Monthly Archives: April 2019

Policies Over Politics: Investing For The Election

As we near the 2020 Presidential election, rhetoric from both sides is ramping up. Depending on your personal “echo chamber” of social media, you are likely confident why your candidate is the best choice, and the opposition is the worst. However, when it comes to economic prosperity and the financial markets, who is the best choice? To answer that question, we will focus on the “policies,” not the “politics.”

In our most recent “Candid Coffee” event, I sat down with Danny Ratliff, CFP, and Richard Rosso, CFP to discuss policies over politics, and investing for the election.

In our conversation, we cover much of the data I recently produced in “Whoever Wins, We All Lose,” from the impact of debts, and deficits, on economic growth, the Candidates policy prescriptions, and how the markets have reacted throughout history.

I hope you find the information useful.


What The Hunt Brothers Can Teach Us About Gamma Squeezes

What The Hunt Brothers Can Teach Us About Gamma Squeezes

“Almost anything is better than paper money. Any fool can run a printing press.” – Nelson Bunker Hunt

A year ago, the phrase “gamma squeeze” would have caught many of Wall Street’s most astute investors off guard. Today, both traditional and social media regularly parrot the phrase. It won’t be long before the shoeshine kid tells the Bank President about his gamma squeeze exploits.

A Gamma squeeze is just the latest innovation in centuries of market manipulation schemes. Given this activity is a source for significant volatility and instability, it is worth exploring.

Before continuing we share a recent tweet from Chris Cole at Artemis Capital.

Think about his powerful statement for a second. Essentially Chris states that stocks are now a derivative of a derivative of stocks. That is an absurd figment of our imagination.

The Hunt Brothers

To provide historical context on market manipulation we look back at an asset squeeze for the ages. In the 1970s, the Hunt brothers, Nelson, Lamar, and William, had extensive holdings in oil, real estate, cattle, and sugar. Concerned about the effects of what they believed to be careless monetary and fiscal policies, as well as risks of the newly formed oil cartel (OPEC), they set out to hedge their businesses and assets. Since it was still illegal for individual investors to own gold, they chose to hedge with physical silver.

The Hunts began buying silver in 1973, acquiring futures contracts equivalent to 55 million ounces of silver. At the time, the price of silver per ounce was $1.50. Over the next six years, the Hunts grew their holdings to well over 200 million ounces, worth more than $4.5 billion.

By 1979, their activity prompted actions by the Commodities Futures Trading Exchange (CFTC) and the Chicago Mercantile Exchange (COMEX). Both entities sought to restrict their buying and forced liquidations. Silver nearly hit $50 per ounce in mid-January 1980 and then fell to $10 per ounce by the end of March. At that point, margin calls on futures contracts and borrowings against existing silver holdings depleted all of Hunt’s cash. They were forced to liquidate silver to cover margin debts.

Leverage Builds and Leverage Kills

The Hunts initially took physical delivery of silver and did not use leverage. Over time though, they understood the power of using their silver as collateral to buy more silver. Buying silver futures on margin meant they could influence the price at a fraction of the cost. Such leverage allowed them to multiply their purchasing power and drive silver prices higher. The only demand on the Hunt’s was to have enough cash to fund their futures margin account adequately.

In addition to the CFTC and COMEX efforts, the Federal Reserve also played a role in breaking the Hunt brothers. Fed Chairman Paul Volcker sharply raised interest rates in January 1980 from 11.75% to 20.0% making borrowing for the Hunts much more expensive and difficult. One week after the Hunts shut down their silver market activity, Volcker began lowering interest rates.

Leverage allowed the Hunts to distort the price of silver, but it also killed their scheme. They lost over $1.1 billion on the trade. They also lost civil charges, which in part led them to declare bankruptcy.

The Tiffany advertisement below describes the economic effect the Hunt’s had on various industries.

What are Delta and Gamma?

The Hunt brothers used leverage and brute force to corner the silver market. Today’s traders employ a more refined technique but one that relies on leverage.

The “Gamma Whale,” which many think is Soft Bank, provides a lesson on how a gamma squeeze operates. Before explaining the scheme, we define option Delta and Gamma.

Delta quantifies the rate of change of the options price per the change in the underlying stock price. A delta of .50 means the option price will increase 50 cents for every $1 in the stock.

Delta is not a linear function, meaning it will not change proportionately with the stock price. Gamma quantifies how Delta will change per the change in the stock price. The chart below shows the non-linear “S-like” shape of Delta and the Gamma curve that warps it.

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

Options trade on leverage of sorts as a relatively small option premium can control many shares. In most cases, the premium is a tiny fraction of the price of the underlying shares. However, if the option is in the money at expiration, the option’s holder takes delivery of the underlying stock and must pay fully for the shares. In most cases, options traders sell the option or roll it to a future month to avoid payment.

The Gamma Whale

The “Gamma Whale” owns a portfolio of stocks. Like all investors, they want the value of their stocks to rise. To better their odds, they buy short-dated call options on stocks they own. Like the Hunts use of silver futures, the Whale can more efficiently manipulate share prices higher using the leverage in the options market.

A Gamma squeeze relies on the hedging actions of options dealers. The banks and brokers who are the largest sellers of options must hedge their trades. Most dynamically hedge, meaning they frequently adjust the hedge amount according to the Delta of the option. If the Delta is .35, then they buy 35 shares for every option contract they are short. If the Delta then rises to .40, they buy five more shares. Conversely, they sell when the Delta falls.

If the Whale buys enough calls, they can trigger a Gamma squeeze. The option purchases force the dealers to buy the stock, which pushes the share price higher. As this happens, the dealers’ buying activity increases the Delta at a non-linear rate (gamma). In circular fashion dealers then must buy more of the stock, and on and on.

Like Hunt’s strategy, this one works as long as you can keep buying calls, and the stock price keeps rising. As the Hunt’s found out, that is not always possible. Here are a few problems the Whale and others face.

  • If they elect to sell the calls, the dealers will also sell the underlying stocks, which hurts their underlying large share positions.
  • The popularity of such strategies results in increased options premiums, making it costlier to execute.
  • Since they do not take delivery of the underlying stock, they have to continue to roll the positions until they sell the underlying stock. Again, selling the options will force dealer selling. Further, there are times they may not want to buy or roll calls, such as heading into the coming election or at quarter/year ends.
  • Dealers will get tired of being on the losing end of a trade and purposely push stock prices lower. Lower prices have the reverse effect, as dealers must sell when deltas decline.

It is also worth considering; the Whale can short a stock and then buy puts to create a squeeze but one that pushes share prices lower.

Summary

Hunt’s scheme failed because they relied on leverage. The Gamma squeeze also depends on leverage and the willingness of important market participants. If the cost of leverage goes up or the intermediaries in the trade become reluctant, then the music of the gamma trade will stop.

Once the Hunt’s began using leverage, they gave the “game” back to the establishment government, banks, and the Rockefellers. Like the Hunt brothers, the Gamma trade squeeze relies on the banks to lose money. As the Hunt brothers can attest, do not bet against the establishment, the banks, and those who sponsor them (Fed, Treasury, etc.)

Equity prices and valuations have lost all relationship to economic reality. Gamma induced surges are yet another example of the false market foundation. Ignoring the inherent risks may be pleasant when the market rises, but at the same time, instability soars. We urge you to look back at the silver chart to indicate what may happen when reality remerges.

Technically Speaking: It’s Coming. A Huge Bond Buying Opportunity.

Here we go again. After plunging to new lows, the calls for the end of the “bond bull” market mount each time rates rise. Is this time the end of the “bond bull?” Or, is there another huge bond-buying opportunity to come? 

We recently reduced our exposure to bonds, the first time in years, due to the more extreme overbought condition of Treasury bonds following the pandemic’s onset. The long-term chart of yields below shows this to be the case.

There are two critical points to take away from the chart above.

  1. Interest rates are currently extremely oversold (top and bottom panels), suggesting that rates could indeed rise over the next few months. Such could coincide with another stimulus package or the passage of an “infrastructure” bill that leads to short-term inflationary concerns.
  2. When rates do rise from deeply oversold levels, there is a point where high rights collide with debt levels triggering either a credit-related event, a stock-market correction, or worse. 

There are currently two significant risks from rising interest rates, which investors should heed.

The Fed Is Permanently Stuck At Zero, #MacroView: The Fed Is Permanently Stuck At Zero

Valuation Expansion

One of the primary themes used by the “Permabulls” is that “valuations are cheap due to low interest rates.” That argument has been the clarion call of a generation of investors who have ignored fundamentals and valuations to chase market returns.

Since 2019, when earnings growth began to deteriorate in earnest, investors bid up shares. As such, the primary driver of returns, as shown below, has come from “multiple expansion.”

The “hope” remains that earnings growth will eventually catch up with valuations. However,  despite being 3/4ths of the way through 2020, the outlook for earnings continues to deteriorate. In just the last 15-days, the estimates for 2021 have declined by almost $7 per share despite repeated statements of a recovering economy.

There are two problems with the thesis that “low rates justify high valuations.”

  1. Historically, such has not ever been the case; and,
  2. When rates rise, valuations quickly become an issue.

However, since stock prices reflect economic growth, the impact of rising rates on the economy is a far more significant issue.

The Debt Problem

People don’t buy houses or cars. They buy payments. Payments are a function of interest rates, and when interest rates rise sharply, mortgage activity falls as payments rise above expectations. In an economy where roughly 70% of Americans have little or no savings, an adjustment higher in payments significantly impacts consumption. 

  1. Rising interest rates raise the debt servicing requirements, which reduces future productive investment.
  2. As stated above, rising interest rates will immediately slow the housing market taking that small contribution to the economy. People buy payments, not houses, and rising rates mean higher payments.
  3. An increase in interest rates means higher borrowing costs. Such leads to lower profit margins for corporations reducing corporate earnings and financial markets.
  4. The negative impact on the massive derivatives and credit markets is the Fed’s worst fear. 
  5. As rates increase, so does the variable rate interest payments on credit cards. With the consumer struggling with stagnant wages and increased living costs, higher credit payments lead to a contraction in spending and rising defaults.
  6. Rising defaults on debt service will negatively impact banks, which are still not adequately capitalized and still burdened by massive levels of bad debts.
  7. Many corporate share buyback plans and dividend issuances are accomplished through cheap debt, leading to increased corporate balance sheet leverage. That will end.
  8. Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs lead to lower CapEx.
  9. The deficit/GDP ratio will begin to soar as borrowing costs rise. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

The Fed Is Permanently Stuck At Zero, #MacroView: The Fed Is Permanently Stuck At Zero

Payments Matter

I could go on, but you get the idea as we discussed concerning debt-to-income ratios:

Such is also why interest rates CAN NOT rise by very much without triggering a debt-related crisis. The chart below is the interest service ratio on total consumer debt. (The graph is exceptionally optimistic as it assumes all consumer debt benchmarks to the 10-year treasury rate.)  While the media proclaims consumers are in great shape because interest service is low, it only takes small increases in rates to trigger a ‘recession’ or ‘crisis’ event.”

Debt-To-Income, Why Debt-To-Income Ratios Are Worse Than They Appear

Am I saying rates can’t rise at all? 

Absolutely not. However, there is a limit before it negatively impacts the economy, and ultimately the stock market.

Bond Prices Very Overbought

In June of 2013, when the cries of the “death of the bond bull market” were rampant, I made repeated calls that then was an ideal time to be a “buyer” of bonds.

“However, the recent spike in interest rates has certainly caught everyone’s attention and begs the question is whether the 30-year bond bull market has indeed seen its inevitable end.  I do not think this is the case and, from a portfolio management perspective, I believe this is a prime opportunity to increase fixed income holdings in portfolios.”

As shown in the chart below, that was the correct call and, despite repeated wrong calls by the mainstream analysts, bonds remained in an ongoing bullish trend.

Since interest rates are the inverse of bond prices, we can look at a long-term chart of rates to determine when bonds are overbought or oversold.

In 2019, rates began to slide slower as the realization that economic growth was weakening weighed on outlooks. As the yield curve began to invert, the Federal Reserve stepped in with expanded “repo” operations to shore up financial institutions.

Rates kept going lower.

In March of 2020, the economy was shut down due to the pandemic causing rates to plunge to record lows.

The Fed Is Permanently Stuck At Zero, #MacroView: The Fed Is Permanently Stuck At Zero

Huge Bond Buying Opportunity Coming

The plunge in rates and massive Fed liquidity caused stocks to surge to new highs despite an underlying recessionary economy.

Currently, the plunge in interest rates pushed bonds to an extreme “overbought” condition. 

Such suggests the most likely target for rates in the near term could be as high as 2.0%. While an increase of 1.2% from current levels doesn’t sound like much, that increase would push bonds back to “oversold.”  That move will provide the best opportunity to increase bond exposure in portfolios.

We can confirm the same using a very long-term chart (50-years) of 10-year interest rates overlaid with a 10-year moving average. As you can see, that moving average has provided formidable resistance and denoted every peak in rates going back to 1988.

Currently, with interest rates at the bottom of their long-term trend, the risk is that rates could indeed rise in the months ahead.

What could cause such an increase in rates?

  1. A massive debt-funded stimulus package that sends increased amounts of funds directly to households.
  2. More debt-funded infrastructure programs.
  3. If the government further increases deficit spending programs that fail to produce economic benefits such as universal basic incomes. 
  4. An increase of economic activity as the economy reopens, and a post-recessionary recovery occurs.
  5. If there is a point where the Federal Reserve is unable or unwilling to monetize the entirety of the debt issuance
  6. A lack of demand by foreign buyers of U.S. debt over concerns on economic strength and financial stability due to debt-to-GDP ratios.

These lead to concerns over temporary inflationary spikes, which could drive interest rates back to the top of the long-term downtrend.

Where To Invest While We Wait For Bonds

While bond prices currently remain overbought, such a condition will likely not last very long. As shown below, markets and volatility have an inverse relationship with rates, hence the non-correlation for portfolios. The long-term log-chart of interest rates and the stock market tells the tale.

This analysis also suggests that the correction that started in March is likely not over as of yet in the longer term. If rates rise back toward the long-term downtrend, bond prices will come under pressure as the stock market corrects.

For investors, we can turn to our colleague Jeffrey Marcus of TPA Analytics. He recently analyzed the best places to invest during rising interest rates for our RIAPro Subscribers.

The 4 best performing sectors are:

  • Technology
  • Consumer Discretionary
  • Industrials
  • Materials

The 4 worst performing sectors are:

  • Utilities
  • Telecomm
  • REIT’s
  • Staples

The 2 best performing broad categories are:

  • Small-Cap Growth
    Small-Cap

The 2 worst performing sectors are:

  • Large-Cap Value
    Large-Cap

Commodities: Crude and Copper are positive over half the time. Crude is the best performing commodity, historically.

Gold is the worst-performing commodity; it is only positive 14% of the time.

2 more focus items:

  • TECH beat the S&P500 100% of the time
  • Utilities underperformed the S&P500 100% of the time”

The Fed Is Permanently Stuck At Zero, #MacroView: The Fed Is Permanently Stuck At Zero

Not The End Of The Bond Bull

In the short term, we have cut our bond exposure and have begun to shift our allocations to protect portfolios for a rise in interest rates.

However, as rates rise within their technical downtrend, the media will be replete with headlines about the death of the 40-year “bond bull market.” 

It won’t be. 

  • The stock market will defy higher rates initially until rates start to undermine the valuation story.
  • A weaker economy will undermine the valuation story as higher interest rates impede consumption.
  • The bullishly biased media will find themselves lost as to why stocks crashed and earnings fell.

While in the very short-term, the current overbought condition suggests we could see more downside pressure in bonds over the next few months. Such would not be surprising.

However, as we approach that point where the market begins to realize the impact of higher rates on economic growth and corporate profitability, bonds will again emerge as a haven for investors against market declines.

In an economy that is $75 Trillion in debt, requires $5.50 of debt per $1 of growth, and running a $3 Trillion deficit, rates can’t rise much.

Which is also why the Federal Reserve is now forever trapped at zero.

Sector Buy/Sell Review: 10-27-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 10-27-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when. It also guides what sectors to overweight or underweight to achieve better performance.

