Monthly Archives: August 2019

The Bandwagon Effect: A World Series Lesson For Investors

Opening day is a glorious time for baseball fans. Warmer temperatures and blooming shrubbery are on their way, and more importantly, their favorite teams will begin a stretch of 162 games that culminates with a best-of-seven battle between the American and National League champions.

With leaves falling and colder temperatures upon us, most baseball fans are left out in the cold. However, here in Washington D.C., and no doubt in Houston, everyone is a diehard fan cheering their team on to a World Series crown.

Curly W’s, the logo of the Washington Nationals (Nats) baseball team, litter the streets, schools, and even office buildings of D.C. Everyone is on board the Nationals train, yet in August you could have spent a paltry $20 for a decent seat and shown up to a half-empty stadium to see the same Nationals play. Today, standing room only tickets for the World Series are said to be fetching $1000.

As the Nationals and Astros begin the World Series, the baseball gods are teaching us a valuable lesson that applies to investing as much as it does sports.

Bandwagon Bias

Within the last month or so, the Nationals and Astros have attracted a huge following of “bandwagon” fans. People who were casual fans or not even fans at all are gripped by a desire and the camaraderie of being with a winner. 

Trina Ulrich, a friend of ours and sports psychology professor at American University, was recently interviewed by radio station WAMU to talk about the psychology behind bandwagon fans. The interview and article can be found HERE. Stay tuned as The Lance Roberts Podcast will be interviewing Trina in November.

Trina Ulrich defines the bandwagon effect as follows: “[It’s] essentially a psychological phenomenon that happens when people are doing something because others are doing it already.” Sound familiar?

We have written many articles describing and warning about the dangers of market bandwagons, in particular, investor conformity and the so-called herding effect. These biases are widespread in today’s market place and are extremely important to grasp.  

In no uncertain terms, a FOMO (fear of missing out) is leading equity markets to valuations that are at or above those of 1929 and only bettered by those in the late 1990s. Other risk assets such as corporate debt, private equity, and high-end real estate trade at similarly rich valuations. The burgeoning bandwagons in these markets have been growing for years, unlike the short term nature of those simmering in Washington, D.C. and Houston.

Trina Ulrich says our attraction to bandwagons is defined by a psychological term called dispositional hope. Dispositional hope is the belief that one can achieve their goals. The high dispositional hopes that some baseball fans and investors carry is attractive to others with less dispositional hope. Those with less hope are enticed as the goal of winning is seen as attainable and beneficial.  

As the Nationals and Astros advanced through the regular season and the playoffs, diehard fans with hope that their team will win attracted others looking for dispositional hope. Similarly, investors over the last few years with high hopes for generous future returns are drawing in a wide swath of investors. In both cases, hope is selling off the shelves.   

Trina Ulrich goes on to explain that human minds are built to buy hope. Per Ulrich, “So if you have a bunch of die-hard Nats fans with high dispositional hope, they will draw in other fans that may have a low dispositional hope. It has to do with the feel-good hormones in the brain like serotonin, oxytocin, and dopamine.

“When [the hormones] rise because of motivation and excitement and success, the brain gets bathed in this and there is a pleasure effect.” “So why not feel this way too when you see someone else feeling this way?”

In The Money Game & The Human Brain Lance Roberts put it similarly:

As individuals, we are “addicted” to the “dopamine effect.” It is why social media has become so ingrained in society today as individuals constantly look to see how many likes, shares, retweets, or comments they have received. That instant gratification and acknowledgment keep us glued to our screens and less involved in the world around us.”

We are addicted to winning, be it on the baseball field or in our investment accounts, because it delivers a gratification that we crave. Consistently winning is remarkably satisfying, ask any New England Patriots fan. Yet, even Patriot quarterback Tom Brady will eventually retire (or die of old age on the field), and the game for Patriots fans will likely change dramatically. Similarly, in spite of a dynastic run of success, there is the cold hard reality that markets do not, indeed cannot, always go up.

Markets have a strong tendency to oscillate between high and low valuations. Rarely, if ever, does a market follow a straight line that mimics the true fundamentals.  When markets are overvalued, they tend to get even more overvalued due in large part to the bandwagon effect. At some point, however, markets must face the reality of the limitations of valuations. When prices can no longer be justified by marginal investors, reality sets in.

In Bubbles and Elevators we stated:

From time to time, financial markets produce a similar behavioral herding effect as those described above. In fact, the main ingredient fueling financial bubbles has always been a strong desire to do what other investors are doing. As asset bubbles grow and valuation metrics get further stretched, the FOMO siren song becomes louder, drowning out logic. Investors struggle watching from the sidelines as neighbors and friends make “easy” money. One by one, reluctant investors are forced into the market despite their troubling concerns.”

