and hold” will outperform. However, as stated, you won’t know when that has changed until it is too late.

For example, an individual runs 100 stop signs without consequence and saves an hour driving to work. It is easy to assume that such activity is “risk-free” because no negative outcome has occurred. On the 101st event, the driver is hit and killed. Was applying the brakes and paying attention to the risk worth avoiding the eventual outcome?

The same applies to the markets. Just because there has been no consequence to investors taking on excess risk over the last 12-years doesn’t mean there won’t be.

Risks Are Mounting

“The temptation to book profits and bail is getting hard to resist after the S&P 500’s best 12-month rally since the 1930s. Increasing the anxiety are a mountain of charts signaling a market that’s stretched to its limits.” – Bloomberg

Bloomberg is correct. Numerous measures are suggesting “risk” far outpaces “reward” currently. But technically, the market remains in a bullish trend for now. How do you navigate such a market safely?

It is essential to understand that no one ever said you must be 100% allocated to equity risk at all times. The chart below shows three allocation models since 1999: 100% Stocks, 60% Stocks and 40% Bonds, and 100% Bonds.

Most would assume that the blue line is 100% stocks.

You would be wrong.

Since 1999, an all bond portfolio (blue line) and a 60/40 blended allocation (orange line) outperformed investors who were 100% long stocks. The reason is the reduction of capital destruction during mean-reverting events.

It is true that over the last 12-years, a 100% stock portfolio grossly outperformed other models. However, given the more extreme valuations, deviations, and speculative activity in the market today, it is unlikely the current streak will go uninterrupted into the future.

Investing Isn’t A Competition.

The markets are indeed currently exceedingly exuberant on many fronts. With margin debt at records, stock prices near all-time highs, and “junk bond yields” near record lows, the bullish media continues to suggest there is no reason for concern.

Of course, such should not be a surprise. At market peaks – “everyone’s in the pool.”

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

Such brings up some essential investment guidelines as we head into the last half of the year.

  • Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.
  • Emotions have no place in investing.You are generally better off doing the opposite of what you “feel.” 
  • The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.
  • Market valuations (except at extremes) are very poor market timing devices.
  • Fundamentals and Economics drive long-term investment decisions – “Greed and Fear” drive short-term trading. 
  • “Market timing” is impossible– managing exposure to risk is both logical and possible.
  • Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.
  • There is no value in daily media commentary– turn off the television and save the mental capital.
  • Investing is no different than gambling– both are “guesses” about future outcomes based on probabilities.
  • No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

The one lesson you should have learned in 2020?

“The unexpected outcome occurs more often than you expect.”

Viking Analytics: Weekly Gamma Band Update 6/01/2021

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

Gamma Band Update

The S&P 500 (SPX) moved above the Gamma Flip level on Monday of last week, spent the rest of the week trading in a fairly narrow range, and closed the week just above 4,200. We agree with many others that options and VIX order flow have become one of the primary “fundamentals” of the market, and as long as the SPX remains above its Gamma Flip levels, we will expect declining volatility and a continuing grind higher.

Our daily Gamma Band model[1] moved to a 100% allocation to SPX on Monday and remained at that level throughout the week.  When the daily price closes below “Gamma Flip” (currently near 4,180), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below the lower gamma level (currently near 3,950), the model will reduce the SPX allocation to zero.

Investors who keep an eye on various gamma-related levels are more aware of when market volatility is expected to increase.  One application of Gamma Bands is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report. With stocks continuing to extend historically high valuations, risk management tools are more important than ever to manage the next drawdown, whenever it comes.

A sample of the SPX report can be downloaded from this link.  Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

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


Cartography Corner – June 2021

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

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

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

GTA Users Guide


May 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESM1) during May 2021. In our May 2021 edition of The Cartography Corner, we wrote the following:  

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

o Q4                 4742.50

o M4                4701.50

o M1                4438.25

o M3                4381.50

o Q1                 4214.50

o PMH             4211.00            

o M2               4208.50

o Q3                 4186.25     

o Close             4174.50

o PML               3964.50    

o M5                 3945.25      

o MTrend        3938.53

Active traders can use Q1: 4214.50 as the pivot, maintaining a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for May 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first two trading sessions began with the market price ascending to just below Clustered Resistance at M2: 4208.50 / PMH: 4211.00 / Q1: 4214.50 and being rejected.  The reversal from the high price of May 3rd to the low price of May 4th totaled 82 points.  However, by the session’s close, the market price had recovered significantly.  The following three sessions saw the market price ascend to, and settle above, our isolated pivot at Q1: 4214.50.  Early in the session on May 10th, the market price put in a six-point higher high at 4238.25.  It never saw that price again.  Over the remainder of that trading session and the following two, the market price declined a total of -166.50 points, or (3.94%), on a closing basis.     

The realized price action for the remainder of May consisted of more of the same, three swings (up, down, up) followed by a consolidation.  The month ended with the market price, again, testing our isolated pivot level at Q1: 4214.50.