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

There are three primary components to each chart below:

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

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

SECTOR BUY/SELL REVIEW: 10-27-20

Basic Materials

  • A common theme through today’s report is the “death of the ‘reflation’ trade.”
  • Areas that were running up on hopes of more stimulus, a Biden victory (more spending), all fell apart on Monday.
  • The good news is XLB held support at the 50-dma. There is now a double-top with a more extreme overbought condition. 
  • We recommended taking profits on trading positions last week, which turned out to be good advice.
  • Momentum is good, but it is still underperforming the market as a whole.
  • Keep stops on trading positions at the 50-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: Hold Positions
    • Stop-Loss moved up to $62
  • Long-Term Positioning: Bullish

Communications

  • Communications is continuing to flirt with its 50-dma support level but is holding its uptrend. 
  • XLC has begun to outperform the broad market while working off its overbought condition. This will likely provide a good setup for a trade post-election, but keep stops in place for now. 
  • Stops remain at $58.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Bullish

Energy

  • Energy, which got no boost from the reflation trade, also got hammered by the expectation of no more stimulus to support economic growth. 
  • The lows must hold, or XLE is going to retest the March lows. 
  • The overall trend is fragile, remain clear for now.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Bearish

Financials

  • Financials continue to underperform, and the “earnings bounce” has now reversed.
  • XLF is testing it’s 50- and 200-dma with a “Golden Cross” now in place. If XLF can hold support and rally, there is a decent upside for the sector. A failure at support will be very disappointing. 
  • We saw the same bounce last quarter that eventually failed, but there wasn’t a positive bias to the moving averages. So, give financials a little breathing room. 
  • We are still avoiding the sector for now, but we will add holdings to our portfolios if support holds and performance improves.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Industrials

  • Like XLB, XLI is heading back to the test the 50-dma.
  • We are holding our reduced exposure for now, but take profits and rebalance risks as needed. 
  • XLI remains extended and overbought short-term. 
  • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bullish

Technology

  • Technology stocks and the Nasdaq failed at a lower high than previous, which is concerning. 
  • The sector is working off its very overbought and is now testing its 50-dma support. 
  • Technology will likely hold up better post-election, particularly if rates continue to push higher short-term. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Hold positions
  • Stop-loss moved up to $110
  • Long-Term Positioning: Bullish

Staples

  • XLP is also correcting its extreme overbought and is finding rotation out of the “relation trade” areas.
  • The correction on Monday was not surprising and is testing the 50-dma. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $62 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Real Estate

  • On Monday, the sell-off took it back below the 50-dma and is now testing the 200-dma support. 
  • XLRE needs to hold these levels.
  • The next critical support is the double bottoms at $34. Below that, and it will get ugly fairly quickly. 
  • Keep stop-losses at the 200-dma.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Utilities

  • XLU continues to push into extremely overbought conditions after breaking above resistance. 
  • XLU is now 4-standard deviations above the moving average. This will not last indefinitely. 
  • Take profits and rebalance risk. 
  • Short-Term Positioning: Neutral
    • Last week: Reduced XLRE by 50%.
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV is sitting on its 50-dma and needs to hold here. 
  • The previous overbought conditions have been resolved, and the buy signal is still intact. Use weakness to add to holdings.
  • The 200-dma is now essential price support for XLV.
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • XLY rallied to new highs previously.
  • We recommended last week to take profits and rebalance risk. The 50-dma is an important initial support. On Monday, XLY is starting to correct back to that level. 
  • We will look for an opportunity to add to our “holiday shopping” stocks on this weakness – after the election is over, of course.
  • Stop-loss remains at $140
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Long-Term Positioning: Bullish

Transportation

  • Last week I wrote: “Transportation has been rallying on hopes from infrastructure but failed at its previous highs. The sector is overbought and ran into previous resistance.”
  • The sell-off on Monday was a bit vicious and looked to take XTN back to the 50-dma. 
  • The “buy signal” remains very extended. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and are waiting for a better entry point to add to our holdings. That may be coming here soon. 
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Neutral

Viking Analytics: Weekly Gamma Band Update 10/26/2020

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 10/26/20

  • The Gamma Band model reduced exposure to 70% heading into the week. At the writing of this report mid-day on Monday, the SPX has traded down to 3,375, which would suggest a further reduction in exposure if the price closes below the Gamma Neutral level of 3,420.  
  • Our binary Smart Money Indicator continues to have a full allocation, as is discussed in greater detail below. The Smart Money indicator has fallen from very bullish levels but is a long way from changing to a flat allocation.
  • SPX skew, which measures the relative cost of puts to calls, shows that put buyers are paying a meaningful premium over call buyers ahead of the U.S. presidential election.
  • We publish several signals each day, ranging from a fast signal in ThorShield to a less active signal (as represented by the Gamma Bands and published in the daily SPX report).  Samples of our SPX and ThorShield daily reports can be downloaded from our website.

Smart Money Residual Index

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

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

SPX Skew – the Price of Protection

In evaluating equity market risk, we also consider the cost of buying puts versus the cost of buying calls.  When puts command a larger-than-usual premium to calls, then the market will have higher volatility (in the red zone below), and this can be a signal to reduce equity exposure. 

Ahead of an important U.S. presidential election, put buyers are paying a premium for the protection. 

Gamma Band Background

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

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

We back-tested this strategy from 2007 to the present and discovered a 76% increase in risk-adjusted returns (shown below).  The Gamma Band model is a relatively slow but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish a faster, daily signal in a portfolio model which we call Thor’s Shield.  Thor Shield has a 20-year Sharpe of 1.5 and a rolling 1-year Sharpe of over 3.4.  Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

Authors

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

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

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


TPA Analytics: Top 10 Buys & Sells As Of 10-26-20

Top 10 Buys & Sells As Of 10-26-20

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


Note from the RIAPro Team:

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

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

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

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

Major Market Buy-Sell Review: 10-26-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 10-26-20

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

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

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

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

Major Market Buy/Sell Review 10-26-20

S&P 500 Index

  • The oversold condition that existed previously has now been reversed. While some extreme extensions have been reduced, the market is still struggling in its recent downtrend as “stimulus” has failed to appear. 
  • The market held support last week at the 50- and 20-dma crossover but is struggling against downtrend resistance. 
  • Maintain exposures for now, but be ready to adjust if more weakness shows up heading into the election. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: Maintaining holdings.
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow also is struggling at previous resistance but is maintaining support for now.
  • After taking profits previously, hold positions for now and maintain stop losses.
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • The Nasdaq continues to work off its overbought condition and continues to reduce excess conditions. The underperformance relative to the S&P 500 is likely going to provide another good trading opportunity soon. 
  • If the market correction continues to hold support, such will likely provide a good opportunity to add exposure aggressively.
  • Hold current positions and honor stop losses.
  • Short-Term Positioning: Bullish
    • Last Week: No changes this week.
    • This Week: No changes this week.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps is extremely overbought and has again become very deviated from its long-term mean.  
  • Risk is currently to the downside, but there is a chase to gain exposure to lagging sectors by investors right now. 
  • It is still suggested to use the current rally to rebalance positions until the downtrend is reversed. 
  • Short-Term Positioning: Bullish
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY performed better than SLY last week, but it is extremely extended from its long-term mean like SLY. 
  • The tradeable opportunity in Mid-caps we discussed previously is likely over for now. Keep stops tight at the 50-dma for now. Look for pullbacks to support to add exposure.
  • The $330 stop-loss remains intact, but just barely. 
  • Short-Term Positioning: Bullish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss is set at $330
  • Long-Term Positioning: Bullish

Emerging Markets

  • Emerging markets are extremely overbought and deviated from the longer-term mean.
  • This is a good opportunity to take profits and reduce exposure for now. 
  • The dollar is continuing to build a bottom, so there is a significant risk to international and emerging markets if it turns up. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved to $42 for trading positions.
  • Long-Term Positioning: Bullish

International Markets

  • International markets performed worse than emerging markets last week but are not as grossly extended either. 
  • As long as the 50-dma holds, positions can be maintained. However, please pay attention to the dollar as it has begun gaining some strength. 
  • Maintain stops.
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bullish

West Texas Intermediate Crude (Oil)

  • The rally in oil occurred and finally broke above the 200-dma. The worst may be over for now in oil if prices can hold above these levels, which it did successfully this week. 
  • Energy stocks, unfortunately, are still not performing with the rally in oil. However, there may be a point where the historical correlation comes back into play, and we see a strong rally in energy. 
  • Historically, the worst-performing sector in the market in any given year has tended to be one of the leaders in the following year. More indications are coming. This will likely be the case. A Trump victory will likely be a strong buy signal for energy stocks. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • After previously adding to our positions in GDX and IAU, we continue to hold our positions. 
  • The sector is currently on a sell-signal and is not extremely oversold. However, further consolidation may provide a perfect entry point to add further exposure. 
  • Stops are reset at $165. 
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Added 1% to GDX and IAU
    • This week: No changes this week.
    • Stop-loss adjusted to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds struggled last week and are now at historically very extreme oversold conditions. 
  • There is a lot of upside potential in bonds from the current oversold condition, which will coincide with a larger correction in stocks. 
  • The “sell signal” is now at levels that have typically preceded more massive rallies in bonds, so continue to maintain exposure.
  • Investors can add to Treasuries at current levels. Post-election, we will take our duration much further out. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Trimmed TLT to 10% to hedge against the election.
    • Stop-loss moved up to $157.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar rally stumbled this past week and is testing previous lows. 
  • The bottoming process continues, and if the recent bottoms hold and the buy signal turns positive, it will suggest an early stage of a dollar rally.
  • Subsequently, a dollar rally will devalue international and emerging market holdings, so act accordingly. 
  • Traders can continue to build a position here with a stop loss at recent lows. 
  • Stop-loss adjusted to $92.

Why Debt-To-Income Ratios Are Worse Than They Appear

I recently published an article discussing why “recessions” are a good thing by reverting debt buildups excesses during expansions. The argument against debt reversions is always the same in that “debt-to-income” ratios low. To wit:

“One reason (of many) we don’t need a debt reversion is that household debt service costs (interest etc.) as a % of household incomes are currently at a 40 year low.” – S. Porter

If you look at a chart, it certainly would seem that would be the case.

But, like most data from the Federal Reserve, you have to dig behind the numbers to reveal the real story.

So let’s do that, shall we?

Living The Dream

Every year, most Americans go further into debt just to “sustain” their standard of living. To wit:

“In 1998, monetary velocity peaked and began to turn lower. Such coincides with the point that consumers were forced into debt to sustain their standard of living. For decades, WallStreet, advertisers, and corporate powerhouses flooded consumers with advertising to induce them into buying bigger houses, televisions, and cars. The age of ‘consumerism’ took hold.

Fed Inflation, #MacroView: Fed Wants Inflation But Their Actions Are Deflationary

The idea of “maintaining a certain standard of living” has become a foundation in society currently. The average American believes they are “entitled” to a specific type of house, car, and general lifestyle. Such includes living necessities such as food, running water, electricity, and the latest mobile phone, computer, and high-speed internet connection. (Really, what would be the point of living if you didn’t have access to Facebook every two minutes?)

However, maintaining this “entitled” lifestyle requires money, and as shown above, when income and savings run short, debt fills the gap.

The Illusion Of Debt Reduction

One of the headline stories of late has been the sharp decline in credit balances as individuals were rapidly paying down credit.

Such isn’t the case.

Each quarter, the Federal Reserve Bank of New York releases its quarterly consumer debt composition and balances survey. (Note that consumers are at near-record debt levels and roughly $1.5 Trillion more than in 2008.)

See that little decline from the recent peak? That is the deleveraging cycle picked up by the media.

However, when we break down the data, a very different picture emerges.

The average American has $90,460 in debt. A recent CNBC article broke down how much debt Americans have at every age.

“Here’s the average debt balances by age group:

  • Gen Z (ages 18 to 23): $9,593
  • Millennials (ages 24 to 39): $78,396
  • Gen X (ages 40 to 55): $135,841
  • Baby boomers (ages 56 to 74): $96,984
  • Silent generation (ages 75 and above): $40,925

According to Experian, consumers in the two oldest age categories have seen a significant decrease in debt since 2015 (about -7.5% for baby boomers and -7.7% for the silent generation overall).

Meanwhile, millennials have seen the largest increase in debt in the last five years: In 2015, the average millennial had about $49,722 in debt, and by 2019 they carried an average of $78,396 in total debt — an increase of 58%,”

A Function Of Income

Much of the analysis touted by the media use either “averages” or “median” measures of a particular set of data. While there is nothing inherently wrong in reporting such data, the message sent can get distorted when there is a skew in the underlying data set.

Such is particularly the case when it comes to disposable incomes. The calculation of disposable personal income (which is income fewer taxes) is mostly a guess due to the variability of households’ income taxes.

More importantly, the measure becomes skewed by the top 20% of income earners, needless to say, the top 5%. As shown in the chart below, those in the top 20% have seen substantially larger median wage growth versus the bottom 80%. (Note: all data used below is from the Census Bureau and the IRS.)

Furthermore, disposable and discretionary incomes are two very different animals.

Discretionary income is the remainder of disposable income after paying for all of the mandatory spendings like rent, food, utilities, health care premiums, insurance, etc.

From this view, the “cost of living” has risen much more dramatically than incomes. According to a previous Pew Research study:

“In fact, despite some ups and downs over the past several decades, today’s real average wage (that is, the wage after accounting for inflation) has about the same purchasing power it did 40 years ago. And what wage gains there have been have mostly flowed to the highest-paid tier of workers.”

, America’s Debt Burden Will Fuel The Next Crisis

In other words, given the bulk of the wage gains are in the upper 20%, any data that reports a “median” or “average” of the information is inherently skewed to the upside.

Data Skew

Again, when you see data using “medians” or “averages,” such is not incorrect. However, the assumptions are skewed by the “wealth and income” gap in the top 20% of the population. Such was a point put forth previously by the WSJ:

The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.”

, The Fed’s Only Choice – Exacerbate The Wealth Gap, Or Else.

“Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A full 33% of that gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.”

, The Fed’s Only Choice – Exacerbate The Wealth Gap, Or Else.

Given this information, it should not be surprising that personal consumption expenditures, which make up roughly 70% of the economic equation, must be supported by surging debt levels to offset the lack of wage growth in the bottom 80% of the economy.

More importantly, despite low debt-to-income ratios, the percentage of government transfer payments (social benefits) now comprises 1/4th of real disposable incomes. Today, nearly 1-in-4 families in the U.S. receive some form of Government assistance.

The study also noted the data anomaly:

“Government transfer payments have ‘offset only a small fraction of the increase in pre-tax inequality,’ Piketty, Saez, and Zucman conclude—and those payments fail to bridge the gap for the bottom 50 percent because they go mostly to the middle class and the elderly.

Real Debt-To-Income Ratios

Here is the point. There is a vast difference between the level of indebtedness (per household)  for those in the bottom 80% versus those in the top 20%. 

Of course, the only saving grace for many American households is that artificially low-interest rates have reduced the average debt service levels. Unfortunately, those in the bottom 80% are still having a large chunk of their median disposable income eaten up by debt payments. Such reduces discretionary spending capacity even further.

The problem is quite clear. With interest rates already at historic lows, the consumer already heavily leveraged, and wage growth stagnant, the capability to increase consumption to foster higher economic growth rates is limited.

Such is also why interest rates CAN NOT rise by very much without triggering a debt-related crisis. The chart below is the interest service ratio on total consumer debt. (The graph is exceptionally optimistic as it assumes all consumer debt benchmarks to the 10-year treasury rate.)  While the media proclaims consumers are in great shape because interest service is low, it only takes small increases in rates to trigger a “recession” or “crisis” event.

An Illusion Of Prosperity

The illusion of the decline in the debt-to-income ratios obfuscates real economic problems and fosters the belief that policies are working.

They aren’t.

The majority of Americans cannot increase consumption, the driver of economic growth, without further increasing debt burdens. For those in the top-10% of the wealth holders, higher asset prices, tax cuts, etc. do not lead to increases in consumption as they are already at capacity. 

While the Federal Reserve’s ongoing interventions, stimulus programs, etc. have certainly boosted asset prices higher, the only real accomplishment has been a widening of the wealth gap. What monetary interventions have failed to accomplish is an increase in production to foster higher economic activity levels.

With the average American still living well beyond their means, the reality is that economic growth will remain mired at lower levels. Such is because the debt service continues to divert savings from productive investment. Of course, the issue is a central theme to the U.S. and the global economy.

The Debt Must Revert

The “structural shift” is quite apparent as high debt levels prohibit the productive investment necessary to fuel higher production rates, employment, wage growth, and consumption.

In the future, many will look back and ask the critical questions:

  1. Why did the government fail to use artificially low-interest rates and excessive liquidity to support the financial system’s deleveraging?
  2. With such low rates and liquidity support, why didn’t they refinance government debts and restructure unfunded social welfare systems?
  3. Why did they insist on continuing to go further into debt rather than working on real solutions to create a more prosperous economy for all?

The answer is that no one is willing to admit there is a problem. Nor are they willing to accept they have a responsibility in it. Politicians want to get re-elected. Individuals would preferably depend on government handouts rather than admit their financial failures.  

Unfortunately, until the deleveraging cycle is allowed to occur, the attainment of more robust and autonomous economic growth will remain elusive.

In the meantime, those in the top 10% of income brackets will continue to enjoy an increase in overall prosperity. For everyone else, it is highly unlikely that debt-to-income ratios have improved much.

Stimulus. No Stimulus. Market Bounces With Headlines.


In this issue of “Stimulus. No Stimulus. Market Bounces With Headlines.”

  • Market Bounces With Headlines
  • Back To Excess Optimism
  • Bull Now, Bear Later
  • Portfolio Positioning Update
  • MacroView: Recessions Are A Good Thing, Let Them Happen
  • Sector & Market Analysis
  • 401k Plan Manager

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


We Need You To Manage Our Growth.

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

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Catch Up On What You Missed Last Week


Market Bounces With Headlines

Over the past couple of weeks, markets haven’t paid much attention to the economic or earnings data but have drifted from one “stimulus” headline to the next.

You get the idea. The daily swings of the market have made it tough to navigate. However, as discussed Monday in our “3-Minutes” video, indicators were already suggesting price action would be weak.

Such was the case as stock prices drifted lower on the daily disappointment of failed stimulus talks.

Deal Or No Deal

The lack of stimulus is NOT surprising. As we stated on the #RealInvestmentShow many times, there is “no incentive” for either side to pass “stimulus” before the election. If the stimulus passes, President Trump will get credit for providing aid to the American people. Such a “feather in the cap” would be something the Democrats are unwilling to provide.

Zerohedge came to the same conclusion on Friday:

“House Speaker Nancy Pelosi told MSNBC a stimulus bill ‘can be passed before the Nov. 3 election if President Trump cooperates.’ However, hedging that statement, she stated that Trump has been ‘back and forth’ on a deal. She also added that Trump needs to get Senate Republicans to back any agreement. 