“Justification for chasing the market higher is further reinforced by leading investors, Wall Street analysts, and the media which use faulty logic and narratives to rationalize prices trading at steep premiums to historical norms. Such narratives help investors convince themselves that, “this time is different,” despite facts evidencing the contrary.”

Summary

In baseball and other sports, the bandwagon effect is a good thing as winning unites people that would otherwise have little in common. Today, a city as politically divided as Washington can greatly benefit when its people of such diverse political mindsets are united, even if only for a few weeks. The downside of joining the wrong bandwagon is an emotional hangover and maybe a lost bet or two.

In markets, the bandwagon effect can also be a good thing as rising markets fuel optimism and help investors meet their financial objectives. Unfortunately, jumping on a market bandwagon at the wrong time can come with steep costs. Bandwagons, after all, are always a speculative venture. Currently, a normalization of equity valuations can result in investors losing half of their wealth or possibly more. Not only will those on the bandwagon have a lasting emotional hangover but they will also have a tremendous loss that could take years to recoup.

Choose your bandwagons wisely and GO NATS!!

Mauldin: How GE Screwed Over Its Retirees

Remember “defined benefit” pensions?

That is the kind of plan in which the employer guarantees the worker a set monthly benefit for life. They are increasingly scarce except for small closely held corporations.

The same rules apply for small closely held businesses as for large corporations.

These plans can be great tools for independent professionals and small business owners. But if you have thousands of employees, DB plans are expensive and risky.

The company is legally obligated to pay the benefits at whatever the cost turns out to be, which is hard to predict.

The advantage is you can use some hopeful accounting to set aside less cash now and deal with the benefit problems later. The problem is “later” comes faster than you would like, and procrastination can be a bitch.

That Brings Us to the Lesson for Today

On October 7, General Electric (GE) announced several changes to its defined benefit pension plans. Among them:

  • Some 20,000 current employees who still have a legacy-defined benefit plan will see their benefits frozen as of January 2021. After then, they will accrue no further benefits and make no more contributions. The company will instead offer them matching payments in its 401(k) plan.
  • About 100,000 former GE employees who earned benefits but haven’t yet started receiving them will be offered a one-time, lump sum payment instead. This presents employees with a very interesting proposition. Almost exactly like a Nash equilibrium. More below…

The first part of the announcement is growing standard. But the second part is more interesting, and that’s where I want to focus.

Suppose you are one of the ex-GE workers who earned benefits. As of now, GE has promised to give you some monthly payment when you retire. Say it’s $1,000 a month.

What is the present value of that promised income stream? It depends on your life expectancy, inflation, interest rates and other factors. You can calculate it, though. Say it is $200,000.

Is GE offering to write you a generous check for $200,000? No. We know this because GE’s press release says:

Company funds will not be used to make the lump sum distributions. All distributions will be made from existing pension plan assets in the GE Pension Trust. The company does not expect the plan’s funded status to decrease as a result of this offer. At year-end 2018, the plan’s funded ratio was 80 percent (GAAP).

So GE is not offering to give away its own money, or to take it from other workers. It is simply offering ex-employees their own benefits earlier than planned. But under what assumptions? And how much? The press release didn’t say.

If that’s you, should you take the offer? It’s not an easy call because you are making a bet on the viability of General Electric.

The choice GE pensioners face is one many of us will have to make in the coming years. GE isn’t the only company in this position.

Unrealistic Assumptions

When GE says its plan is 80% funded under GAAP, it necessarily makes an assumption about the plan’s future investment returns.

I dug around their 2018 annual report and found the “expected rate of return” was 8.50% as recently as 2009, when they dropped it to 8.00%, then 7.50% in 2014, to now 6.75%.

So over a decade they went from staggeringly unrealistic down to seriously unrealistic. They still assume that every dollar in their pension fund will grow to almost $4 in 20 years.

That means GE’s offered amounts will probably be too low, because they’ll base their offers on that expected return.

GE hires lots of engineers and other number-oriented people who will see this. Still, I doubt GE will offer more because doing so would compromise their entire corporate viability, as we’ll see in a minute.

Financial Engineering

GE has $92 billion in pension liabilities offset by roughly $70 billion in assets, plus the roughly $5 billion they’re going to “pre-fund.”

But that is based on 6.75% annual return. Which roughly assumes that in 20 years one dollar will almost quadruple.