Up Swings:

  1. May 13 – May 14, +149.00 points, low-to-high
  2. May 19 – May 24, +150.75 points, low-to-high

Down Swing:

  1. May 17 – May 19, -123.25 points, high-to-low

Consolidation:

  1. May 25 – May 28, +17.00 points, close-to-close

Much like running on a treadmill, the market expended a lot of energy in the swings and essentially went nowhere, settling 28.00 points higher than April.

Figure 1:

Soybean Futures

We continue with a review of Soybean Futures (ZSN1) during May 2021.  In our May 2021 edition of The Cartography Corner, we wrote the following:  

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

o Q4                 19.0700

o M4                17.9228

o M1                16.8920

o M3                16.3900

o Q1                 15.9940

o Q2                 15.8300

o PMH             15.7460            

o Q3                 15.4780

o Close             15.3420    

o MTrend        14.3512

o M2                13.9228     

o PML              13.7460       

o M5                12.8920

Active traders can use Q1: 15.9940 as the pivot, maintaining a long position above that level and a flat or short position below it.  

Figure 2 below displays the daily price action for May 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  Within the overall context of essentially unchanged prices, the realized price action in May consisted of two swings.  The two-period low we were anticipating, highlighted in May’s edition, was realized the week of May 17th.

Up Swing:

  1. May 3 – May 12, +10.0%, low-to-high

Down Swing:

  1. May 12 – May 26, (10.7%), high-to-low

Again, much like running on a treadmill, the market expended a lot of energy in the swings and essentially went nowhere, settling (0.24%) lower than April.

Figure 2:

June 2021 Analysis

We begin by providing monthly time-period analysis of E-Mini S&P 500 Futures (ESM1).  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Current Settle         4202.50        

o Daily Trend             4198.39

o Weekly Trend         4154.58        

o Monthly Trend        4054.64        

o Quarterly Trend      3591.98

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for four quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Trend Up”, settling seven months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”.

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  The signal was given the week of May 10th to anticipate a two-week high within the next four to six weeks (now, two to four weeks).  That high can be achieved this week with a trade above 4217.50. 

Support/Resistance:

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

o M4                4512.00

o M1                4265.50

o PMH             4238.25

o M3                4230.50

o Close            4202.50           

o M2                4094.00

o MTrend        4054.64     

o PML              4029.25       

o M5                3847.50

Active traders can use M1: 4265.50 as the pivot, maintaining a long position above that level and a flat or short position below it.

Canadian Dollar Futures

For June, we focus on Canadian Dollar Futures (“the Loonie”).  We provide a monthly time-period analysis of 6CM1.  The same analysis can be completed for any time-period or in aggregate.

 

Trends:  

o Current Settle       0.8274           

o Daily Trend           0.8271

o Weekly Trend       0.8269           

o Monthly Trend      0.8088           

o Quarterly Trend    0.7726

The relative positioning of the Trend Levels is bullish yet shows early indications of a possible phase transition.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  As can be seen in the quarterly chart below, the Loonie is “Trend Up”, having settled above Quarterly Trend for three quarters.  Stepping down one time-period, the monthly chart shows that the Loonie is “Trend Up”, having settled above Monthly Trend for seven months.  Stepping down to the weekly time-period, the chart shows that the Loonie is “Trend Up”, settling above Weekly Trend for eight weeks.

The early indications of a possible phase transition that we referred to are related to two aspects.  First, Weekly Trend has risen to be at-the-market.  It will only take a (0.0006) decline for the bears to be “in control” in the weekly time-period.  Secondly, the slope of the Weekly Trend has started to flatten out.  From the week of April 19th, the distance (measured in points from the previous week) between observations of Weekly Trend progressed as follows: 0.0045, 0.0073, 0.0089, 0.0060, and 0.0027.  It peaked two weeks ago.  The blue dots on the weekly graph are starting to crest.

Figure 3 below, shows the relative positioning of Speculative Money and Patient Money.  As a review, we noted the following in May.

We model the positioning of these participants within the context of price and volatility, measured as Z-Score.  This allows us to not have to depend upon Commitment of Traders reports which reflect a time delay.  The correlations noted in the graph are between our model positioning and the complete set of actual historical COT reports.

Speculative Money participants’ decision-making framework centers on momentum, trend, and price.  They typically employ leverage and focus on short time-periods.  Patient Money participants’ decision-making framework centers on value, mean-reversion, and fundamental reality.  They typically do not employ leverage and play the long game.

Concerning commodity trading, our experience suggests that you want to trade with the Speculative Money except for at extreme positioning.  At the extreme, the speculative narrative is likely fully reflected in the price (and we should anticipate mean-reversion).

Figure 3:

 

Figure 4 below, shows the Structural Momentum of the Loonie, using monthly inputs.  Structural Momentum measures the absolute dispersion of returns, in units of Z-Score.  The red and green diamonds are scripted to appear when a certain Confidence Interval is reached.  They do not appear often and isolate significant turning points in price well.  Caution is warranted.