In response, the White House immediately countered with Press Secretary McEnany saying Pelosi is making it harder by not budging ‘even one inch’ on her stimulus demands.”

The market read between the lines and realized no “deal” is coming. While the markets were hammered initially, traders bid shares up on “hope” stimulus is still coming. The good news is that while the market remains in a downtrend, it continues to hold support at the 20-dma and 50-dma cross.

Market Back To Excess Optimism

What is most fascinating is that while Congress and the media are complaining about how the economy needs more stimulus, the market doesn’t agree. Despite the fact, there has been no stimulus passed, retail stores and the housing market have posted record sales. Restaurants are getting customers back, and credit card spending has picked up sharply from the lows, and, in Houston, traffic has returned.

The market is also picking up on the “recovery,” bifurcated as it may be, as stock market speculation has now surged back to records in both record low short-interest and options contracts.

As I noted on Tuesday in “Bulls Are All In, Again,” 

“Fed actions shifted the ‘risk appetite’ of investors through ‘perceived’ insurance against losses. As we head into a potentially contentious election, market ‘bulls’ are ‘all in’ again as hopes remain high that more ‘stimulus’ will soon come.

Since the Fed intervened in March, investor sentiment has gotten run back up to extremes despite the economy remaining amid a deep recession.”

Market Bulls All-In, Technically Speaking: Market Bulls Are “All-In” Again

I also pointed out that professional asset managers are also back to being fully long in portfolios.

“One of the sub-components of the ‘Fear/Greed’ gauge is the NAAIM index of professional investors, which measures the percentage allocation to that group’s equities. Currently, equity allocations of professional investors are back to full weightings. While such doesn’t mean the markets are about to crash, more often than not, their ‘bullishness’ has tended to be an excellent short-term ‘contrarian’  indicator.”

Market Bulls All-In, Technically Speaking: Market Bulls Are “All-In” Again

However, while the stock market is wildly bullish, there is a clear disconnect with the economic recovery, such as it may be.

The Great Disconnect

There is currently a “Great Divide” between a “recessionary” economy and a surging bull market in stocks. Given the relationship between the two, they both can’t be right.

The economy, earnings, and asset prices over time are highly correlated, as shown by the chart below.

stock market economy, Economically Speaking: The Stock Market Is Not The Economy?

Since 1947, earnings per share have grown at 6.21% annually, while the economy expanded by 6.47% annually. That close relationship in growth rates should be logical, particularly given the significant role consumer spending has in the GDP equation. 

The correlation between the two is shown in the chart below.

The current “negative correlation” is quite an anomaly given that corporate earnings are derived from economic activity. However, that relationship broke due to the massive amount of Federal Reserve interventions in the financial markets. Currently, the Fed owns the largest amount of the Treasury Bond market in history.

As shown above, the liquidity flowed into the most highly liquid equities (mega-caps.) Such led to a massive distortion in the markets between the vast majority of index constituents and a handful of mega-cap companies.

That distortion of the financial markets by the Federal Reserve has created an illusion that the stock market, which should represent the economy, is doing exceedingly well when it reality it isn’t.

Bull Now, Bear Later

The is no arguing the market is bullishly biased in the short-term. However, in the longer-term, slower economic growth rates will eventually impact companies’ ability to generate higher profit margins. Such will especially be the case in the event of Biden victory and higher tax rates.

Valuations remain problematic on many levels, but the distortion of the markets to the economy is most prevalent in the market capitalization to GDP ratio.

More importantly, the deviation of the market from long-term means remains extreme. With the markets overbought, extended, and, as noted above, extremely optimistic about the near-term future, the risk of a bigger correction remains elevated.

While the Federal Reserve, through its interventions, quickly abated the previous decline by not allowing for a reversion to occur, the risk of a secondary reversion remains.

In particular, pay attention to interest rates. The recent rise in interest rates, on the assumption of more stimulus leading to an inflationary impulse, has a long history of not playing well with equity markets. Higher interest rates undermine the market’s mantra of overpaying for assets on an equivalent yield basis.

As stated last week, “risk happens fast,” which is why we continue to encourage you to focus on your overall exposures.

Portfolio Positioning Update

As we have discussed with our RIAPro Subscribers (30-Day Risk-Free Trial) during the course of this week, we have been gradually raising cash and rebalancing portfolio risks as we head into the Presidential election.

During the course of the last three weeks, we discussed that markets, between the election and the end of the year, tend to be positive if there is a “clean election.” 

However, the market does not do well when there is a contested election where the outcome is unknown for several days to weeks. Such an event is what we deem to currently be a potential outcome given the large number of “mail-in” bailouts being cast this year due to the pandemic. Delayed collections, extended periods to count votes, etc., all suggest there could be a delay in the election process.

Raising Cash

We have increased our cash holdings during the past week, reduced our bond duration, and rebalanced equities. This is a process that we will continue into next week as more clarity emerges around the election and delivery of more stimulus.

While such actions may seem “silly” in a very bullish and exuberant market, let me repeat the critical mistakes investors most often make in managing their portfolios from last week.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

If the election process goes smoothly, we will quickly add back equity exposure in the areas that we think will benefit the most from the next president’s policies. If “risk happens,” we have cash, allowing us to take advantage of discounted asset prices the market gives us.

As noted last week, this is why we hold cash.

“Given the length of the current market advance, deteriorating internals, high valuations, and weak economic backdrop, reviewing cash as an asset class in your allocation may make some sense. Chasing yield at any cost has typically not ended well for most.”

The best asset any investor can have is “liquidity,” which provides “opportunity.” 


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

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


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.


Sector Model Analysis & Risk Ranges

How To Read.

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


Weekly Stock Screens

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

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

S&P 500 Growth Screen

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

Aggressive Growth Strategy


Portfolio / Client Update

As stated last week, the good news is the support levels just below Friday’s closing levels, with the 20-dma crossing back above the 50-dma, are holding. Such should keep the markets fairly range-bound heading into next week.

The not-so-good news is that we are just one week away from the Presidential election, which potentially argues for more market volatility. Our biggest concern remains the risk of a contested election. As noted in the main body of this week’s newsletter:

“Over the past week, we have increased our cash holdings, reduced our bond duration, and rebalanced equities. This is a process that we will continue into next week as more clarity emerges around the election and delivery of more stimulus.

While such actions may seem “silly” in a very bullish and exuberant market, let me repeat from last week the critical mistakes investors most often make in managing their portfolios.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later.

If the election process goes smoothly, we will quickly add back equity exposure in the areas that we think will benefit the most from the policies of the next President. If “risk happens,” we have cash which will allow us to take advantage of discounted asset prices the market gives us.”

We are keenly aware of the risk and continue to take action to position ourselves accordingly.

Portfolio Changes

Over the course of the past week, we took several actions to increase cash in portfolios to provide a downside hedge.

In the Equity & ETF Models, we sold 5% of our Treasury Bond (TLT) position to lower duration currently as interest rates are temporarily under the pressure of more stimulus expectations. The belief is that more stimulus will lead to inflation and higher rates. As we have repeatedly discussed, the stimulus is actually “deflationary” as it uses debt for a one-time boost. While we temporarily reduced our holdings, we are setting up for an excellent opportunity to add back to our holdings for a sizable gain in the future.

We also sold ATT (T). While we like the position from a “value” perspective, it violated our stop-loss levels. We used the earnings announcement to remove the portfolios’ position to reduce an underperforming asset’s drag. While we still believe that “value” will eventually be the “place to be,” the market doesn’t agree with us currently.

We are currently holding roughly 15% in cash, along with our bond holdings and reduced equity weightings. We will likely take further actions next week, depending on market actions, to further shore up our defenses.

Our short-term concern is protecting your portfolio. Once we get through the election, we can focus on the economic recovery and where we go from here.

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

Nick Lane: The Value Seeker Report- Energy Sector Part I

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

In this edition of the Value Seeker Report, we provide some initial high level thoughts on the energy sector. We plan to follow up on this report with an analysis of a few companies that we see value in.

Overview

  • The Energy sector lies among those most battered and bruised by the pandemic. To further complicate matters, the United States is approaching a Presidential election between two candidates with starkly different views on Energy.
  • While the S&P 500 has climbed back to positive territory year-to-date, XLE remains down nearly 50% since January 1st.
  • While there are many headwinds for the energy sector, the valuations of some energy stocks are well below fair value.

Why The Cold Shoulder?

  • We think there are four major factors that may help explain investors’ apathy toward energy stocks. Two of them are related to weak demand for oil and gas, one related to market forces, and one related to politics.
  • Quite obviously, regional lockdowns and associated limitations on travel are a big problem for stocks in the energy sector. The collapse in worldwide demand is wreaking havoc on crude oil and natural gas prices, which directly affects revenue and profits. As much as we would like to be winning the fight against COVID, winter is quickly approaching in the US, and we see limited signs of demand recovery.
  • There is also the issue of whether the US will receive additional stimulus in the coming months. The economic recovery is slowing, and further delay of stimulus will only make things worse. Stimulus will play a key role in the demand for crude products in the fourth quarter. Making this factor tough to game, it appears that both parties are playing political football without regard to the Americans suffering as a result.
  • A delay in demand recovery is a valid concern, but if it justifies the recent performance of XLE, then we should also see it reflected in the price of crude oil. Since May when economic recovery took hold and oil prices recovered, the price of XLE as a ratio to crude oil prices has been cut in half.
  • It is important to point out a negative for that sector that will be a long term positive. As a result of weakened demand and teetering balance sheets, many wells have been shut-in. As of September, the Baker Hughes Worldwide Rig Count stands at 1019. Not only is that lower than in the spring and summer, but the lowest since at least 1975. The U.S. rig count is also at 45-year lows.
  • Further hurting energy stocks are popular investment trends. The rise of passive investing and demand for index ETFs create imbalances, leading to market inefficiencies over time. As our portfolio manager, Michael Lebowitz, recently wrote in The Market’s Invisible Guardrails Are Missing, “The massive surge in passive strategies’ popularity has pushed the market to the brink of instability. Instability can result in price surges to unprecedented valuations”. Consider this. For every $100 invested in SPY, $25 goes to technology, $14 goes to health care, but only $2 is invested in energy. Imagine this effect on a market being led higher by passive investors. Still, is this significant enough to explain the troubles of XLE?
  • A significant factor to consider is the policy implications that this election may have in store for the energy sector.

Energy Stocks and The Election

  • The outcome of this election carries important implications for stocks in the energy sector. The two candidates, President Trump and former Vice President Joe Biden possess diverging views on the issue of climate change.
  • Mr. Biden is making his campaign based, in part, on laying the groundwork for the United States’ push towards green energy. While Biden plans to roll out a $2T plan of action, President Trump would likely maintain the status quo in the energy sector.
  • Whether you believe the polls or not, they suggest that Biden has held a lead for quite some time, and it seems that the stock market is taking this into consideration. As shown below, the returns on XLE began to diverge from those of the overall market in late June. Then, on August 11th, Biden announced Senator Kamala Harris as his running mate. That same day, XLE entered a bearish price channel and the divergence widened to where it is today.

What Would a Biden Administration Really Mean for Energy Stocks?

  • We cannot definitively say what a Biden administration would mean for energy stocks, as there are a multitude of factors at play. Although we do have an idea based on what we see in the futures market for WTI crude.
  • According to Joebiden.com, “Biden will make a $2 trillion accelerated investment, with a plan to deploy those resources over his first term, setting us on an irreversible course to meet the ambitious climate progress that science demands”. Further, in last night’s debate, Biden openly acknowledged his intention to move away from fossil fuels. What Biden’s campaign site leaves unmentioned is that this will likely include regulations that create headwinds for the US shale industry. US shale oil makes up roughly 8% of global production. If onerous policies are implemented in the current economic environment, resulting headwinds will raise breakeven prices for US shale drillers and lead to increased bankruptcies. Incentives to transition to clean energy could result in bankrupt drillers’ reserves being “left on the table”. This combined with the previously mentioned worldwide rig count could lead to a lower long-term supply of crude, even as demand recovers. While certain drillers may struggle, reducing global supply by 8% would have a massive positive effect on the price of oil, thereby benefiting low cost producers in the sector.
  • What some investors fail to consider is how many of the everyday products that the world consumes are derived from crude oil and its byproducts. A Biden policy which results in less US shale production, and consequently a higher crude price, could create significant inflation for the working-class. Not the “good kind”, fueled by demand, that the Fed prefers. The US could see cost-push inflation, which would be especially destructive in a fragile post-COVID economy.
  • Thus, because of inflationary and economic implications, we do not believe it is feasible for Biden to implement the type of policies that investors appear to expect in a first four-year term.
  • Finally, we still lack the technology necessary to make the transition to green energy that Biden envisions. We require more efficient storage and long-distance transmission before new technologies will get moving at scale, but that does not curb Biden’s belief in “spend and the breakthrough innovation will come”.
  • In the end, it is impossible to know whether a Biden victory would be good or bad for the Energy sector, but we think the stock market is overreacting to this prospect. The futures market for WTI crude may be calling Biden’s bluff, or it could be picking up on something else, but it is telling a different tale than XLE.
  • It is worth adding that many of the major oil companies are making significant investments in green energy. In the long run, some of these companies are well-positioned for a transition to green energy.
Latest Report DateTickerLast Close PriceIntrinsic ValueForecast Upside RemainingOriginal Conviction RatingCurrent Conviction RatingCurrently Held in RIA Pro Portfolio?
8/6/2020T$ 28.28$ 38.0934.7%3-Star2-StarNo
8/13/2020XOM$ 34.86$ 55.4259.0%3-Star2-StarNo
8/28/2020VIAC$ 29.10$ 36.7026.1%4-Star2-StarNo
9/3/2020DOX$ 57.29$ 76.7634.0%3-Star3-StarYes
9/11/2020CVS$ 59.48$ 85.3543.5%3-Star3-StarYes
9/18/2020PETS$ 29.99$ 41.1437.2%3-Star3-StarNo
9/24/2020SPB$ 61.33$ 61.18-0.2%4-Star4-StarNo
10/2/2020DKS$ 59.53$ 68.7615.5%4-Star4-StarNo
10/9/2020WCC$ 44.98$ 61.4236.5%4-Star4-StarNo

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

Technical Value Scorecard Report For The Week of 10-23-20

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

Commentary 10-23-20

  • On a relative value and absolute basis Utilities and Transports are grossly overbought. We reduced our exposure to utilities a week ago and will likely further reduce it shortly. On an absolute basis, Utilities are now registering the highest score (12.02 or 89% of the max) that we have seen over the last few months. Technology (XLK), the prior hot sector, maxed at 10.5 in mid-August. We already have minimal exposure to the transportation sector.
  • Financials continue to show signs of life. Its normalized relative score is extended at two standard deviations, but its score is at fair value. The discrepancy is a function of how weak XLF has traded over the last few months. Energy is similar with a sigma at fair value yet a very weak score.
  • Real Estate continues to look weak, and given potential credit issues that may come to the forefront in the coming months, we are not tempted to increase exposure. We are being careful in the equity model to avoid commercial real estate REITs.
  • Small caps, Midcaps, and emerging markets are moving further into overbought territory as the reflation trade continues. Essentially they are playing catchup to the market.
  • Other than the high yield sector, bond asset classes are trending weaker. Given the back up in interest rates, this is not surprising. We suspect rates may go higher but the ceiling is not far away as the economy is overly sensitive to interest rates. To wit, the housing market has been on fire in large part to record-low mortgage rates.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

#MacroView: Policies Over Politics. Whoever Wins, We All Lose

As we near the 2020 Presidential election, rhetoric from both sides is ramping up. Depending on your personal “echo chamber” of social media, you are likely confident why your candidate is the best choice, and the opposition is the worst. However, when it comes to economic prosperity and the financial markets, who is the best choice? To answer that question, we will focus on the “policies,” not the “politics.”


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP, for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for.

  • When: TOMORROW – Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)
Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade 10-16-20

The Great Divide

One of the great tragedies of the modern age is that we have stopped “listening” to each other. There was a time when individuals could have a conversation about political issues. While neither person would change their position, they could politely agree to disagree. Today, the media has locked individuals into “information silos” where they disregard any “facts” which conflict with personal bias. If an intruder infiltrates the space, the “mob” levies a torrent of hate-filled expletives and threats

More than ever, such is the case in 2020.

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

Today, the division between parties is greater than at any other single point in history. (2017 was the latest data from a 2019 report. That gap is even larger currently as Social Media fuels the divide.) The divide between parties has many dire long-term outcomes, from transitioning to a socialistic economy to the lack of real positive changes.

Pre-Election Correction, The Pre-Election Correction Continues, Is It Over? 09-18-20

How can progress occur when no one is willing to listen, much compromise, with anyone else?

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

The Cynic In Me

In 2020, both parties are proposing fairly disastrous policies.

Biden’s proposed tax changes, green energy plans, and Government takeover of “healthcare” would indeed be bad for the markets. Such policies would weaken corporate profitability, specific sectors (energy and healthcare) would come under stress, and the surge in debt will make the Fed’s programs less effective.

On the other hand, Trump’s plans are not much better economically. More bailouts, poorly chosen infrastructure projects, and proposed tax policy lead to further indebtedness, larger deficits, and slower economic growth.