Figure 4:

One rule we have is to anticipate a two-period low (high), within the following four to six periods, after an Upside (Downside) Exhaustion level has been reached.  The signal was given the week of April 26th to anticipate a two-week low within the next four to six weeks (now, one to three weeks).  That low can be achieved this week with a trade below 0.8234. 

30% of Canada’s top exports are commodity-based, including: mineral fuels and oil (17.7%), gems & precious metals (5.9%), wood (3.4%), and ores/slag/ash (2.5%).  The rise in the Loonie reflects the rise in commodity prices and inflation.  A reversal of its price trend could have broader implications.

Support/Resistance:

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

o M4                0.8746

o M1                0.8496

o M3                0.8404

o PMH             0.8325

o M2                0.8288              

o Close             0.8274      

o PML               0.8096

o MTrend        0.8088       

o M5                0.8038

Active traders can use PMH: 0.8325 as the pivot, maintaining a long position above that level and a flat or short position below it.

Summary

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

S&P 500 Monthly Valuation & Analysis Review – 05-31-21

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S&P 500 Monthly Valuation & Analysis Review: 05-31-21

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


J. Brett Freeze, CFA, founder of Global Technical Analysis. Each month Brett will provide you their valuable S&P 500 Valuation Chart Book. This unique analysis provides an invaluable long-term perspective of equity valuations. If you are interested in learning more about their services, please connect with them.

David Robertson: The Great Inflation Debate

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The great inflation debate has arrived. After several false starts over the years, inflation is now officially a hot topic of discussion. Along with it are views and analyses that run the gamut of different perspectives. While many individual ideas provide helpful information content, they often favor one potential outcome over another.

Doing so, however, diverts attention away from the reality there is absolutely nothing deterministic about inflation. Such is a reasonably helpful revelation since it implies investors will have a very different landscape to navigate.

Inflation Rage

The graph for the search term “inflation” on Google Trends paints a thousand words. It remained anchored in a well-defined band for most of the last five years. Inflation started piquing interest early this year and shot up in the previous few weeks.

There have certainly been several contributing factors. Excessively loose monetary policy seeded concerns. A slew of anecdotal reports of price increases and a hot CPI number on May 12 helped confirm them. Another critical factor, described by Bloomberg’s John Authers, is the symbiotic relationship between media content and audience interest. In other words, journalists write about subjects for which their audience has appeal, and that creates a self-reinforcing loop:

​”Inflation is the topic of the moment. Some cynics can argue that it’s only such a big deal because I and other journalists have made it so. But judging by the number of Bloomberg clients who fired in questions for the live blog Q&A session we held on the terminal Tuesday, there is quite a lot of interest out there in the financial markets. And it is the interest in inflation from investors and other consumers of financial journalism that prompts people like me to write more about it; we have the perfect example of reflexivity, in which perceptions can change reality.”

The heightened level of interest in inflation has spawned quite a few debates about inflation. I outlined some of these in a previous blog post. William White provided excellent context at John Mauldin’s Strategic Investment Conference (SIC).

Debates

Even before the pandemic hit, he described, the economy had “morbidities,” The most important of which was the excessive accumulation of debt relative to economic output. Since “those morbidities are still there,” White expects debt pressures to win out and induce deflation in the medium term. However, after that is the problem.

​”Longer term, if the stagnation continues, I suspect what will happen is the governments will throw everything they can at it. Which is, they will double down on both fiscal and monetary. And this is where the problem arises. And we’ve seen this many times in history and we’ve got good theory to try to explain it, what happened is that in that kind of an environment where you’ve got big government deficit and a very large government debt and growing recourse to the central bank, as the only group of people still left that will lend money to this government. At a certain point, the fear of fiscal dominance creeps in, and the minute the fear of fiscal dominance comes in, the central bank will do anything to keep this government afloat.” – White

​While the endgame is inflation for White, he acknowledges the path there is not a foregone conclusion.

“To be honest, it is not impossible in a complex adaptive world for people to go directly from the short-term to the long-term.”

In other words, instead of governments waiting for continued stagnation to “throw everything they can at it,” they may not wait. Instead, they may try to pre-empt any softness by throwing everything at it before stagnation can manifest. In such a case, conditions would go straight to inflationary by skipping the deflationary medium-term step.

Policy

Such is a point very much corroborated by Karen Harris of Bain & Company at the SIC. As she and her team assessed “the biggest, most lasting scars of COVID-19.”

“The most striking is the step-change in what is considered acceptable intervention in an emergency and the lower bar for what constitutes an emergency.”

In other words, the threshold for “throwing everything they can” just got lower while the “everything” grew more prominent.

An interesting element of White’s analysis is that he does not mention CPI, money supply, or any economic equation. Indeed, this dovetails with Martin Wolf’s recent thinking in the FT:

​”Milton Friedman said that ‘inflation is always and everywhere a monetary phenomenon. This is wrong: inflation is always and everywhere a political phenomenon. The question is whether societies want low inflation. It is reasonable to doubt this today. It is also reasonable to doubt whether the disinflationary forces of the past three decades are now at work so strongly.”

​These are strong words by Wolf. He has long advocated the roles of economic and monetary policy to solve problems. He has also supported most of the monetary interventions since the financial crisis. Now he is essentially saying, “The control of inflation is out of our (policymakers’) hands,”

The current political desires seem to create a more robust tailwind for inflationary forces.

Politics

With inflation being primarily a political phenomenon, then, it makes sense to scrutinize politics more carefully. Jonah Goldberg provided helpful insight into such matters with a recent piece about the Republicans’ removal of Liz Cheney from leadership:

​”But the idea that this [Cheney’s removal from leadership] was just a tempest inside the beltway tea pot strikes me as profoundly wrong. History is a bit like one of those choose-your-own-adventure books. Small decisions that seem trivial move events, people, and institutions along paths that lead to more choices while simultaneously foreclosing other choices. If you’ve ever read a book about the lead up to World War I, you know this.”

​”Think of it [Cheney’s removal] like dynamic scoring. This decision will have multiplier effects. The closet normals will become Trumpier, and some of them will follow the path of Graham and stop being normals at all. This event will make it harder to reject the next crazy thing Trump wants or says. Elise Stefanik will fulfill her mandate to signal that the GOP is Trump’s party, full stop.”

​Goldberg makes two critical points here. One is the “decision will have multiplier effects,” not least of which is to swing the party further in the direction of pursuing culture wars rather than promoting conservative ideology. Another point is that such a swing will “foreclose other choices,” which most likely includes constructive bipartisan dialogue regarding fiscal policy.

Political Tension

The Financial Times corroborated a view of increasing political tension on infrastructure talks in Congress. In vowing to obstruct efforts by Democrats to raise taxes to pay for infrastructure, Mitch McConnell declared:

​“This [tax increases] will slow the economy down to a crawl, and I think our chances of stopping it . . . are pretty good,” he told Fox News. “They may be able to pull it off, but I think it is going to be really hard, and we are going to fight them the whole way.”

While decrypting political rhetoric always requires a large margin of error, words like “obstruct” and “fight” do not sound like opening salvos for constructive political collaboration. As such, with monetary ammunition running out and fiscal spending essentially disabled by political discord, the prospect of “throwing everything they can at it” may not amount to very much.

Pulling It Together

So, where does all of this leave us? In a superficial sense, not very far. We might get deflation. Or, we might get inflation. We might get both. In a complex adaptive world, it is just hard to say how things will turn out.

While this is all true, it is too cynical a view. As Rusty Guinn from Epsilon Theory highlights, the uncertainty and variability implied by such a landscape have their own set of implications:

​”What that narrative [Which direction are prices going?] misses, however, is the importance of sensitivity to price volatility in a path-dependent world. If you think that what’s happening in auto supply/demand and pricing is generally good for auto dealerships and the related industry infrastructure, you are probably right. But there will also be leveraged dealerships who participate heavily in inventory acquisition at prices and quantities that they can’t turn over before the pricing environment flips back. There will also be winners who figure out how to accommodate and navigate higher used price expectations in trades for new vehicles.”

​Such reveals a key point regarding inflation. The high potential for variability in prices increases the cost of doing business, regardless of direction. It takes time and effort to track price changes and to incorporate them into business plans. Some vendors will be reluctant to increase prices and instead will defer delivery times. Either way, increased variability makes it more complicated and more costly to coordinate business activity.

Business Risk

In addition, since price volatility increases the overall riskiness of doing business, an inflation “premium” will be incorporated into discount rates by the market. One lesson learned from the inflation of the 1970s and 1980s is higher levels of actual inflation also expand the distribution of expected inflation. After several decades of meager real and expected inflation, the emergence of an inflation “premium” can increase discount rates whether inflation roars in full fury or not.

Such hints at a final point. Although we may not know the future path of inflation, we do know something useful: Inflation is likely to be much more volatile than it has been the last three decades. As such, investment strategies built on a foundation of stability and disinflation are unlikely to prove nearly as fruitful. Indeed, an environment of heightened volatility demands very different portfolio construction than what has worked in the past.

Conclusion

Much like there is nothing inherently wrong with different types of weather, the challenge comes when it changes dramatically, and one isn’t prepared. A shocking example happened during a recent ultra-marathon event in China. When a cold spell trapped runners on a mountain, twenty-one of them died from exposure. While this is an extreme example, it highlights the importance of being prepared when the environment can change quickly.

China, Yields, And The Coming Deflationary Impulse

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In this issue of “China, Yields, And The Coming Deflationary Impulse.

  • Market Review And Update
  • China Drives Inflation
  • Yields Need A New Narrative
  • Portfolio Positioning
  • #MacroView: Bear Markets Matter More Than You Think
  • Sector & Market Analysis
  • 401k Plan Manager

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



Catch Up On What You Missed Last Week


Market Review & Update

Finally, after a week of false starts, the “buy signals” kicked in, and the markets mustered a rally. As we stated last week:

With markets deeply oversold on a short-term basis and with signals at levels that generally precede short-term rallies, the rally on Thursday and Friday was not unexpected. Notably, the S&P 500 held support at the 50-dma and rallied back into the previous trading range. 