However, the reality is that while Presidential candidates make lots of claims on the campaign trail, it is Wall Street and Corporations that ultimately dictate policy. Such is why many suggest that our Congressmen wear racing jackets to see who is sponsoring them for office.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

If you think for a moment that Congress comes up with, and writes, bills on their own, you are sadly mistaken. They are not that smart. Such is why whenever bills come to the floor for a vote, they always favor the group or industry whose lobby wrote and promoted the bill in the beginning.

I am not cynical. It is just how the Government works.

Okay, let’s dig into the policies with some help from our friends at the Committee For A Responsible Federal Budget (CFRB)

The Proposed Policies

“President Donald Trump has issued a 54 bullet point agenda. It calls for lowering taxes, strengthening the military, increasing infrastructure spending, expanding spending on veterans and space travel. It also calls for lowering drug prices, expanding school and health care choice, ending wars abroad, and reducing spending on immigrants. He also has proposed a “Platinum Plan” for black Americans, which increases spending on education and small businesses.

Meanwhile, Vice President Joe Biden has proposed a detailed agenda. From increasing spending on child care and education, health care, and retirement, to disability benefits, infrastructure, research, and climate change. It also aims to lower the costs of prescription drugs, ending wars abroad, and increasing taxes on high-income households and corporations.

Under our central estimate, both plans would add substantially to the debt. Specifically, we find the Trump plan would add $4.95 trillion to the debt over the 2021 to 2030 budget window. The Biden plan would add $5.60 trillion.” – CFRB

Market Regains Footing Stimulus, Market Regains Footing On Hopes Of More Stimulus 10-09-20

The table below breaks down the spending by candidates in different areas of the economy.

Market Regains Footing Stimulus, Market Regains Footing On Hopes Of More Stimulus 10-09-20

Assuming that both candidates were able to get their respective policies passed, which is highly doubtful, the impact on economic growth will be negative as the Federal debt surges higher.

Retirement Income, Retirement Income Planning Truth with Jim Otar. Part 1.

The Cost

“Under the candidates’ plans, debt will continue to grow over the next decade and beyond.  Debt has already grown from 39 percent of the economy in 2008 to 76 percent in 2016. It is estimated to reach 98 percent by the end of FY2020. Under current law. The Congressional Budget Office (CBO) projects debt will continue to rise to 109 percent of GDP by 2030.

Our central estimate of the Trump plan finds debt would rise to 125 percent of the economy by 2030, excluding the effects of further COVID relief. Under our central estimate of the Biden plan, debt would rise to 128 percent of the economy by 2030, again excluding COVID proposals. For context, the standing historical record for debt is 106 percent of GDP, set just after World War II.” – CFRB.

As discussed in CBO & The One-Way Trip Of American Debt,” instead of running on a policy platform to reduce spending and the debt, both candidates have decided that more deficit spending is the only solution.

Debt continues to increase in most years thereafter, reaching 195 percent of GDP by 2050. That amount of debt will be the highest in the nation’s history, and will increase further. High and rising federal debt makes the economy more vulnerable to rising interest rates and, depending on financing of the debt, rising inflation. The growing debt burden also raises borrowing costs and slows the growth of the economy and national income. There is an increased risk of a fiscal crisis or a gradual decline in the value of Treasury securities.” – CBO

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

The Debt

The policies put forth by both President Trump and Joe Biden require substantial debt issuance to meet those objectives. Given that mandatory spending already consumes more than 100% of Federal revenues, the debt increases will be massive.

Unfortunately, what continues to elude policy-makers in Washington is that the continuing expansion of debt erodes economic growth.

It is a myth that the economy has grown by roughly 5% since 1980. In reality, economic growth rates have been steadily declining over the past 40 years, supported by a massive push into deficit spending by both the Government and consumers.

Up until 1980, economic growth was trending higher from roughly 5% to a peak of nearly 15%. There were a couple of reasons for this.

  1. Lower levels of debt allowed for personal savings to remain robust, fueling productive investment in the economy.
  2. The focus of the economy was primarily on production and manufacturing, which has a high multiplier effect on the economy. 

Unlike the steadily growing economic environment before 1980, the post-1980 economy has experienced a steady decline. Therefore, a statement the economy has been growing at 5% since 1980 is grossly misleading. The trend of economic growth, wages, and productivity (5-year averages) show the real problem.

As wages declined, families turned to credit to fill the gap in maintaining their current living standards. What should be evident is that it requires increasing amounts of debt to create each dollar of economic growth. Such is due to the “diminished rate of return” for each successive increase in debt-funded growth.

Debt Isn’t The Answer

Such is one of the primary reasons why economic growth will continue to run at lower levels going into the future. As I showed just recently in the “2nd Derivative Of Debt:”

“From 1947 to 2008, the U.S. economy had real, inflation-adjusted economic growth than had a linear growth trend of 3.2%.

However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve provided policies that fostered even greater unproductive debt and leverage levels.

Coming out of the 2020 recession, the economic trend of growth will be somewhere between 1.5% and 1.75%. Given the amount of debt added to the overall system, the ongoing debt service will continue to retard economic growth.”

stimulus 2nd derivative effect, #MacroView: More Stimulus And The 2nd Derivative Effect

Given the permanent loss in output and rising unproductive debt levels, the recovery will be slower and more protracted than those hoping for a “V-shaped” recovery. Notably, the U.S. economy will never return to either its long-term linear or exponential growth trends.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

The Markets

The Republicans claim that Biden will crash the market. The Democrats suggest the same with President Trump. From a portfolio management perspective, we need to understand what happens during election years to stock markets and investor returns.

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

Pre-Election Correction, The Pre-Election Correction Continues, Is It Over? 09-18-20

However, it is worth noting that while returns are positive regardless of who is elected, it should be of no surprise the markets performed better during a year when voters re-elect the incumbent. 

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

The market hates uncertainty. 

What markets do prefer is political gridlock.”

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

Pre-Election Correction, The Pre-Election Correction Continues, Is It Over? 09-18-20

It’s Not A Risk-Free Outcome

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

I don’t envy the person who takes the Oval Office in the months ahead. Whoever is inaugurated on January 20, 2021, will enormous fiscal challenges as trillion-dollar annual budget deficits will become the new normal. As we discussed recently, the national debt is projected to exceed the post-World War II record high over the next four-year term and reach twice the economy’s size within 30 years.

Four major trust funds are also headed for insolvency, including the Highway and Medicare Hospital Insurance trust funds, within the next presidential term. Furthermore, economic growth rates will continue to decline as the “wealth gap” widens.

There is no “will” to fix the problems plaguing the economy and welfare system before they break. Such is why whoever wins the Presidency, we all still wind up losing.

#WhatYouMissed On RIA This Week: 10-23-20

What You Missed On RIA This Week Ending 10-23-20

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

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


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for. 

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)

What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 10-23-20


What You Missed: Video Of The Week

Michael Lebowitz, CFA and I discuss the impact of a Trump or Biden Presidency on the markets, economy and the Fed. Also, what Mike and I would do if elected to get the country back on track to long-term economic prosperity.



Our Best Tweets For The Week: 10-23-20

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Seth Levine: Back To The Future With Private Investments

Back to the future with private investments.

I often feel like the financial markets are crumbling around me. It’s not their price levels that trouble me, but their health. The capital markets are a tremendous boon to humanity. However, intrusive central bank and government policies seem to strangle the golden geese of capitalism and free markets increasingly. Some argue that the neurotic obsessions with market stability are killing active investment management and disarming the very mechanisms that make financial markets invaluable. The decline is inevitable; the only question is whether it comes slowly or as a quick collapse. While I’m sympathetic to this perspective, what if we humans are better and smarter than credited? What if the investment markets aren’t dying but evolving to circumvent the unwanted barriers?

Let’s face it; it’s hard being human. The world is highly complex, fret with imperfect information. It isn’t easy to make sense of things. Often, multiple explanations can seem just as plausible, given the same set of facts. As conceptual animals, chaos is paralyzing and uncomfortable. Perhaps this is why we seek narratives; they help explain phenomena and enable action. However, even the most water-tight narrative can spring a leak, given new information or a different perspective. I’m beginning to see the expansion of private investment markets in this light. I had viewed their growth as negative at first but now think differently.

If It Bleeds It Leads

Investing today is as hard as it’s ever been. Bond yields are the lowest in history. Equities appear overvalued. Alpha—the amount of excess return available to active investment managers—is a mere fraction of what it had been. Everything’s gone passive. There’s no return to be had no matter how hard one tries. Why is this happening?

Active manager “alpha” has been falling for decades in equity markets.
Source: Logica Capital Advisors, LLC

To some, these conditions indicate the market’s demise. Central bank intervention has reached such a large degree that the capital markets can no longer function properly. They’re rigged to rise. Stripped of the freedom to fluctuate, investment markets can no longer provide the critical price signals they are designed to deliver.

Furthermore, investors are flocking to private markets. Private equity, venture capital, direct lending, and other investment strategies are on the rise. Starved for yield, investors ignore obvious risks to make an extra few basis points of return. It’s pure debauchery. Society is in decay, so the story goes.

Source: Counterpoint Global Insights

Back To The Future

Source: Counterpoint Global Insights

More is Better

To be sure, the shift from public to private investing comes with risks. First and foremost, most individuals are shut out from private investment markets. Only large, institutional investors have access due to regulations and practical matters. Also, reporting standards for private companies can vary and require more sophistication to decipher. They are more bespoke than for public companies. Another risk is that return dispersion is wide, indicating the importance of proprietary deal flow.

The largest drawback of private investments versus public ones is their illiquidity. Private investments are harder to sell and convert into cash. Hence, their values can be difficult to assess during one’s holding period accurately. This feature has likely dampened private investments’ perceived volatility and their correlations with other assets, thereby understating their true risks.

Source: Counterpoint Global Insights

However, private market investing also has benefits. First, they tend to have higher returns to compensate investors for the (obvious) drawbacks. Their institutional ownership also yields advantages. Governance and operational efficiencies can improve with more sophisticated owners. Also, capital markets’ professionalization likely facilitates a greater number of value-creating financial transactions and with greater complexity. These have widespread positive impacts.

Source: Counterpoint Global Insights

Above all, though, private markets increase available investment choices. More options allow for more experimentation, the greater discovery of financial knowledge, and, ultimately, increased prosperity. This is critical when government interventions in public markets stunt their growth.

Private markets can act as a safety valve and allow capital to leave the markets forcing it into suboptimal investments and allowing it to flow into better alternatives.

Source: Counterpoint Global Insights

Life Finds a Way

While the public markets appear to be dying by the hands of central bankers, passive investors, and any number of bogymen, private investments are undergoing a renaissance. Inflows into private equity, venture capital, and private debt markets have surged over the years as investors seek new and higher return streams. While they’re no panacea, the growth in private investment markets may not be the decay that’s popularly claimed.

The growth in private investing illustrates the power of free-flowing capital. Humanity is too creative to let harmful, artificial barriers slow progress. Life always finds the way. While capital allocators are going extinct in public markets, they are reborn in private ones.

Investment markets are not dead. They are evolving. This movement should ultimately facilitate financial innovation, increase productivity, and create more prosperity for all.

Shedlock: Unemployment Claims Drop For The Wrong Reason

While the recent drop in unemployment claims was celebrated by the markets and media, it shouldn’t have been. The drop in unemployment claims occurred for the wrong reason.

Continued Claims

Continued state unemployment claims lag initial claims by a week, and are more important than initial claims. It is continued claims that determine the official unemployment rate.

The rate is set by survey on the week that contains the 13th of the month, the weeks in boxes.

Suspect Improvement

Last week I reported “Seasonally-adjusted continued claims fell from 11,183,000 last week to 10,018,00 this week.”

This week we see continued claims fell from 9,373,000 to 8,373,000.

We had massive revisions primarily in California which was investigating fraud. 

Continued Claims Distortions

  1. BLS Methodology Change on August 29.
  2. California is so messed up it froze reporting. California is now reporting
  3. People in some states have expired all of their state benefits and thus fell off the rolls.

In a subsequent post, I will take a deeper look at expiring benefits. 

Expired benefits are not a good reason for claims to be dropping. Expect more of it.  

Initial Claims

Initial  State Unemployment Claims in 2020 October 22  Report

Initial claims continue a very slow downward trend. They were also impacted by California which is now back reporting. 

Given the recent surge in Covid cases and state restrictions, we are likely to see a reversal in initial claims. 

Initial claims and continued claims are seasonally adjusted.

Primary PUA Claims In 2020

Primary PUA Claims in 2020 October 22  Report

Primary Pandemic Unemployment Assistance

Unlike state claims, PUA applies to people working part-time, gig workers, and self-employed workers who do not qualify regular state unemployment programs.

The PUA claims are not seasonally adjusted. They were heavily revised due to California.

Over 10 million people receive PUA. This is where most of the fraud is hidden.

I suspect most of it is not fraud, but no one knows the real numbers due to the loosy-goosy nature of the program.

In terms of determining unemployment, I believe that at least 2 million of those 10 million are genuinely unemployed.

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

All Continued Claims In 2020

All Continued Claims in 2020 October 22  Report

Like PUA Claims, All Continued Claims are not seasonally adjusted.

They lag continued claims by a week and initial claims by 2 weeks. 

Over 23 million people receive some assistance. That number, minus fraud and mistakes should match the U6 (alternate unemployment rate) but it doesn’t. 

Pandemic Emergency Unemployment Compensation 

PEUC is part of all continued claims but it is worth special mention. 

PEUC automatically kicks in for a period of time after state benefits expire.  

Expect further increases in PEUC claims as regular state benefits expire.

Most states offer 26 weeks of unemployment insurance, but some states way less.

These numbers lag initial claims by two weeks and continued claims by a week and are thus a bit stale.

Explaining the Drop in Continued Claims

PEUC claims jumped from 2,786,333 on September 26 to 3,296,156 on October 3.

That’s a rise of 509,823. Since it lags, the current number is higher.

A drop in continued claims accompanied by a rise in PEUC claims is not an improvement at all. 

PEUC claims now total over 3 million. Add that number to continued claims for a better estimate of what’s really going on.

Trump vs. Biden on the Economy, Fed, and Markets

Trump vs. Biden on the Economy, Fed, and Markets

On November 3, 2020, the White House, one-third of the Senate, and the entire House of Representatives are on the ballot. In case it is not obvious, this election will be significant.

In the current politically charged environment, either Presidential candidate will be powerless to enact significant change if the opposing party holds a majority in the Senate and House. Conversely, a sweep whereby the President and both houses are from the same party can produce substantial change.

This article’s focus is on Donald Trump’s and Joe Biden’s policies; however, we stress the outcome of the legislative elections may nullify or exaggerate our forthcoming thoughts.

Does It Matter?

The age of passive investing is upon us. Passive investors do not assess earnings or economic factors. They buy and sell based on cash on hand or cash needs. They are price insensitive. It is a brain-dead strategy.

It is tempting to conclude that the election will not matter in this environment. That might be true, but this current bit of investor irrationality will end. When it does, we would be well-served to understand the economic underpinnings of corporations. Therefore, it is incumbent upon us to review the candidates and consider how they might affect the economy, Fed, and, ultimately, the financial markets.

The following sections provide our unbiased opinions on how Donald Trump and Joe Biden are likely to approach critical economic matters if elected.

International Trade

The most significant change in international trade over the last 40+ years is the “America First” stance Donald Trump hoisted onto global trade. His policy was most evident in China relations.

Trump is the first President to attack China’s trade policies since they became an exporting powerhouse. Not only did he put $350bn in tariffs on China, but pledges more negotiations if wins. The effectiveness of actions is questionable, but they are a step in the right direction to reduce our trade deficit and become less dependent on a totalitarian adversary.

Biden seems to agree with Trump’s stance on China and may leave the tariffs in place. We are less sure as to whether he will take the baton and stay aggressive.

The more significant difference between them lies in how they manage relationships with our second and third biggest trade partners, Canada and Mexico, as well as Europe and Japan. Trump has upped rhetoric towards these countries and introduced tariffs in some cases. We suspect similar actions will continue under a second term as he aims to level the trade playing field.

Biden will likely be friendlier to our allies and much less likely to buck current trade norms. Any trade agreement/pact in place is much more likely to remain intact under Biden than Trump.

The dollar may fare worse under Trump as his actions will incentivize foreign nations to use their currencies for trade.

Taxes

Trump reduced taxes in 2018 and is now allowing the deferral of payroll taxes for lower and middle-class wage earners. Both changes are temporary but Trump promises to make them permanent if he wins a second term. He is also likely to push for further tax cuts for individuals and corporations. The tweet below speaks volumes.

Biden’s team has made a variety of tax proposals, but we can outline the “Big 5” –

  1. Raising the top income tax rate on regular income to 39.6% from 37.0%
  2. Raising the corporate tax rate to 28% from 21%
  3. Ending the step-up basis at death
  4. Treating long-term capital gains and qualified dividends as regular income for those earning over $1 million
  5. Applying the social security payroll tax on incomes over $400,000

Needless to say, Biden appears likely to increase taxes on the wealthy. It is unclear how Biden will treat lower and middle-income taxpayers.

JP Morgan believes stockholders may see an increase in their tax burden under a Biden presidency. Per JP Morgan “Biden’s proposal is for the maximum tax rate for long-term capital gains to rise to 39.6% from 23.8% currently, a 66% proportional rise.

All of the “Big 5” are controversial and politically charged, so a Biden-Harris administration would probably need more than a 51 or 52 Senate advantage to enact some or all the changes.

Regulations

Trump is perceived to be business-friendly as he rolled back a large number of regulations. Some of the key regulations include those in agriculture, education, environmental, finance, health, housing, labor, and transportation.