On Wednesday, the Nasdaq triggered its short-term “buy signal,” which will likely provide some relative outperformance over the S&P 500. It will be important for the Nasdaq to hold above the 50-dma into next week

The good news is that we did indeed get the rally we were expecting. The not-so-good news is that the rally already consumed a majority of the “buy signal.” Such does not mean the market is about to correct; it does suggest that upside remains limited near term.

However, the S&P 500 buy signal has a bit more room to run. Such suggests we may see some relative performance pickup between the S&P 500 and the Nasdaq over the next week or so. 

Our more significant concern remains the weekly “sell signal.” Historically, these weekly signals typically denote periods of more significant volatility swings or corrections. The biggest correction risk comes when the daily and weekly signals align.

Importantly, these weekly sell signals do not always resolve into a correction. However, by the time you realize a correction has started, it is often too late to do much about it. Therefore, we tend to take these weekly signals at face value and adjust our risk exposures accordingly.

Still Expecting A Bigger Correction

As discussed over the last few weeks, we still expect a more extensive correction this summer. Currently, the markets are in an exceptionally long stretch in the market without a 5% pullback, so the odds are rising.

Importantly, as noted in this week’s “3-Minutes” video below, the one thing we continue to watch very closely is interest rates. 

Wall Street analysts continue to ratchet up earnings at one of the fastest paces on record. For earnings to meet these rather lofty expectations, economic growth must sustain a very high growth rate into 2022. However, interest rates peaked a couple of months ago suggesting economic growth will weaken in the months ahead.

If rates are sniffing out slower economic growth as stimulus fades from the system, the earnings are at risk of fairly significant downward revisions. In the market figures this out, a repricing of assets is likely.

Such is why we continue to suspect a 5-10% correction is a higher probability than most think.

Santa Claus Broad Wall, Technically Speaking: Will “Santa Claus” Visit “Broad & Wall”

Inflation Is Likely Transient

We previously discussed that inflation might indeed be more transitory given the impacts creating increased prices were artificial. (i.e., stimulus, semi-conductor shortages, and pandemic-related shutdowns.) To wit:

“Inflation is and remains an always ‘transient’ factor in the economy. As shown, there is a high correlation between economic growth and inflation. As such, given the economy will quickly return to sub-2% growth over the next 24-months, inflation pressures will also subside.” 

Inflation transitory 04-30-21, All Inflation Is Transitory. The Fed Will Be Late Again. 04-30-21

“Significantly, given the economy is roughly comprised of 70% consumption, sharp spikes in inflation slows consumption (higher prices lead to less quantity), thereby slowing economic growth. Such is particularly when inflation impacts things the bottom 80% of the population, which live paycheck-to-paycheck primarily, consume the most.”

However, another important factor behind inflationary pressures is an individual’s own actions. As noted last week by Société Générale’s Albert Edwards:

“Surveys suggest that inflation fears have become investors’ number one concern. But why look at it that way? We could equally say it is investors’ own bullishness on the strength of this economic cycle that is driving prices sharply higher in the most cyclically exposed equity sectors and industrial commodities.”

Bloomberg’s John Authers discussed the same, noting a “reflexivity” to investors’ belief in rising inflation.

“In inflation, as in many other areas of economic life, perceptions can form reality, and that is certainly true of inflation. The University of Michigan monthly survey of consumers’ expectations perennially shows shoppers foreseeing more inflation than will in fact arrive. The important factor here is the direction of travel. If they are more worried about inflation, they will do more to guard against it, which will tend to push up prices.”

China Drives Inflation

Such is an important point, as Albert notes:

“When investors pile into commodities as an investment vehicle to benefit from rising inflation, they create substantial upstream cost pressures. Beyond the cascading effect of upstream commodity price pressures, headline CPIs are also quickly impacted as food and energy prices rip higher.”

In other words, investors cause inflation by their actions. However, this is where Albert keys in on another critical driver of inflation.

“In addition to this, the observation by investors that industrial commodity prices are rising only serves to reaffirm their belief about cyclical strength and rising inflation, most especially ‘Dr. Copper.” Many investors see copper as extremely sensitive to economic conditions.

The circular, or as George Soros terms it, ‘reflexive’ nature of financial markets makes them extremely vulnerable to being whipsawed. Yet because of the current extreme momentum, it would take a very heavy weight of evidence to convince this market to reverse direction.

We continue to highlight that commodity prices are at high risk of a major reversal because of the steep downturn in the Chinese Credit Impulse. We have highlighted this before and we are not alone. Julien Bittel of Pictet Asset Management posted the following chart.”

“When commodity prices do start to fall, expect a major reversal in inflation sentiment. Furthermore, expect momentum to become as self-reinforcing and reflexive on the way down just as it was on the way up.”

As we discussed previously, this is what the bond market is already pricing in.

Yields Need A New Narrative

While investors expect surging inflation, the bond market continues to price in weaker future economic growth. As noted in “No, Bonds Aren’t Over-Valued.”

“The correlation between rates and the economic composite suggests that current expectations of sustained economic expansion and rising inflation are overly optimistic. At current rates, economic growth will likely very quickly return to sub-2% growth by 2022.”

Note: The “economic composite” is a compilation of inflation (CPI), economic growth (GDP), and wages.

Surging Inflation 05-14-21, Despite Surging Inflation, The Bulls Shake Off Weakness 05-14-21

Currently, as shown in our opening commentary, yields have remained range-bound between 1.5-1.6%. Such suggests that expectations for price pressures have moderated.

While the markets wonder when the Fed will start to talk more about tapering the bond purchases, yields are currently suggesting inflation may not be the real “risk.” 

The most considerable risk is a divergence among Fed policymakers which possibly leads to a policy mistake of tapering too quickly or even hiking rates. 

The majority of the inflation and economic growth pressures are artificial, stemming from the stimulus injections over the last year. However, with those inputs fading as year-over-year comparisons become more challenging, the “deflationary” impact could be more significant than expected.

There is also one other point about the Fed tapering the purchases. As shown in the chart below, rates rise during phases of QE as money rotates from bonds to stocks for the “risk-on” trade. The opposite occurs when they start to taper, suggesting a decline in rates if “taper talk” increases.

Earnings Yields Are A Problem

Switching from economics to equities, the recent spike in inflation has caused a drop in the “earnings yield” into negative territory.

Let’s start with what is “earnings yield.”

“Earnings yield has been the cornerstone of the ‘Fed Model’ since the early ’80s. The Fed Model states that when the earnings yield on stocks (earnings divided by price) is higher than the Treasury yield, you should invest in stocks and vice-versa.”

The problem here is two-fold.

  1. You receive the income from owning a Treasury bond, whereas there is no tangible return from an earnings yield. For example, if we purchase a Treasury bond with a 5% yield and stock with an 8% earnings yield, if the price of both assets remains stable for one year, the net return on the bond is 5% while the return on the stock is 0%. 
  2. Unlike stocks, bonds have a finite value. At maturity, the principal gets returned to the holder along with the final interest payment. However, stocks have price risk, no maturity, and no repayment of the principal feature. The risk of owning a stock is exponentially more significant than holding a “risk-free” bond.

If we look at periods of exceptionally low earnings yields compared to the market, we find a better correlation to corrections and outright bear markets.

Forward Returns Fall, Technically Speaking: Forward Returns Continue To Fall

As shown, there is a reasonable correlation between low earnings yields and low forward returns. Historically speaking, with an earnings yield of 2.66%, forward returns over the next decade should somewhere between +2% and -5%.

Forward Returns Fall, Technically Speaking: Forward Returns Continue To Fall

But what about the NEGATIVE yield?

Negative Real Yields Are A Bigger Problem

An interesting note this past week from Sentiment Trader discussed the outcomes for markets when inflation-adjusted earnings yields are negative.

“Until recently, one of the main arguments for stocks was that even though they weren’t yielding much, at least they were earning more than Treasuries, even after accounting for inflation. Now that there has been a spike in inflation gauges, the earnings yield on the S&P 500 has turned negative. This is not a condition that investors have had to tackle much over the past 70 years.

When an investor in the S&P adds up her dividend check and share of earnings, then subtracts the loss of purchasing power from inflation, she’s barely coming out even. This is a record low, dating back to 1970, just eclipsing the prior low from March 2000.”

“If we ignore dividends, then there have been five other times when the S&P 500’s inflation-adjusted earnings yield turned negative. You may want to close one eye and use the other to look askance at the table because it’s not pretty.”

The issue of negative earnings yield tells you three things:

  1. The market is hugely overvalued relative to the strength of underlying earnings. 
  2. Expectations for future earnings growth are unlikely to match current expectations leading to a future repricing of risk. 
  3. Bond yields are confirming that both economic and earnings growth has likely peaked. 

Portfolio Update

This past week we started trimming back on our QQQ index trading position to lock in some recent gains. Given that markets are still bullishly biased, we continue to hold our core equity positions for now.

However, we are closely watching our weekly indicators, which continue to approach the next “sell signal.” While such doesn’t mean the markets will have a deep correction, as noted, it typically suggests a pick-up in volatility and investment risk. For us, we would prefer to rebalance exposures and wait for the next buying opportunity to come along.

Let me reiterate from above.

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

Therefore, we must treat each signal with the same respect and adjust risk accordingly. The opportunity costs of doing so are minimal.

If we reduce risk and the market continues to rise, we can quickly increase our exposures. Yes, we sacrifice some short-term performance. However, if we reduce risk and the market declines sharply, we not only protect our capital during the decline but have the cash to deploy at lower price levels.

Such is the biggest problem with “buy and hold” strategies. Yes, you will perform in line with the market, but given that you didn’t “sell high,” there is no cash available with which to “buy low” in the future.