In Trump’s words- “For every one new regulation added, nearly eight regulations have been terminated.”  We expect more deregulation under a second term. From a shareholder perspective, this will be favorable for corporate earnings.

Biden is likely to walk back some of Trump’s regulatory actions, especially those affecting labor, environment, and housing. The energy sector probably has the most at risk.

Trump has opened up drillable land and waters and promoted pipelines. He is even trying to keep the coal industry alive. His agenda is very much pro domestic carbon energy.

As was the case under Obama, the Biden-Harris administration will be greener. They will probably create headwinds for the carbon-based energy industry while favoring renewable energy. The “Green New Deal” liberal wing of the Democratic Party has a strong voice and power to persuade legislation.

Biden and Harris are accused of wanting to shut down fracking. Although they have been documented as having said it, they both deny it. Natural Gas, on the other hand, maybe more at risk. Per Bloomberg: “Biden’s plan could speed up natural gas becoming “economically and environmentally untenable within the power sector.”

Under Biden, renewable energy producers are likely to benefit. This helps explains why TAN (Invesco’s solar ETF) has been surging as Biden’s polling lead expands.

Biden will likely try to re-engage in the Paris Climate Agreement and possibly enter the U.S. into other global environmental pacts. Again, those companies in alternative energy space should benefit at the expense of carbon-based companies.

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

Deficit Spending

One thing we can count on from both candidates is massive fiscal deficits. In the first debate, both candidates made it clear that spending, albeit on different items, is a top priority. They both recognize that economic growth is heavily reliant on federal spending. As we know, electability heavily rests on economic activity.

One crucial difference between the two is that Biden will likely spend more than Trump but will raise taxes. Trump may spend less but cut taxes. At the end of the day, both are likely to administer trillion-dollar-plus annual deficits

Before COVID, Trump averaged deficits of almost $800 billion per year. In the current fiscal year ending this month, he will administer a record $3.1 Trillion deficit. That deficit is massive, even by 2009/10 recession standards.

While government spending accelerated under Trump due to COVID, we should expect similar trends if Biden is the President. He says he will introduce over five trillion dollars in additional spending to what is already in forecasts.

Trump is more likely to focus on defense spending, while Biden on infrastructure and social causes.

Both will perpetuate the deficit problems. Companies that are closer to the Treasury’s money spigot are likely to benefit the most. As discussed earlier, policy implementation is dependent on the composition of the House and Senate and the ability of Congress and the President to work together.

“Under our central estimate, neither major candidate for President of the United States in 2020 has put forward a plan that would address our unsustainable fiscal path. Instead, both President Donald Trump and former Vice President Joe Biden have promoted policy agendas that would likely significantly add to annual deficits and increase debt-to-GDP over the next decade.” – The Cost of the Trump and Biden Campaign Plans – Committee for a Responsible Federal Budget (CRFB)

Federal Reserve

Chairman Jerome Powell’s current term ends in February 2022. We suspect that both candidates are likely to keep him at the helm. While Trump had public qualms with Powell, Powell seemed to redeem himself with the COVID era policy. Powell’s Fed has, and continues to provide monetary stimulus to a level this country has never seen before. Markets are up in large part due to the Fed flooding the system with liquidity. Despite his criticism of Jerome Powell, President Trump has been a beneficiary of Federal Reserve policies.

While Powell is a Republican, we think Biden could likely keep him aboard as well for similar reasons.

COVID

When assessing COVID from an economic standpoint, it may not matter who the President is. As we have learned, much of the power to restrict economic activity lies at the state, county, and city levels. Further, most individuals, regardless of restrictions, take matters into their own hands.

Biden is much more likely to encourage restrictions than Trump. Indeed, both candidates will aggressively push for a vaccine and treatments.

Summary

In 2016, as it became evident that Trump would beat Hillary Clinton, the market plummeted. It followed the “Trump is bad for the market” narrative of the time. In 24 hours, the market ran an audible with a new “Trump is pro-market” narrative.

Coincidently, until a few weeks ago, Trump was considered good for the Market and Biden bad. Biden has extended his lead in polling, and not surprisingly, the narrative changed. Biden’s massive spending plans can only be good for stock prices, they say.

As we noted earlier, a President’s power is dependent on the composition of the House and Senate. If the future President is working with the opposite party in Congress, less is likely to occur. As such, many of the differences noted above may not matter. Conversely, if one party sweeps the legislative and executive branches, the differences will be significant.

One final consideration. We know what we are getting with Trump. Despite nearly 50 years in government, Biden is a wild card. He has shown a willingness to change prior long-held views to accommodate the quickly evolving liberal wing of his party. How will that play out if Biden wins the election? Will he take on the platform of his party’s very liberal side, or will he maintain the more moderate views he has held consistently over his lifetime?

Sector Buy/Sell Review: 10-20-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 10-20-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when. It also guides what sectors to overweight or underweight to achieve better performance.

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

There are three primary components to each chart below:

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

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

SECTOR BUY/SELL REVIEW: 10-20-20

Basic Materials

  • XLB held support and bounced off the 50-dma surging back to its previous highs. There is now a double-top with a more extreme overbought condition. 
  • Take profits on trading positions and look for a correction back to support to increase sizing.
  • Momentum is good, but it is still underperforming the market as a whole.
  • Keep stops on trading positions at the 50-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: Hold Positions
    • Stop-Loss moved up to $62
  • Long-Term Positioning: Bullish

Communications

  • Communications is continuing to flirt with its 50-dma support level. 
  • The uptrend remains intact, but XLC is underperforming the broad market while working off its overbought condition. This will likely provide a good setup for a trade post-election, but keep stops in place for now. 
  • Stops remain at $58.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Bullish

Energy

  • Energy did bounce off of recent lows but failed to do much with it. Energy is massively underperforming the broad index and will retest recent lows. 
  • The lows must hold, or XLE is going to retest the March lows. 
  • The overall trend is fragile, remain clear for now.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Bearish

Financials

  • Financials continue to underperform, and the “earnings bounce” has now reversed.
  • XLF is testing it’s 50- and 200-dma with a “Golden Cross” now in place. If XLF can hold support and rally, there is a decent upside for the sector. A failure at support will be very disappointing. 
  • We saw the same bounce last quarter that eventually failed, but there wasn’t a positive bias to the moving averages. So, give financials a little breathing room. 
  • We are still avoiding the sector for now, but we will add holdings to our portfolios if support holds and performance improves.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Industrials

  • XLI has rallied sharply and is back to extreme overbought levels and extensions.
  • We are holding our exposure for now, but take profits and rebalance risks as needed. 
  • XLI is pushing back up into the 3-standard deviations of the 50-dma and is underperforming the S&P. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bullish

Technology

  • Technology stocks and the Nasdaq failed at a lower high than previous, which is concerning. 
  • The sector is back to very overbought and is now running into the previous resistance. 
  • Beware of short-term risks, but the 50-dma is holding for now. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Hold positions
  • Stop-loss moved up to $110
  • Long-Term Positioning: Bullish

Staples

  • XLP has exploded higher over the week and went back into extreme overbought territory. The correction on Monday was not surprising. 
  • The sector is back to very overbought and well above the 50-dma, so more correction is likely. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $62 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Real Estate

  • Last week, XLRE rallied back into previous resistance. On Monday, the sell-off took it back below the 50-dma. 
  • Last week, we noted that XLRE was very overbought and extended with multiple tops providing resistance at current levels. That resistance proved to be too formidable for now. 
  • Move stop-losses up to the 200-dma.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Utilities

  • XLU had been struggling with resistance at the 200-dma. However, XLU surged back to extremely overbought conditions after breaking above resistance. 
  • XLU is now 4-standard deviations above the moving average. 
  • Take profits and rebalance risk. 
  • Short-Term Positioning: Neutral
    • Last week: Reduced XLRE by 50%.
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV is sitting on its 50-dma and needs to hold here. 
  • The previous overbought conditions have been resolved and are still intact. Use weakness to add to holdings.
  • The 200-dma is now essential price support for XLV.
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Discretionary

  • XLY rallied back to new highs last week after we added exposure and is extremely extended. 
  • Take profits and rebalance risk. The 50-dma is an important initial support. 
  • Stop-loss moved to $140
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Long-Term Positioning: Bullish

Transportation

  • Transportation has been rallying on hopes from infrastructure but failed at its previous highs. 
  • The sector is overbought and ran into previous resistance. 
  • The “buy signal” remains very extended. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and are waiting for a better entry point to add to our holdings.
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Neutral

Technically Speaking: Market Bulls Are “All-In” Again

In yesterday’s post on “Moral Hazard,” we discussed how Fed actions shifted the “risk appetite” of investors through “perceived” insurance against losses. As we head into a potentially contentious election, market “bulls” are “all in” again as hopes remain high that more “stimulus” will soon come.

Since the Fed intervened in March, investor sentiment has gotten run back up to extremes despite the economy remaining amid a deep recession.

As I noted in this past weekend’s RIAPro Subscriber Newsletter (30-day Risk-Free Trial), both the Technical and market positioning “Fear/Greed” gauges have moved back into more extreme territory following the brief September decline. Such is the case even though “stimulus” remains elusive, the Fed is on the sidelines, and economic growth has begun to disappoint as noted by the Economic Surprise Index.

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. Given this is weekly data, its readings move slowly and align with short-term peaks and troughs of markets

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade

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.

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade

This Week 10-02-20, #WhatYouMissed On RIA This Week: 10-02-20

More Sentiment Extremes

One of the sub-components of the “Fear/Greed” gauge is the NAAIM index of professional investors, which measures the percentage allocation to that group’s equities. Currently, equity allocations of professional investors are back to full weightings. While such doesn’t mean the markets are about to crash, more often than not, their “bullishness” has tended to be an excellent short-term “contrarian” indicator.

The same goes for large speculative traders in the options market. With call option buying back to more extreme levels, the risk remains skewed to the downside.

Short-term market timers are also back into the “excessively bullish” zone.

Okay, you get the idea; investors are “all-in” as we head into the election.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Short-Term Trends Remain Bullish

Despite market sentiment on the more extreme side, the market’s short-term dynamics remain bullish for now. As shown below, the market remains above both the 20- and 50-dma, with the 20-dma very close to a positive cross. Such gives the market a decent level of nearby support, which should buoy prices near term.

There is a risk of a deeper sell-off in the short-term. As noted this past weekend, a contested election leaves the market vulnerable to a decline. September lows, and below that, the 200-dma are viable targets for a short-term correction. Furthermore, given the markets have been running on hopes of “more stimulus,” there is a growing realization that another rescue package may not be coming until well after the election.

Either of those events would most certainly lead to lower asset prices in the short-term.

Intermediate Trends More Cautious

On a weekly basis, the market remains in a clear bullish trend from the 2009 lows. The correction in March did not clear the market excesses in terms of valuations and price action. Note in 2008, chart below, the depth of the decline in the indicators. The decline in March did not reach those more extreme levels. As noted in that article:

  • “Corrections” generally occur over short time frames, do not break the prevailing trend in prices, and are quickly resolved by markets reversing to new highs.
  • “Bear Markets” tend to be long-term affairs where prices grind sideways or lower over several months as valuations are reverted.

I discussed this concept in the video below.



While the “correction” in March was unusually swift, it did not break the long-term bullish trend. Such suggests the bull market that began in 2009 is still intact as long as the monthly trend line holds.

With the current deviation above the long-term bullish trend and a negatively diverging RSI, the risk of a bigger correction in 2021 has grown. The only two real questions that investors must consider:

  1. What will be the catalyst that starts the liquidation event; and, 
  2. Will the Federal Reserve be able to “bailout” the markets a third time?

The monthly trends confirm the same.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Monthly Trends Remain Bearish

On a longer-term basis, we remain concerned about the dichotomy of signals from the market. RSI’s negative divergences also appear on a monthly basis, along with the number of stocks above their respective 200-dma and extreme monthly overbought conditions.

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade 10-16-20

The previous extensions over the last decade have led to decent corrections and outright bear markets.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Hedging For Unknowns

Could this time be different? Sure, anything is possible. However, as investors, we want to remain focused on the “probabilities.”

What it won’t be is the “election.” Market participants have already “weighed and measured” the various outcomes of the election from a Biden “win” to a “blue wave.” Historically speaking, the markets quickly adapt to the next President and “price in” potential policy shifts.

The market likely has not fully priced in a “contested election” as we saw in 2000, which implies a 7-10% decline in the market. 

There is no clear pathway for the markets currently, which is why we are beginning to evaluate our current holdings and starting to hedge for potential risks heading into the election.

Slow At First, Then All Of A Sudden

What all of this suggests is that “risk” is building in the markets.

However, risk builds slowly. Such is why the investment community often uses the analogy of “boiling a frog.” Turning up the heat slowly, frogs don’t realize the peril until it’s too late. The same is true for investors who make a series of mistakes as “risk” builds up slowly.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

The end effect is not a pretty one.

When the buildup of “risk” is finally released, the explosion happens all at once, leaving investors paralyzed, trying to figure out what just happened. Unfortunately, by the time they realize they are the “frog,” it is too late to do anything about it.

Rules To Follow

Given that markets are still hovering within striking distance of all-time highs, there is no need to take action immediately. However, the continuing erosion of underlying fundamental and technical strength keeps the risk/reward ratio out of favor. As such, we suggest continuing to take actions to rebalance risk.

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Hedge portfolios against major market declines.
  3. Take profits in positions that have been big winners.
  4. Sell laggards and losers.
  5. Raise cash and rebalance portfolios to target weightings.

As stated, the market’s long-term dynamics remain unfavorable, and the liquidity-fueled rally from the March lows have only exacerbated previous overvaluations. Could the market rise from current levels through the end of the year? Absolutely, and is something that we currently expect to happen. 

However, we think 2021 may start the “payback” process as economics and fundamentals play catch up with reality.

But we will deal with that issue next year.

TPA Analytics: Top 10 Buys & Sells As Of 10-19-20

Top 10 Buys & Sells As Of 10-19-20

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


Note from the RIAPro Team:

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

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

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

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

Viking Analytics: Weekly Gamma Band Update 10/19/2020

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 10/19/20

  • We continue to maintain full exposure to the S&P 500 (SPX) entering this week. Price retreated from the upper gamma band and found support near the Gamma Neutral level last week.  
  • The upper band is currently at 3,542, and while this level may occasionally be seen to act as resistance, the back-test does not suggest reducing exposure when SPX hits the upper band level.
  • Our binary Smart Money Indicator continues to have a full allocation, as discussed in greater detail below. The Smart Money indicator is turning lower but is a long way from changing to a flat allocation.
  • SPX skew, which measures the relative cost of puts to calls, continues to be neutral.
  • Our Thor Shield daily allocation model will significantly reduce exposure to SPY at the close today (10/19).  ThorShield is a fast, daily signal based upon daily put and call volume.  Samples of all of our SPX and ThorShield daily reports can be downloaded from our website.

Smart Money Residual Index

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

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

SPX Skew – the Price of Protection

In evaluating equity market risk, we also consider the cost of buying puts versus the cost of buying calls.  When puts command a larger-than-usual premium to calls, then the market will have higher volatility (in the red zone below), and this might be a signal to reduce equity exposure.  We consider skew to be neither bullish nor bearish at the moment.

Gamma Band Background

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

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

We back-tested this strategy from 2007 to the present and discovered a 76.4% increase in risk-adjusted returns (shown below).  The Gamma Band model is a relatively slow but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish a faster, daily signal in a portfolio model which we call Thor’s Shield.  Thor Shield has a 20-year Sharpe of 1.5 and a rolling 1-year Sharpe of over 3.4.  Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

Authors

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

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

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


Major Market Buy-Sell Review: 10-19-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 10-19-20

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

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

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

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

Major Market Buy/Sell Review 10-19-20

S&P 500 Index

  • As noted last week: “The oversold condition that existed last week has now been reversed. While some extreme extensions have been reduced, the market is likely to run into some decent resistance at the previous highs.” 
  • This past week, the market did indeed struggle but is currently holding above the 50-dma.
  • Maintain exposures for now, but be ready to adjust if more weakness shows up heading into the election. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: Maintaining holdings.
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The tradeable rally in the Dow we suggested previously has worked well. It is now time to take profits and rebalance risk accordingly. 
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • The Nasdaq continues to work off its more extreme buy signal and has continued to hold above the 50-dma. 
  • If the market correction continues to hold support, such will likely provide a good opportunity to add exposure aggressively.
  • The tradeable opportunity in Technology stocks recommended previously has passed for now. Hold current positions and honor stop losses.
  • Short-Term Positioning: Bullish
    • Last Week: No changes this week.
    • This Week: No changes this week.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps has gotten a bit overbought and has again become very deviated from its long-term mean.  
  • Risk is currently to the downside, but there is a chase to gain exposure to lagging sectors by investors right now. 
  • It is still suggested to use the current rally to rebalance positions until the downtrend is reversed. 
  • Short-Term Positioning: Bullish
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY performed better than SLY last week, but it is extremely extended from its long-term mean like SLY. 
  • The tradeable opportunity in Mid-caps we discussed previously is likely over for now. Keep stops tight at the 50-dma for now. Look for pullbacks to support to add exposure.
  • The $330 stop-loss remains intact, but just barely. 
  • Short-Term Positioning: Bullish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss is set at $330
  • Long-Term Positioning: Bullish

Emerging Markets

  • Emerging markets had performed better on a relative basis during the correction. Still, now they are pushing back into 3-standard deviation territory, which has previously been a good opportunity to take profits. 
  • EEM is no longer oversold, so use this rally to reduce risk temporarily. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved to $42 for trading positions.
  • Long-Term Positioning: Bullish

International Markets

  • International markets performed worse than emerging markets last week but are not as grossly extended either. 
  • As long as the 50-dma holds, positions can be maintained. However, please pay attention to the dollar as it has begun gaining some strength. 
  • Maintain stops.
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bullish

West Texas Intermediate Crude (Oil)

  • The rally in oil occurred and finally broke above the 200-dma. The worst may be over for now in oil if prices can hold above these levels. 
  • Energy stocks, unfortunately, are not performing with the rally in oil. However, there may be a point where the historical correlation comes back into play, and we see a strong rally in energy. 
  • Historically, the worst-performing sector in the market in any given year has tended to be one of the leaders in the following year. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • After previously adding to our positions in GDX and IAU, we continue to hold our positions. 
  • The sector is currently on a sell-signal and is not extremely oversold. However, further consolidation may provide a perfect entry point to add further exposure. 
  • Stops are reset at $165. 
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Added 1% to GDX and IAU
    • This week: No changes this week.
    • Stop-loss adjusted to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds continued to hold up last week and is continuing its consolidation process. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Sold AGG and added a 5% position in PFF.
    • Stop-loss moved up to $157.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar rally stumbled this past week and is testing the 50-dma and did hold that support. 
  • If the dollar just formed a higher low, we could see a stronger rally in the weeks ahead. This will be good for bonds and not-so-good for stocks and commodities.
  • Watch for the buy signal in the lower panel of the chart for a signal to go long the $USD.
  • Subsequently, a dollar rally will devalue international and emerging market holdings, so act accordingly. 
  • Use weakness to add to positions that hold the 50-dma. 
  • Stop-loss adjusted to $92.