While I agree you can not “time the markets,” you can “manage risk” to improve your long-term outcomes. 

For us, that is our primary focus.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

 


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 84.70 out of a possible 100.


Portfolio Positioning “Fear / Greed” Gauge

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

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 84.5 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

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


Weekly Stock Screens

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

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

S&P 500 Growth Screen

 

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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

With the daily “buy signal,” the market has performed as expected. We have made recent gains in our portfolios, and currently, we don’t need to take any aggressive action.

The model is well balanced for now, and we continue to focus on risk management as we enter into the “doldrums of summer.” Volume in the markets has been exceedingly light, and “exuberance” seems to be fading from the market as well. Such aligns with our expectation that we could see a larger correction this summer as concerns on inflation clash with worries the Fed may be close to “tapering” their balance sheet.

What ultimately causes the correction is always unknown, but our weekly signals are suggesting that we are close to a correction than not. However, with that said, we do not expect the correction to any more than a typical 5-10% decline before we see the Fed begin to talk about additional supports and withdraw the idea of any potential taper.

As noted below, we did start taking profits in QQQ and are beginning to shift exposure mildly toward more defensive sector weighting heading into that potential scenario. If the anticipated correction occurs, we will use that opportunistically to add back into our holdings accordingly.

For now, we will be patient and wait and see what next week brings.

Portfolio Changes

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

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

“This morning we reduced our 4% QQQ position in both models by 1% to 3% of the portfolio. The technical signals that led us to buy are getting extended, so we are just taking some profits. When our signals begin to suggest a “sell signal” is approaching we will remove the rest of the position.

We are also adding 2% AMLP in both models as it technically looks strong and we think inflationary stocks will have decent relative outperformance in the coming days. This is a trade for a near-term bump in inflationary pressures and picking up an 8% dividend yield at the same time.

The buy signals on the Dow and S&P are not as extended as the NASDAQ.” – 05/27/21

Equity & ETF Models

  • Reduce the 4% position in QQQ to 3% of the portfolio. 
  • Initiate a 2% position in AMLP

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

Lance Roberts

CIO


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


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

Have a great week!

Technical Value Scorecard Report For The Week of 5-28-21

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

Commentary 5-28-21

  • The relative and absolute scores are little changed from last week. The weekly best performing index was momentum (MTUM) while communications were the best relative performing sector. Technology, discretionary, and utilities, remain the weakest sectors. Real estate is the most overbought sector, but not to an extreme. Most of the factor/indexes are hovering around fair value on a relative basis.
  • It is important to note that MTUM shifts its holdings based on individual stock momentum readings. In March TSLA, MSFT, AAPL, AMZN, and NVDA were the top five holdings. Today Tesla remains the top holding, but JPM, BRK/B, DIS, and BAC make up the remaining four. The index is more biased toward inflationary sectors versus disinflationary than it was 3 months ago.
  • The market started the week favoring deflationary sectors but ended with more of an inflationary bias. For the week the inflationary/deflationary index was close to flat.
  • The scatter plot in the bottom right of the first set of graphs continues to post a high r-squared, providing us confidence that scores and performance are inline.
  • The third graph below shows the relative value of gold miners (GDX) to the price of gold (GLD). Frequently, gold miners lead gold both to the upside and the downside. As shown, the relative score (GDX:GLD) has been increasing, denoting miner technicals are doing better than gold technicals. Since March 1, miners have risen about 25%, while the price of gold is up 10%. We will continue to monitor the pair and their relative performance to assess the sustainability of the recent rally.
  • Like the relative value graphs, the absolute value graphs moved little this past week. The only slight change was the gravitation of sectors and factors/indexes toward fair value. The S&P also moved closer to fair value, and while still above its fair value, it is now the least overbought it’s been since early March.
  • Real estate is the only sector or factor/index above 2 standard deviations from its 200 dma. Looking at prices versus the 20, 50, and 200 dma, communications are the most overbought, sitting about 1.75% standard deviations from each respective moving average. The fourth table shares more data on the topic.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

#MacroView: Bear Markets Matter More Than You Think (Part-2)

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Bear markets matter, and they matter much more than you think. (Read Part 1 Here)

In part-1, we discussed the differences between a “correction” and a “bear market.” But what is often missed by mainstream analysis is the long-term damage done to investor’s financial outcomes.

Now and then, you will see a version of the following chart floating around suggesting that over the long-term, “bear markets” don’t matter.

If you only do a cursory analysis of the chart, such would undoubtedly seem to be the case.

The problem is the analysis is exceptionally deceptive due to how math works. 

Blowing Up Everything Bubble, Technically Speaking: Blowing Up The “Everything Bubble”

It’s The Math

Notice that the chart uses percentage returns. As noted, that is a deceptive take if you don’t examine the issue beyond a cursory glance. Let’s take a look at a quick example.

Let’s assume that an index goes from 1000 to 8000.