Neel Kashkari Is The Definition Of “Moral Hazard”

Neel Kashkari, in a recent CNBC interview, said, “I don’t see any moral hazard here when asked if the Fed’s massive liquidity injections have blown a bubble.

What exactly is the definition of “moral hazard.” 

Noun – ECONOMICS
The lack of incentive to guard against risk where one is protected from its consequences, e.g., by insurance.

Take a look at the following chart.

The Zombie Apocolypse

Zombie companies depend on a speculative investment climate for bond issuance for their survival. As discussed in “Recessions Are A Good Thing:”

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem. Zombie firms are less productive, and their existence lowers investment in, and employment at, more productive firms. In short, a side effect of central banks keeping rates low for a long time is it keeps unproductive firms alive. Ultimately, that lowers the long-run growth rate of the economy.” – Axios

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

Such also explains why there are currently record levels of “junk bond” issuance in the market.

“Issuance in 2020 through August was $291.9 billion, up 71% year over year. Credit strategists at BofA Global Research now project a full-year primary volume of $375 billion. Such would shatter the current record total of $344.8 billion in 2012, according to LCD.”

Interestingly, the number of “Zombie” companies in the market has hit decade highs in 2020. The massive Federal Reserve interventions, bailouts, and zero rates provided the life support failing companies needed. From a market perspective, the liquidity flows from the Federal Reserve increased speculative appetites and investors piled into “zombies” with reckless abandon.

Why?  Because of a lack of incentive to guard against risk as investors believe the Fed is protecting them from the consequences of risk.

In other words, the Fed has “insured them” against potential losses.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No-Risk Anywhere

Of course, Neel doesn’t see any moral hazard in the charts above. Nor does he see any “moral hazard” from the distortion of the credit markets either. Currently, yield spreads are trading near historically low levels in the midst of an economic recession.

Nor does he seem to notice the “moral hazard” of both a surge in debt accumulation and inflated asset prices. Such can only exist as long as rates remain near zero and monetary policy remains accommodative.

While Kaskari “doesn’t see any correlation between the Fed’s monetary interventions and the stock market,” even CNBC made the connection.

‘The increase in the Fed’s balance sheet has been in near lockstep with the stock market’s climb. The balance sheet has expanded 10% since October, while the S&P 500 shot up 12%, including notching its best fourth quarter since 2013.’” – CNBC

, Technically Speaking: Extreme Deviations & Eventual Outcomes

However, there is no “free lunch.” 

Not The Worst Of It

For the Fed to continue providing monetary support to the markets, they must monetize nearly every dollar of U.S. debt issuance for the foreseeable future.

“Randy Quarles said the Fed might have to remain engaged in asset buying for some time as financial markets are dealing with too many Treasurys to handle on their own. Total public debt now stands at just under $27 trillion, up from $23 trillion in this year’s first quarter. Debt is also $9.4 trillion higher than in the first quarter of 2008 in the midst of the financial crisis and the Government engaged in a long-running surge in borrowing.” – WSJ

Given the amount of debt required to sustain current economic growth, the Fed has no choice but to continue monetization of the Federal debt indefinitely. 

Such leaves only TWO possible outcomes from here, both of them are not good.

    1. Powell & Co. continue to keep rates at zero. As aging demographics strain the pension and social welfare systems, the debt will continue to stifle inflation and economic growth. The cycle that started nearly 40-years ago will continue as the U.S. adopts the “Japan Syndrome.”
    2. The second outcome is far worse, which is an economic decoupling that leads to a massive deleveraging process. Such an event started in 2008 but was cut short by Central Bank interventions. In 2020, the Fed arrested the deleveraging process once again. Both events led to an even more debt-laden system, which increases the risk of a crisis the Fed’s interventions may not stop.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

As noted, there is a precedent for a Central Bank becoming nearly the entire holder of the bond market.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Failure To Launch

Since the financial crisis, Japan has been running a massive “quantitative easing” program, which, on a relative basis, is more than 3-times the size of that in the U.S. While stock markets have performed well, economic prosperity is less than before the century’s turn.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

Furthermore, despite the BOJ’s balance sheet consuming 80% of the ETF markets, not to mention a sizable chunk of the corporate and government debt market, Japan has been plagued by rolling recessions, low inflation, and low-interest rates. (Japan’s 10-year Treasury rate fell into negative territory for the second time in recent years.)

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

While financial engineering props up asset prices, I think Japan is a perfect example that financial engineering not only does nothing for an economy over the medium to longer-term, it actually has negative consequences.” – Doug Kass

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Forgetting The Lessons Of 2008

The debt problem exposes the Fed’s risk and why they are now forever trapped at the zero-bound.

Given economic growth remained elusive over the last decade, it is unlikely doubling the Fed’s balance sheet will improve future outcomes. While Mr. Kashkari fails to recognize the impact of their policies, we now have a decade of experience showing that surging debt and deficits inhibit organic growth.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

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

Interestingly, while Mr. Kashkari says he “sees no moral hazard,” he recently stated we are forgetting the lessons of the 2008 financial crisis“:

“The shareholders got bailed out. The boards of directors got bailed out. Management got bailed out. So from their perspective, there was no crisis. We forget the lessons of the 2008 crisis. The bailouts worked too well. Financial crises keep happening ‘because we forget how bad they were.’” – Neel Kashkari

Yes, we bailed out everything, and the consequences of not allowing the system to “clear itself” has led to further distortions in the economy and markets.

The Fed Is The Cause

When the Fed tries to normalize monetary policy, they immediately cause a financial crisis in the market. The resulting destruction of household net worth requires an immediate response by the Fed of zero interest rates and liquidity. Subsequently, they create the next “bubble” to offset the deflation of the last.

A recent Fed study shows the result of their actions is the retardation of economic growth and a massive expansion of the “wealth gap,” where the top-10% controls most of the net worth.

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

Since a majority of the population does not, or only marginally, participates in the financial markets, the “boost” has remained concentrated to the upper 10%. The Federal Reserve’s study confirms this. So either the Fed willfully chose to ignore the consequences of their actions, or blatantly lied about it.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No Choice

Unfortunately, policy-makers, along with the Federal Reserve, are stuck.

“Since politicians want to get re-elected, sending money to households is a way to ‘buy the vote.’ The average American doesn’t understand their demands on the Government for more support creating their economic inequality.” 

Conversely, the Federal Reserve serves at the mercy of the central Wall Street banks. Such is why their policy focuses on inflating asset prices for the top 10%, hoping it will one day trickle down to the bottom 90%. After a decade, it hasn’t happened.

As noted, Japan is the path we are following.

“Monetary growth (and QE) can mechanically elevate and inflate equity markets. For example, in the U.S. market, a side effect is that via the ‘repo’ market, it turns into leveraged trades into the equity markets. Again, authorities are running out of bullets and have begun to question the efficacy of monetary largess.

The bigger picture takeaway is that financial engineering does not help an economy. It probably hurts it. If it helped, after mega-doses of the stuff in every imaginable form, the Japanese economy would be humming. But the Japanese economy is doing the opposite. Japan tried to substitute monetary policy for sound fiscal and economic policy. And the result is terrible.” – Doug Kass

One thing is for sure, “repeating the same failed actions and expecting a different outcome” has never been a solution for success.

We are reasonably confident it won’t work this time either.

Market Stumbles As Stimulus Hopes Fade


In this issue of “Market Stumbles As Stimulus Hopes Fade.”

  • Hopes For More Stimulus
  • Election Night Risk
  • Economic Disappointment
  • Portfolio Positioning Update
  • MacroView: Recessions Are A Good Thing, Let Them Happen
  • Sector & Market Analysis
  • 401k Plan Manager

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


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP, for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for.

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)
This Week 10-09-20, #WhatYouMissed On RIA This Week: 10-09-20

Catch Up On What You Missed Last Week


Market Stumbles As Stimulus Hopes Fade

Over the past couple of weeks, we have discussed the market rally from the recent oversold lows.

“The Federal Reserve needs ‘more stimulus’ to monetize the underlying debt issuance for investors. Such is how, ultimately, liquidity gets into the markets. With markets only about 3% away from all-time highs, there is really nothing to stop it from getting there unless stimulus talks break down once again.”

Unfortunately, the latter happened as the stalemate between House Democrats and Treasury Secretary Mnuchin continued. While both the Treasury Secretary and the President have signaled they are open to a much bigger stimulus package, the House’s Speaker isn’t budging off her demands for State bailouts. Neither is Senate Majority Leader Mitch McConnell, who has already stated he will not take up any House bill. He stated he would put a roughly $500 billion targeted relief bill to vote in the Senate as soon as next week. That bill is also doomed.

However, even without a stimulus package, the market rallied nicely from recent lows. The good news is the bit of trading sloppiness last week allowed the market to start working off the overbought condition. While we could see some additional weakness early next week, the downside risk is fairly limited going into the election.

Conditions Are Less Favorable

As shown below, both the 20- and 50-dma’s sit just below current levels. Those averages should act as initial support. Below that support are the recent lows, which will likely contain the market within the current range. Such would entail a roughly 8% decline from current levels and certainly well within the context of a normal market correction.

However, a break of that important support will quickly find the 200-dma, which is currently about 11% below current levels. As we will discuss momentarily, a “contested election” could certainly provide the catalyst for such a decline.

The fuel for a bigger decline remains this week. With speculation ramping up again, the risk/reward in the short-term has become less favorable. Call option buying remains extremely elevated relative to historical norms and exacerbates market declines when those positions are unwound.

On a longer-term basis, we remain concerned about the dichotomy of signals from the market. Negative divergences of RSI,  the number of stocks above their respective 200-dma, and the more extreme monthly overbought condition are concerning.

The previous extensions over the last decade have led to decent corrections. Could this time be different? Sure, anything is possible. However, as investors, we want to remain focused on the “probabilities.”

While the market seems assured that more stimulus is coming sooner rather than later, one risk facing the market may be a “contested election.”

An Election Night Risk

Over the last few weeks, we have discussed much of what happens to the stock market both pre- and post-Presidential elections.

However, there is the potential for a delayed election outcome this year, which could rattle the stock market. As noted by Morgan Stanley via Zerohedge:

“Contrary to some expectations that the election outcome could take as much as a month to be decided – a la Gore vs Bush – new data cited by Morgan Stanley suggests ‘the worst-case outcome is the least likely.’ And while vote-by-mail (VBM) requests are breaking records, a concern given the slower process for counting those ballots, voters appear to be returning those ballots at a rapid pace in key battleground states according to Morgan Stanley’s Michael Zezas.”

“Morgan Stanley says thatthere is an 80% chance the result is not determined on election night.'”

Is there a precedent for such an outcome?

Markets Don’t Like Uncertainty.

From a historical perspective, we have the precedent of the Gore/Bush election in 2000.

What does this mean for financial markets? The outcome of the election between George W. Bush and Al Gore was not decided on election day. Instead, Gore demanded a recount in Florida, where the vote was close, and “hanging chads” were at issue. It took over a month before we knew the election outcome when the U.S. Supreme Court decided Bush v. Gore on December 12, 2000.

What markets don’t like is uncertainty; over the course of the next several weeks, the S&P 500 decline by 7.5% at its nadir. However, the volatile swings of the market over that period were excruciating for investors. While not the “devastating event” the media has portrayed such an outcome to be, it is still worth noting. The inherent risk of a sharp rise in volatility and potential loss of gains if the unexpected does indeed occur. 

Here’s the point.

If you are about to get on a boat and go out deep sea fishing, it generally never hurts to take a Dramamine if the seas get rough. Otherwise, the entire experience becomes a single nauseating memory.

Economic Disappointment

Another risk is a further economic disappointment. Coming off of the March lows and the economic shutdown, expectations for recovery had gotten extremely dire. However, as the Federal Reserve and the Government injected money directly into the financial system, sent checks to households, and provided additional benefits, the data improved faster than expected.

However, what is important to remember is that we measure data on a “rate of change” basis.

For example, think about a restaurant that was shut down entirely. When they are allowed to reopen, they go from ZERO customers to just ONE. That is a 100% increase from the prior period. Next period they have TWO customers, which is a 50% increase from the period. The business remains on the brink of bankruptcy, but the growth rate of sales is stunning. 

This is what is happening with the economic data currently. The Citigroup Economic Surprise Index measures the difference between Wall Street’s expectations for economic data versus what is actually reported. If the data is better, the index rises, and vice versa. The chart below, courtesy of Sentimentrader, shows the index compared to the S&P 500 index.

“The Citigroup Economic Surprise Index is retreating after the biggest spike in this data series’ history.”

Why is this important?

Back To Uncertainty

With no stimulus currently on the horizon and a resurgence of economic weakness, there is more than a reasonable risk we may see more disappointment in economic data ahead. Such could have return implications for the stock market.

“When the Citigroup Economic Surprise Index dropped rapidly in the past, the S&P’s returns over the next month were slightly more bearish than random.” – Sentimentrader

With the potential for a delayed or contested election, weaker economic data, no stimulus, and already elevated asset prices and valuations, the risk of a correction has certainly risen.

All that is need is an “unexpected, exogenous event,” which sends traders scrambling for the exits.

Such leads us to this week’s portfolio positioning.

Portfolio Positioning Update

As we have noted previously, we currently have more equity exposure than we are comfortable with. However, technically, there is no reason to reduce exposure as trends remain positive sharply, the sentiment remains clearly bullish, and volatility remains suppressed.

With that said, we are still hedging portfolios by holding slightly higher levels of cash and adjusting the duration of the bond portfolio to mitigate drawdown risk. It’s challenging to hedge portfolios in an environment driven by daily news flows and sentiment and ignoring a wide range of “risks.”

The following quote from Sven Heinrick seems apropos at this juncture:

“Markets have been rallying not only on stimulus hope but also on the premise that the risk of a contested election is diminished or so the popular pablum goes. Well, for there to not be a contested election there needs to be a concession speech on the eve of the election. If that doesn’t happen, there is no election clarity until at least December 14 when the electoral college votes. That’s 6 weeks of uncertainty. And what if this gets contested, or what if there are legal challenges in between or beyond?

I’m raising these questions to highlight that there are all sorts of risks floating about that this market is not pricing in. At all. Rather the market is making all kinds of positive presumptions in terms of what it appears to perceive as the most positive outcomes. And they may well be correct, But whether these presumptions are correct, or not, I’m not one to say. However, it appears that if these presumptions are wrong, then the risk is very much under-appreciated. For now, this market hears of no risk, sees no risk, and speaks of no risk.”

Risk Happens Fast

His comments are certainly worth considering, even if you are “uber” bullish and completely disagree with my assessment. The reason is that when markets heavily discount downside risk or become exceedingly complacent, such creates an atmosphere where a rapid unwinding of markets can occur.

“When we superimpose the market structure (with so many in one side of the investment boat), the secondary market implication is a continuation of a new regime of heightened volatility and a wide trading range. Such favors trading sardines over eating sardines.” –Doug Kass

Investors tend to make critical mistakes in managing their portfolios.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

While the market is bullish now, and there is clearly an upside bias, an unexpected, exogenous event will cause a sharp reversal. Such suggests hedging equity risk until there is more “clarity” concerning the risk and reward.

As we have stated previously, “risk happens fast.” 

Why We Hold Cash

The great thing about holding extra cash is that it is a simple process to make the proper adjustments to increase portfolio risk if we’re wrongs. However, if we are right, we protect investment capital from destruction and spend far less time “getting back to even.”

Importantly, I want to stress that I am not talking about being 100% in cash.

I am suggesting that holding higher levels of cash during periods of uncertainty provides both stability and opportunity. With heightened political, fundamental, and economic risks, understanding the value of cash as a “hedge” against loss becomes more important. 

Given the length of the current market advance, deteriorating internals, high valuations, and weak economic backdrop, reviewing cash as an asset class in your allocation may make some sense. Chasing yield at any cost has typically not ended well for most.

Of course, since Wall Street does not make fees on investors holding cash, maybe there is a reason they are so adamant that you remain invested all the time.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

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


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.


Sector Model Analysis & Risk Ranges

How To Read.

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


Weekly Stock Screens

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

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

S&P 500 Growth Screen

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

Aggressive Growth Strategy


Portfolio / Client Update

The market rally stumbled this week as hopes of more stimulus faded. While the market came close to testing previous highs, it fell a bit short.

The good news is there is a good bit of support just below Friday’s closing levels, with the 20-dma very close to crossing back above the 50-dma. Such should keep the markets fairly range-bound heading into next week.

The not-so-good news is that we are just two weeks away from the Presidential election, which potentially argues for more market volatility between now and then. With the risk of a contested election higher than normal, and as noted in this week’s missive’s main body, there is downside risk.

We are aware of that risk and continue to position ourselves accordingly. Over the last few weeks, we have increased our bond duration, reduced laggards, and repositioned holdings to align portfolios with our expected outcomes. We also continue to carry a slightly higher than normal cash level, which we can increase quickly if the need arises.

We are also continuing to monitor our positioning closely and let the market dictate our next moves.

Portfolio Changes

There were no changes to the portfolio this week.

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

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

Technical Value Scorecard Report For The Week of 10-16-20

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

Commentary 10-16-20

  • On a relative and absolute basis, the utility and consumer discretionary sectors are the most overbought.
  • On a relative basis versus the S&P, healthcare, communications, banks, and energy are cheap. Healthcare, energy, and communications both have a lot of skin in the game in regards to the Presidential election, so they will be tougher to handicap over the coming weeks. Energy and banking remain the two most oversold sectors.
  • Banks (XLF) are an interesting play here as the ETF sits on top of its 50 and 200-day moving averages. Further, the 50-day is about to cross above the 200-day forming a so-called Golden Cross. For those wishing to buy XLF, manage risk with a stop loss a few percent below both moving averages.
  • On an absolute and relative basis, Small and Mid-cap stocks remain overbought. Foreign stocks (EFA and EEM) are back to oversold on a relative basis, yet emerging markets are still rich on an absolute basis.
  • On an absolute basis, TIPs are now oversold. They were flat on the week despite a decent performance from the other bond sectors. Inflation expectations fell slightly calling into question the reflationary recovery. This was likely the result of CPI and PPI which did not show signs of an inflationary burst.
  • Like last week, the S&P is overbought, but over the last few days, the signal has moderated.
  • When a sector is trading 3 standard deviations above its 200 or 50-day moving average or 2 standard deviations above both, a sell-off or consolidation is likely. There are no sectors that meet either criterion.
  • XLY looks to be the strongest sector on the spaghetti graphs as it runs toward the upper right-hand corner. That said, it is overbought with limited room to run. The sector is likely nearing a period of weaker relative performance.

Graphs (Click on the graphs to expand)


Users Guide

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

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

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

The ETFs used in the model are as follows:

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

#MacroView: Recessions Are A Good Thing, Let Them Happen

It is a given that you should never mention the “R” word. People immediately assume you mean the end of the world: death, disaster, and destruction. Unfortunately, the Federal Reserve and the Government also believe recessions “are bad.” As such, they have gone to great lengths to avoid them. However, what if “recessions are a good thing,” and we just let them happen?

“What about all the poor people that would lose their jobs? The companies that would go out of business? It is terrible to think such a thing could be good.”

Sometimes destruction is a “healthy” thing, and there are many examples we can look to, such as “forest fires.”

Wildfires, like recessions, are a natural part of the environment. They are nature’s way of clearing out the dead litter on forest floors, allowing essential nutrients to return to the soil. As the soil enrichens, it enables a new healthy beginning for plants and animals. Fires also play an essential role in the reproduction of some plants.

Why does California have so many wildfire problems? Decades of rushing to try and stop fires from their natural cleansing process as noted by MIT:

“Decades of rushing to stamp out flames that naturally clear out small trees and undergrowth have had disastrous unintended consequences. This approach means that when fires do occur, there’s often far more fuel to burn, and it acts as a ladder, allowing the flames to climb into the crowns and takedown otherwise resistant mature trees.

While recessions, like forest fires, have terrible short-term impacts, they also allow the system to reset for healthier growth in the future.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No Tolerance For Recessions

Following the century’s turn, the Fed’s constant growth mentality exacerbated rising inequality and financial instability. Rather than allowing the economy to perform its Darwinian function of “weeding out the weak,” the Fed chose to “mismanage the forest.” The consequence is that “forest fires” are more frequent.

Deutsche Bank strategists Jim Reid and Craig Nicol previously wrote a report that echos what other Austrian School economists and I have been saying.

“Actions are taken by governments and central banks to extend business cycles and prevent recessions lead to more severe recessions in the end.” 

, Trying To Prevent Recessions Leads To Even Worse Recessions

Prolonged expansions had become the norm since the early 1970s, when President Nixon broke the tight link between the dollar and gold. The last four expansions are among the six longest in U.S. history .

Why so? Freed from the constraints of a gold-backed currency, governments and central banks have grown far more aggressive in combating downturns. They’ve boosted spending, slashed interest rates or taken other unorthodox steps to stimulate the economy.” MarketWatch

But therein also lies the problem.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

More Debt Leads To Less Of Everything Else

The massive indulgence in debt, what the Austrians refer to as a “credit induced boom,” has now reached its inevitable conclusion. The credit-sourced boom led to artificially stimulated borrowing, which sought out diminishing investment opportunities.

Ultimately, diminished investment opportunities led to widespread malinvestments. Not surprisingly, we saw it play out “real-time” in everything from subprime mortgages to derivative instruments previously.

Tytler cycle, Tytler Cycle & Why More Government Help Leads To Less

When credit creation can is no longer sustainable, the markets must clear the excesses before the cycle can restart. Only then, and must be allowed to happen, can resources be allocated towards more efficient uses.

Such is why all the efforts of Keynesian policies to stimulate growth in the economy have ultimately failed. The ongoing fiscal and monetary policies, from TARP and QE to tax cuts, only delayed the clearing process allowing it to grow larger. That delay worsens the current impact and the eventual reversion.

The economy currently requires roughly $5 of total credit market debt to create $1 of economic growth. A reversion to a structurally manageable debt level would require a reduction of nearly $40 trillion. The last time such a clearing process occurred, it was called the “Great Depression.”

Tytler cycle, Tytler Cycle & Why More Government Help Leads To Less

The chart shows why “demands for socialism” is now “a thing.”

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Austrian Theory Of Business Cycles

“As the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles, and lowered savings.”

In other words, the proponents of Austrian economics believe that a sustained period of low rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. In other words, low rates tend to stimulate borrowing from the banking system that, in turn, leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money.

Therefore, as one would ultimately expect, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities, ultimately resulting in widespread malinvestments.

When the exponential credit creation is longer sustainable, a “credit contraction” occurs. Such ultimately shrinks the money supply and the markets finally “clear.” The clearing process allows resources to be allocated back towards more efficient and productive uses.

As shown in the chart above, the Federal Reserve’s actions halted the much needed deleveraging of the household balance sheet. With incomes stagnant and debt levels still high, it is worth little wonder why 80% of Americans currently have little or no “savings” to meet an everyday emergency.

Furthermore, the velocity of money has plunged as overall aggregate demand has waned.

Monetary Velocity

What the Federal Reserve has failed to grasp is that monetary 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 converts into purchasing of 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, money velocity has slowed along with the breadth and economic activity strength.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

However, it isn’t just the Fed’s balance sheet expansion, which undermines the economy’s strength. 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. Instead, the “debt burden” detracted from it.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

To illustrate the last point, we can compare monetary velocity to the deficit.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

To no surprise, 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.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

The Fed’s Mistake

The Fed continues to follow the Keynesian logic, mistaking recessions as periods of falling aggregate demand. They believe lower rates and asset price inflation will stimulate demand and increase the rate of consumption.

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

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, is wrong. It has not happened in 30 years. Despite the short-term benefit of policies like tax cuts, or monetary injections, they do not create economic growth. Debt-driven policies merely reschedule future growth into the present. The average American may fall for a near-term increase in their take-home pay. However, any increased consumption in the present will be matched by a decrease later when the tax cut is revoked.

Of course, such assumes the balance sheet at home is not a complete disaster. As we saw during the “Great Depression,” most economists thought that the simple solution was just more stimulus. Work programs, lower interest rates, and government spending didn’t work to stem the depression era’s tide.

There Has Been A Cost

The Fed’s foray into “policy flexibility” did extend the business cycle longer than normal. Those extensions led to higher structural budget deficits, increased private and public debt, lower interest rates, negative real yields, and inflated financial asset valuations.

The Fed’s interventions have also led to a massive leveraging of U.S. corporations, which has led to lower defaults via cheap corporate debt.

Unfortunately, it has also created an economy with a record level of “zombie companies.” 

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms. In short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.” – Axios

Just as poor forest management leads to more wildfires, not allowing “creative destruction” to occur in the economy leads to a financial system that is more prone to crises.

Given the structural fragility of the global economic and financial system, policymakers remain trapped in the process of trying to prevent recessions from occurring due to the extreme debt levels. Unfortunately, such one-sided thinking ultimately leads to skewed preferences and policymaking.

As such, the “boom and bust” cycles will continue to occur more frequently at the cost of increasing debt, more money printing, and increasing financial market instability.

Welcome Recessions

The problem currently is that the Fed’s actions halted the “balance sheet” deleveraging process keeping consumers indebted and forcing more income to pay off the debt, which detracts from their ability to consume.

Such is the one facet that Keynesian economics does not take into account. Most importantly, it also impacts the equation’s production side since no act of saving ever detracts from demand.

Consumption delayed is merely a shift of consumptive ability to other individuals. Even better, money saved is often capital supplied to entrepreneurs and businesses that will use it to expand and hire new workers.

The continued misuse of capital and erroneous monetary policies are responsible for 30-years of an insidious slow-moving infection that destroyed the American legacy.

We should embraceRecessions.” Allow recessions to clear the “excesses” accrued during the first half of the economic growth cycle.

Trying to delay the inevitable only makes the inevitable that much worse in the end.

#WhatYouMissed On RIA This Week: 10-16-20

What You Missed On RIA This Week Ending 10-16-20

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

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


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for. 

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)

What You Missed This Week In Blogs

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



What You Missed In Our Newsletter

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



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 10-16-20


What You Missed: Video Of The Week

Michael Lebowitz, CFA and I discuss the important impact that passive investors have on the markets and the potential risk to future outcomes.



Our Best Tweets For The Week: 10-16-20

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

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Nick Lane: The Value Seeker Report- New Feature

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

In this edition of the Value Seeker Report, we introduce our summary table and explain the table’s “Conviction Rating” feature.

Value Seeker Summary Table

  • The table, shown below, provides key details from all past Value Seeker reports in a central location. The full report for each stock can be accessed by following the link embedded in its ticker.
  • Future Value Seeker reports will include an updated version of this table.
Latest Report DateTickerLast Close Price (10/13)Intrinsic ValueForecast Upside RemainingOriginal Conviction RatingCurrent Conviction RatingCurrently Held in RIA Pro Portfolio?
8/6/2020T$ 27.75$ 38.0937.3%3-Star3-StarYes
8/13/2020XOM$ 34.22$ 55.4262.0%3-Star2-StarNo
8/28/2020VIAC$ 27.45$ 36.7033.7%4-Star2-StarNo
9/3/2020DOX$ 58.31$ 76.7631.6%3-Star3-StarYes
9/11/2020CVS$ 59.12$ 85.3544.4%3-Star3-StarYes
9/18/2020PETS$ 32.06$ 41.1428.3%3-Star3-StarNo
9/24/2020SPB$ 61.98$ 61.18-1.3%4-Star3-StarNo
10/2/2020DKS$ 62.04$ 68.7610.8%4-Star4-StarNo
10/9/2020WCC$ 45.63$ 61.4234.6%4-Star4-StarNo

Conviction Rating

  • Based on the degree of conviction we have in our forecasts, we assign a rating to each of our companies ranging from one to five stars. We will update conviction ratings as needed.
  • The conviction rating is based on both fundamental and technical analysis as well as any specific factors affecting the industry and the broad macroeconomic environment.
  • There are also other factors that affect our conviction rating. For instance, DCF valuations, and the embedded assumptions within the DCF model, can be more straightforward and easier to forecast for some companies than others. Unfortunately, the pandemic is exacerbating this factor in a variety of ways.
  • It is important to note that the conviction rating does not reflect the likelihood of a stock reaching our forecast intrinsic value. It only aims to provide our subscribers with more context for making investment decisions based on our reports.

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

Medicare Q&A with Aetna’s Christopher Ciano.

To better understand Medicare, especially Medicare Advantage, I queried Christopher Ciano, president of Medicare at Aetna®, a CVS Health® company. He is also a caregiver to his 93-year-old parents. Therefore, I thought it would be beneficial for readers to gain his perspective.

(Note: Open Enrollment is from October 15 through December 7.)

QUESTION: Please give us your vision of the future for Medicare programs. What would be the most significant changes you anticipate over the next decade overall?

COVID-19 has already impacted Medicare programs and will likely continue to have an impact for the foreseeable future.

Telehealth – A strong area of growth.

One of the areas where we’ve begun to see tremendous growth is in digital health, particularly telehealth. Medicare plans will continue to offer benefits that allow for care at home. The next few generations of seniors will likely have a higher level of comfort with technology than previous generations.

We already see this trend start to rise. According to the CVS Health Path to Better Health Study, 45% of respondents 65+ said they would be more likely to communicate with health care professionals if they could do so through digital messaging. Older adults opening up to new, digital means for communication is something I believe we’ll see much more of in years to come.

At Aetna, we’re taking steps to make sure our Medicare plans can help support members stay healthy in their homes during this time. Such is essential since older adults are among the most vulnerable to serious effects from COVID-19.

To ensure our members can safely receive the care they need, we extended waivers for Medicare Advantage member cost shares. Such allows for in-network primary care office visits and all telehealth visits for any reason through December 31, 2020.

Self-Care At Home Gains Popularity.

We also recently shipped Caring for You kits of over-the-counter items, such as thermometers, hand sanitizer, and face masks. Such helped support all Medicare Advantage members with simple self-care at home.

Also, all Aetna 2021 Medicare Advantage plans will offer virtual primary and urgent care visits to help members access to care, including after-hours or weekend care, sick visits, and prescription refills. Select plans will also cover virtual mental and behavioral health visits.

QUESTION: Medicare Advantage is a cost-effective program. However, we have great concerns over Part C, especially when it comes to innovative treatments for life-altering diseases. What improvements do you foresee down the road for Medicare Advantage?

In recent years, the Centers for Medicare & Medicaid Services (CMS) expanded the supplemental benefits Medicare Advantage plans can offer to members with chronic conditions. This increased flexibility allows MA plans to offer more innovative programs and benefits.

For example, in 2021, Aetna implements a Congestive Heart Failure (CHF) Remote Monitoring Program with six individual plans in Pennsylvania, Ohio, and Kentucky.

Eligible high-risk members with CHF who agree to participate in the program and follow the care management requirements will receive a 5G-enabled scale, blood pressure cuff, and electronic tablet to monitor their weight and blood pressure at home.

We’re also expanding the number of plans offering supplemental benefits for members with high cholesterol or high blood pressure to make it easier to access care. Aetna will provide a blood pressure monitor for our members with high blood pressure, which allows members to monitor their blood pressure from home at their convenience.

Individual members with high blood pressure and high cholesterol may also be eligible for transportation assistance to keep their appointments with health care providers.

Additional Benefits To Aetna’s Plans.

Other benefits we’re introducing with select plans in select locations include a Healthy Foods debit card, companionship benefit, a fall prevention benefit, and a program to lower insulin costs. These benefits are designed to bring care closer to home and make it more affordable for our members.

I foresee the continued expansion of benefits like these to help members with chronic conditions and more programs to address social determinants of health.

QUESTION: Please provide your thoughts for caregivers of elderly loved ones. How can they remain healthy and viable?

Speaking as a caregiver to my own 93-year-old parents, one of the most important, and often overlooked, is remembering to take time for yourself.

While caregiving is rewarding, it can also take a toll on your physical and emotional well-being. This is especially true during COVID-19, as we all continue to deal with additional stressors the pandemic has placed on our everyday lives. Ensure you’re taking care of yourself and finding time to relax, eat healthily, and exercise regularly.

Also, remember that you don’t have to do everything by yourself — ask for help. Aetna Medicare members and their caregivers have access to Resources for Living, which caregivers can use to connect with local support groups and other services that make their responsibilities feel more manageable.

Additionally, Aetna recently published a guide full of great information and resources for older adults and their caregivers called Putting the ‘Me” in Medicare, found at AetnaMedicare.com/eBook. The eBook offers tips and resources on eating healthy, staying active, using technology tools, and maintaining mental health during and after the pandemic.

QUESTION: What are your best ideas, pitfalls for the Medicare Open Enrollment season?

Choosing a Medicare plan and sifting through all the information Medicare beneficiaries receive can be overwhelming at this time of year.

Medicare Advantage Is All-inclusive.

It’s important to understand the various parts of Medicare and what each part covers. Original Medicare includes Part A (hospital insurance) and Part B (medical care), and consumers often elect to purchase a Part D plan for prescription drug coverage. On the other hand, Part C is a Medicare Advantage plan.