  • 1000 to 2000 = 100% return
  • From 1000 to 3000 = 200% return
  • The next 1000 to 4000 = 300% return
  • The final 1000 to 8000 = 700% return

No one would argue that a 700% return on their money wasn’t fantastic.

So, why should you worry about a correction when you just gained 700%.  Right?

The problem with using percentages to measure an advance is that there is an unlimited upside. However, you can only lose 100%. 

In our example, while our hypothetical investor garnered a 700% return, a 100% loss reverses that gain to zero. Nothing. Zip. Nada.

That is the problem of percentages.

Blowing Up Everything Bubble, Technically Speaking: Blowing Up The “Everything Bubble”

Valuations & Forward Returns

As noted in Part-1, the other issue investors must account for over the long term is inflation. The first chart above is the inflation-adjusted S&P index. For all examples in this article, I am using Dr. Robert Shiller’s monthly data for consistency.

As we discussed, the three most important factors are drawdowns, inflation, and life expectancy. 

Of course, these long periods of very low returns are a function of valuations.

While it may “appear” that investing your money will assure you a return over time, the problem is there are extended periods where returns have been close to zero and even negative. 

The two charts below show the inflation-adjusted total (dividends included) return of a $1000 investment over both 10-year and 20-year periods.

You will notice that in both charts there are very long periods of near-zero or negative returns. The reason is that declines in markets from previous peaks erased most, if not all, of the preceding gains.

Therefore, if we remodel the “percentage” chart above to reflect each cycle’s “point” gains and losses, the damage becomes apparent. As shown in the chart below, a large chunk of each preceding “bull market” advance has eventually gotten reversed by the subsequent decline.

While many suggest that simply ignoring “bear markets” is survivable in the long run, that brings into question just how long is “the long-run.”

Blowing Up Everything Bubble, Technically Speaking: Blowing Up The “Everything Bubble”

When You Start Matters

Investing for the long term is essential. However, as noted above, there are exceptionally long periods in market history that have denoted sub-par returns.

Over the last 120-years, the one factor that denotes the success or failure of the investment journey has been “valuations” when you started. Such is why, if you are near to, or entering, retirement, there is a solid argument to be made for rethinking the amount of equity risk currently being undertaken in portfolios.

In the short term, a period of one year or less, political, fundamental, and economic data has very little influence over the market. Such is especially the case in a late-stage bull market advance where the momentum chase has exceeded the grasp of the risk undertaken by investors.

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

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

But in the long-term, fundamentals are the only thing that matters. Both charts below compare 10- and 20-year forward total real returns to the margin-adjusted CAPE ratio. Review the two charts above showing the historical 10- and 20-year total returns. Given we are currently pushing the second-highest levels of valuations in market history, the charts below confirm that historical data. Investors should expect very low rates of future returns.

1920 Valuations Returns, Technically Speaking: Why This Isn’t 1920. Valuations & Returns

1920 Valuations Returns, Technically Speaking: Why This Isn’t 1920. Valuations & Returns

Unfortunately, most investors remain woefully behind their promised financial plans. Given current valuations and the ongoing impact of “emotional decision making,” the outcome is not likely going to improve over the next decade.

Blowing Up Everything Bubble, Technically Speaking: Blowing Up The “Everything Bubble”

Conclusion

For investors, understanding potential returns from any given valuation point are crucial when considering putting their “savings” at risk. Risk is an important concept as it is a function of “loss.” The more risk an investor takes within a portfolio, the greater the destruction of capital will be when reversions occur.

The analysis above reveals the important points that individuals should OF ANY AGE should consider:

  • Investors should downwardly adjust expectations for future returns and withdrawal rates due to current valuation levels.
  • The potential for front-loaded returns in the future is unlikely.
  • Your life expectancy plays a huge role in future outcomes. 
  • Investors must consider the impact of taxation.
  • Investments allocations must carefully consider future inflation expectations.
  • Drawdowns from portfolios during declining market environments accelerate the principal bleed. Plans should be made during up years to harbor capital for reduced portfolio withdrawals during adverse market conditions.
  • Over the last 11-years, the yield chase and the low rate environment have created a hazardous environment for investors. 
  • Investors MUST dismiss expectations for compounded annual return rates in place of variable rates of return based on current valuation levels.

In conclusion, chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk than you most likely realize. Over the last decade, two massive bear markets have left many individuals further away from retirement than they ever imagined.

Investing for retirement should be done conservatively and cautiously to outpace inflation over time. Trying to beat some random, arbitrary index with nothing in common with your financial goals, objectives, and most importantly, your life span has tended to end badly.

Bear markets matter, and they matter much more than you think.

#WhatYouMissed On RIA This Week: 05-28-21

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What You Missed On RIA This Week Ending 05-28-21

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

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


RIA Advisors Can Now Manage Your 401k Plan

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


What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



Video Of The Week

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

Video Of The Week For 05-28-21Mid-Year Market Outlook


Latest 3-Minutes On Markets & Money



Our Best Tweets For The Week: 05-28-21

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

See you next week!