Such plans bring together the benefits of cost, coverage, and convenience into a single plan and often include:

  • Annual out-of-pocket maximum
  • Prescription coverage
  • Dental, vision, hearing, and fitness-related benefits
  • Coverage through a private insurance company
  • A network of doctors and hospitals

 A common misconception about Original Medicare is that it pays for everything. Everyone who is enrolled in Original Medicare pays a premium for medical (or Part B) coverage.

Original Medicare Doesn’t Cover Everything.

Original Medicare also doesn’t cover prescription drugs or cap your annual out-of-pocket spending for medical care, which means that there’s no limit to the expenses you may have to pay each year for your medical services.

Second, check if the plan fits your budget. When it comes to plan pricing, no matter whether consumers select an Original Medicare or Medicare Advantage plan, many mistakenly only look at the monthly premium cost. While important, it is not the only price point to consider. Make sure you review all of the plan’s out-of-pocket costs, such as deductibles, copays, and co-insurance.

Prescription drugs are another important item to consider. Check if the plan’s formulary or drug list covers your prescriptions. Know what tier your prescription drugs are on and whether there are any coverage rules like step therapy or prior authorization. And don’t forget every year, plans can change which drugs are covered and at what tier and cost.

Also, check your plan’s network to see if your preferred doctors, hospitals, and pharmacies participate.

Finally, if extra benefits like routine vision, dental, hearing, and fitness are important to you, make sure the plan you choose covers them.

Visiting the Medicare.gov website and entering your zip code will allow you to see all of the various Medicare plans available in your area. You can also speak with a local trusted broker or community advisor. To learn more about Aetna’s 2021 Medicare plans, visit AetnaMedicare.com or see our latest announcement.

Important Points from RIA.

As a matter of disclosure, this post isn’t an endorsement of Aetna’s plans. However, it provides perspective from a senior professional in the trenches.

At RIA, we prefer Medigap solutions over Medicare Advantage plans. Many older Americans with strained cash flows find Medicare Advantage cost advantageous. Everybody’s situation is different; therefore, Medicare and healthcare planning are crucial.

HealthView Services is a company that provides healthcare projection analysis and tools to the financial services industry. The organization draws upon a database of 530 million medical cases, longevity, and government statistics to create their projections.

They estimate that the total lifetime healthcare costs (which include premiums for Medicare, supplemental insurance, prescription drug coverage) for a healthy 65-year-old couple retiring this year are projected to be $387,644 today’s dollars assuming the Mr. lives 22 years and Mrs. – 24.

Health-care inflation is averaging roughly 4.4% a year; we use a 4.5% inflation rate in our planning at RIA. Medigap or supplemental insurance coverage, which is offered by private insurance companies, has increased consistently by more than 6% a year, according to The Senior Citizens League.

Medicare Advantage vs. Medigap.

Medicare Advantage Plans are inclusive, which means they cover all services of Original Medicare, including prescription drugs. Most offer extra coverage like vision, hearing, dental, and/or wellness plans. Two-thirds of the plans offered are through closed-physician network HMOs.

Advantage Plans usually have lower premiums than Medigap (also known as Medicare Supplemental Insurance) and are offered without insurability evidence.

Per KFF.org: While average Medicare Advantage premiums paid by MA-PD enrollees have been relatively stable for the past several years ($36 per month in 2017), enrollees may be liable for more of Medicare’s costs, with average out-of-pocket limits increasing 21 percent and average Part D drug deductibles increasing more than 9-fold since 2011; however, there was little change in out-of-pocket limits and Part D drug deductibles from 2016 to 2017.

At RIA, we suggest older Americans select a Medigap policy over Medicare Advantage but our views may change in the future. Monthly premiums for Medigap policies will absolutely be higher. However, the Medigap insured can benefit from more choice among providers and ultimately lower total out-of-pocket costs.

Keep in mind, based on our study and Mr. Ciano’s expert commentary, if there’s room for great improvement and affordability, it would be within Medicare Advantage. Obviously, companies like Aetna are adept at changing with the tumultuous times!

Finally, Medicare-eligible individuals must be aware of Medigap enrollment periods; otherwise, they may not obtain coverage in the future.

, Medicare Advantage? A Couple of Things To Consider

Be mindful of Medigap’s open enrollment.

Medigap policies are available to eligible recipients during open enrollment periods regardless of pre-existing health conditions. Medicare Advantage plans are not subject to similar exclusions. Medigap’s supplemental coverage open enrollment is a six-month open enrollment period that starts the month you are 65 or older and enrolled in Part B.

Thank you, Mr. Ciano, for your insights from the C-Suite!

David Robertson: Should I Stay, Or Should I Go?

Should I Stay, Or Should I Go?

While large doses of monetary and fiscal policy got the rebound in stocks started, it was declining infection rates and economic recovery throughout the summer that kept the party going.

However, with progress stalling on both fronts in the fall, it’s a good time to reassess investment conditions. Liquidity is still ample, but momentum is slowing. Perhaps most importantly, several sources of potential volatility are imminent. That leaves investors with the challenge: Should I stay, or should I go?

Risky Business

That decision, of course, involves tradeoffs, and those tradeoffs involve some assessment of risk. Although it has been quite a while now since the financial crisis in 2008, that event focused minds on topics like risk management and financial system fragility that had earlier received little but passing attention, much like today.

Many of the insights came from physics, engineering, and other disciplines with long histories of contending with systemic failure.  Concepts such as “fat tails” and “nonlinearity” entered the investment vernacular.

However, after years of rising markets and a rapid recovery from the selloff in March, discussion of these topics has faded from the public sphere as concerns about risk have abated. This is a shame because the structural risk elements are more relevant now than ever.

London Bridge

On this note, it is useful to take a short walk down memory lane to review some of those risk elements, specifically the conditions leading to nonlinear events. Michael Mauboussin set the stage with a research report on nonlinearity in 2007 that predated the financial crisis. He described what has become a classic example of nonlinearity at work:

“On June 10. 2000, the Millennium Bridge opened to the public with great fanfare. London’s first bridge across the Thames in over a century had a sleek design. The architect wanted it to look like a ‘blade of light.’ However, when thousands of people stepped on the bridge that day, it started to sway from side to side so much that people had to stop or hold on to the rails. Fearing for the public’s safety, officials closed the bridge two days later and, following a retrofitting, it reopened in February 2002.”

An important element of a nonlinear system is the critical point or threshold. Mauboussin describes the critical point as a situation in which “small incremental condition changes lead to large-scale effects.” In the case of the Millennium Bridge, that critical point was about 165 pedestrians. Under that threshold of people walking the bridge, there was no noticeable effect. When thousands of people walked across on the day it opened, it began to sway to such a degree pedestrians had to grab for support.

One Small Step

What happened? Ren Cheng answered the question in a separate report that included the same example of the Millennium Bridge:

“‘The lateral vibration, or ‘wobble,’ as many Londoners called it, was attributed to a ‘positive feedback phenomenon,’ whereby pedestrians crossing a bridge that has a lateral sway have an unconscious tendency to match their footsteps to the sway, thereby exacerbating it.'”

Cheng used the example to investigate a more specific phenomenon, however. He had observed increases in both correlations and volatility in the stock market and wondered if the increasing popularity of passive strategies could explain the phenomena. He compared passive investing to the bridge:

“The Millennium Bridge example is analogous to the increased flows to passive strategies and the unwanted side effects of higher correlations and volatility. Passive strategies reflect the independent investment decisions of many people, but in reality, all passive investors are making the same investments (or steps). Like the pedestrians walking independently on the bridge, eventually, the bridge (equity market) starts to sway in the same direction (higher correlations.) It then sways more violently in the same direction (heightened volatility) as more people walk (or invest) the same way.”

Commonalities

Cheng makes a good case in highlighting the commonalities of the two systems. In both systems, individuals pursue their own optimal activity. In the case of the bridge, that is stepping in sync with the sway of the bridge. When it comes to investing, that is investing passively. In both systems, individually optimized activity leads to collectively risky conditions. 

Cheng concludes,

“As the Millennium Bridge analogy helps illustrate when a greater number of investors are choosing the same investments via passive strategies, there is less independent decision-making. Subsequently, there is less information discovery driving market prices.”

In other words, beyond a certain threshold, passive investing creates greater inefficiencies in the market.

Interestingly, Cheng raised his concerns about the impact of passive investing in 2012. Since then, the share of passive investments relative to active ones has continued to grow. Although Cheng’s concerns have remained underappreciated, they have resurfaced from a couple of prominent voices.

Going, Going … 

In 2018 Chris Cole at Artemis Capital Management published a report that highlighted the importance of liquidity. His broader point was that focusing too intently on liquidity prevents us from seeing a deeper reality underneath. His specific point was the increasing share of passive investing is increasing systemic risk at the expense of active investing. He forecasts, “A crisis-level drought in liquidity is coming between 2019 to 2022”. 

Mike Green from Logica Funds has also (frequently) discussed the structural impact of passive investing on the market. In an interview on MacroVoices, he described,

“When you move to a passive framework, it becomes rules literally as simple as: Did you give me cash? If so, then buy …”

In a RealVision interview, he described the influence of passives as providing “a giant, systematic player that reinforces momentum.”

Lessons Learned

All of this serves to provide a useful perspective from which to assess investment opportunities. The “reinforced momentum” generated by passive investing creates a short-term tailwind for traders and speculators that proves tempting.

For longer-term investors, passive management’s continued growth at the expense of active looks more like a nonlinear system that has exceeded its critical threshold. No longer does the balance of active and passive result in stock prices that reflect a semblance of fair value. Rather, passive investing’s ongoing march has served to stretch prices further away from a fair value like a rubber band.

This highlights another interesting take. Eight years after Cheng expressed his concerns about the role of passive investing in boosting systemic risk, passive has continued to grow, and we are much farther removed from balance than we were then. Instead of becoming more concerned about downside risk and volatility, many investors are becoming less so.

Mental Models

One reason for this may be that the nature of nonlinear systems does not fit neatly into the mental models of risk that many people have. For instance, one common set of beliefs is those bad things happen due to bad behavior. While bad behavior is often involved, many times, the more important cause is fragile systems. Certainly, this was the case in the financial crisis when several bad actors exacerbated problems but did not create the financial system they operated.

Another common belief is that passive investing is low risk. In narrow terms, this is true. Passive funds have lower fees than active funds and have a low risk of significantly underperforming their benchmark. However, passive funds do the same thing regardless of whether expected returns are plus ten percent or minus ten percent. Cheng highlights, “As importantly, investors should not view the decision to invest solely in passive strategies as a way to minimize their risk exposure in a certain asset class.”

Conclusion

In sum, one of the great challenges for long-term investors is to calibrate risk exposure to opportunity. It is important to remember that relationship changes over time. The particular example of the Millennium Bridge and the general case of nonlinear systems provide a useful tool for envisioning that risk. This is especially helpful in an environment in which passive investing continues to shape the investment landscape and the risks it entails.

The Market’s Invisible Guardrails Are Missing

The Market’s Invisible Guardrails Are Missing

If you have ever driven on California’s Pacific Coast Highway (PCH), you understand risk. For those that haven’t made the drive, you are missing out on a spectacular winding road perched between a steep cliff and the ocean well below. Staying safe on this harrowing road requires strong driving skills and a good set of brakes.

Above and beyond what is in the driver’s control, the essential defense protecting drivers are the guard rails. If the PCH were fortified with 20-foot concrete walls, the risks of driving the road would be minimal but the incredible views lost. Conversely, if there were no guardrails, the risks increase substantially. A healthy compromise lies between these two extremes.

Investors also have the ability to employ guardrails in the market. Sometimes they are large and protective. Other times they are negligible. Unfortunately, most investors have little appreciation for these invisible guardrails and which type of investors manage them. In reality, the efficacy of market guard rails’ should largely determine our risk-taking stance.

Credit

Before progressing, we would be remiss if we did not thank Steven Bregman from Horizon Kinetics. Steve brought the pitfalls of passive investing to our attention over six years ago. Here is a LINK to a great speech he gave at the Grants Fall 2016 conference.

Also, Chris Cole and Mike Green have done substantial work in quantifying the risks associated with the increasing popularity of passive strategies. The following LINK offers an outstanding interview of Mike Green by Grant Williams.

Passive versus Active

The market guardrails we allude to are based on the capabilities of active investors. Before explaining, it is worth a short review on passive and active investment strategies.

In 2016, we wrote Passive Negligence, the first of many articles on this topic. Per the article:

“Passive index strategies are all the rage. Investors, desperate for “acceptable” returns are investing in funds whose value is directly linked to stock market indices. Unlike active funds, indexed funds do not perform investment analysis and are not looking for sectors or companies that offer greater return potential than the market. They do one thing, and that is replicate a particular equity index.”

In 2016 passive index strategies were “all the rage.” Today they are the market. Active investors have become endangered species. Due to poor relative returns and short-term thinking clients, many active professionals have been forced to become less value and more growth oriented. Failing to adapt ultimately means business failure as clients flee to the growth/passive style. Similarly, most individual active investors have similarly swapped active for passive strategies.

The graph below shows how value investors (active) have recently fared versus growth investors (mostly passive). The duration and magnitude of value’s underperformance is unprecedented.

Passive in Action

In the article five years ago we also wrote: In other words, the prices of underlying stocks will increasingly rise and fall together in correlation with the market and not based on their individual merits.”

Little did we know how profound those words would be. In “How to Find Value in an Upside Down World” we show the following graph.

As of September 2020, year to date returns were highest for the largest companies and lowest for the smallest within the S&P 500. The return differentials are stunning. As the saying goes, size matters. It appears that size is all that matters.

As we wrote, “The S&P 500 and NASDAQ are market-cap-weighted indexes, meaning the largest companies contribute more to the index than the smallest.” Ergo, when passive investors buy the index, they are mainly buying the largest companies.

Value

Active investors seek out value. While value investing is defined in many ways, it generally means buying assets they deem cheap. Conversely, they tend to sell assets that fulfill their valuation forecast and become overpriced. Some active investors also short overpriced assets.

With that in mind, we present some graphs from the same article.

As shown, the companies with the best fundamental ratios had the worst performance.

From January to September, value was left for dead. The only thing that seems to matter to investors is market cap.

These results demonstrate that value investors are not a viable force in the market. The activities of those who are left are being overwhelmed by the growing preference for passive investing.

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

Active Guardrails

The graph below highlights the exodus from active to passive strategies over the last 12 years.

The obvious takeaway from the graph is the larger role of passive investors (net inflows) and the smaller share of active investors (net outflows). What is not obvious but of utmost importance to the health of the market are the repercussions of the dramatic shift taking place.

To help you understand the role active investors play, let’s consider a simple and somewhat hypothetical case. From 2010 to late 2019, Apple’s (AAPL) price to earnings ratio was between 10 and 20. In this case, it should be self-evident that active investors might generally view Apple as cheap at 10 and expensive at 20. By contrast, passive investors, are indifferent at any P/E.

As shown below, P/E gyrates in the range. As it approaches the bounds, active managers get involved. Their interest provides buying and selling pressure to regulate the range. Active investors have enough market share in our example to uphold the range.

The graph shows that active investors may have lost enough market share in 2019 and could not provide their protective services. It is important to note that there is little about Apple’s prospects to be giddy about. Their earnings have been flat for the last five years.

In reality, active investors have many different views and opinions. They also have different strategies and vastly different evaluations on rich versus cheap. That said, the more active investors there are, the more prices are grounded to historical valuation norms. In other words, active investors reduce volatility, and therefore risk. Active investors are the guardrail.

Quantifying our Guardrails

Market and individual stock guardrails can be thick or flimsy. Also, there is not one proverbial guardrail but many based on the differing opinions of active investors. Regardless, the ability of active investors to provide a valuation check is purely a function of how powerful active investors are.

The question, therefore, is at what point passive investors negate the ability of active investors to regulate markets.

Chris Cole of Artemis, in his brilliant article “What is Water?,” helps put a number on our question.

When passive participants control 60%+ of the market the simulation becomes increasingly unstable, subject to wild trends, extreme volatility, and negative alpha. In the real world, because the ratio between active to passive is not constant, the instability threshold will occur at a much lower threshold as investors shift their preference to passive in real-time.

The irony of the Bogle-head crowd is that they tout efficient market hypothesis to support passive investing while simultaneously failing to comprehend how the dominance of the strategy causes markets to become highly unstable and inefficient. The most immediate realities are the ones that are the hardest to see… If you want to know when volatility will truly arrive, watch the shift in the medium. 

The “medium”, in Cole’s terminology, is the balance between the roles of active and passive investors. He computes that when passive investors are more than 42% of the market, volatility increases and active investors gain an edge. As he writes, above 60%, the market lacks guardrails. Without guardrails, active investors have a considerable advantage as price becomes grossly detached from fundamentals.

Summary

The massive surge in passive strategies’ popularity has pushed the market to the brink of instability. Instability can result in price surges to unprecedented valuations. It can also produce immense volatility and tremendous price declines, as we saw in March. Volatility is here to stay as long as investor preferences remain the same.

There are no longer guardrails on our winding road of wealth accumulation. Those guardrails have been temporarily put out to pasture in favor of the laziness of passive strategies. Most troubling is that so few investors, many of which are heavily dependent on their investment portfolios, understand there are no guardrails for their wealth.

As you would drive on the PCH without guardrails, we recommend managing your wealth with the same attention. This article is not a recommendation to divest and sit in cash. However, it should serve as a warning that the hair raising declines in March, and vertical surge afterward may not have been an anomaly but a preview of things to come.