What if you assume a 3.5% return? Then you are roughly looking at $2, which would mean the pension plan is underfunded by over $100 billion—and that’s being generous.

GE’s current market cap is less than $75 billion, meaning that technically the pension plan owns General Electric.

This is why GE and other corporations, not to mention state and local pension plans, can’t adopt realistic return assumptions. They would have to start considering bankruptcy.

If GE were to assume 3.5% to 4% future returns, which might still be aggressive in a zero-interest-rate world, they would have to immediately book pension debt that might be larger than their market cap.

GE chair and CEO Larry Culp only took over in October 2018.

We have mutual friends who have nothing but extraordinarily good things to say about him. He is clearly trying to both do the right thing for employees and clean up the balance sheet.

He was dealt a very ugly hand before he even got in the game.

GE needs an additional $5 billion per year minimum just to stave off the pension demon. That won’t make shareholders happy, but Culp is now in the business of survival, not happiness.

That is why GE wants to buy out its defined benefit plan beneficiaries. Right now, the company is on the wrong side of math.

It doesn’t have anything like Hussman’s 31X the benefits it is obligated to pay. Nor do many other plans, both public and private. Nor does Social Security.

Tough Choices

To be clear, I think GE will survive. Its businesses generate good revenue and it owns valuable assets. The company can muddle through by gradually bringing down the expected returns and buying out as many DB beneficiaries as possible. But it won’t be fun.

Pension promises are really debt by another name. The numbers are staggering even when you understate them. We never see honest accounting on this because it would make too many heads melt.

If I am a GE employee who is offered a buyout? I might seriously consider taking it because I could then define my own risk and, with my smaller amount, take advantage of investments unavailable to a $75 billion plan.


The Great Reset: The Collapse of the Biggest Bubble in History

New York Times best seller and renowned financial expert John Mauldin predicts an unprecedented financial crisis that could be triggered in the next five years. Most investors seem completely unaware of the relentless pressure that’s building right now. Learn more here.

Sector Buy/Sell Review: 10-22-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • As noted in this past weekend’s newsletter, we are expecting a modest advance into year-end and that there could be a rotation back to more cyclical plays.
  • We are looking to increase weighting slightly to Materials particularly if the current “sell signal” is reversed.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • XLC held important support and has now rallied back to previous resistance at the highs.
  • XLC is currently a full-weight in portfolios but should perform better if a year-end advance ensues.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $47.50
  • Long-Term Positioning: Bearish

Energy

  • XLE is now testing that previous support, now resistance, and needs to move higher other a potential break of recent lows becomes a real possibility.
  • The “sell signal” was in the process of being reversed, but that has failed also as stated last week.
  • While there is “value” in the sector, there is no need to rush into a position just yet. The right opportunity and timing will come, it just isn’t right now.
  • We were stopped out of our position previously but are looking to add a small piece back to the portfolio for now as we should catch some cyclical rotation into the end of the year.
  • Short-Term Positioning: Bearish
    • Last week: Stopped out.
    • This week: Stopped out.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF is another sector trapped below multiple highs but has reversed its “sell” signal” on a short-term basis.
  • The good news is that XLF held support above the previous downtrend line. With the reversal to a buy signal we can review adding back into a position.
  • We previously closed out of positioning as inverted yield curves and Fed rate cuts are not good for bank profitability. That is still the case, however, the sector is performing technically which we can not ignore.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • XLI also, after failing a breakout, remains trapped below multiple highs.
  • As with Materials above, a rotation into cyclical exposures is likely heading into year end.
  • While it appears that XLI wants to make another attempt at all-time highs, it is going to take some work to move above that resistance.
  • We have adjusted our stop-loss for the remaining position. We are looking to add back to our holdings on a reversal to a buy signal.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $72
  • Long-Term Positioning: Neutral

Technology

  • XLK is back to an overbought condition, and is testing previous broken support which is now resistance.
  • The rising consolidation trend will be an important breakout and will lead to higher highs if it occurs.
  • We are currently target weight on Technology, but may increase to overweight on a confirmed breakout.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $75.00
  • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform a little “less well” as of late as money is rotating from some defensive areas.
  • XLP continues to hold its very strong uptrend but is threatening to break that support. If it does, it could lead to a rather abrupt sell off.
  • The “buy” signal (lower panel) is still in place but is threatening to turn into a sell if performance doesn’t pick up soon.
  • We previously took profits in XLP and reduced our weighting from overweight. We will likely look to reduce further when opportunity presents itself.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $58
    • Long-Term Positioning: Bullish

Real Estate

  • As noted last week, XLRE was consolidating its advance within a very tight pattern.
  • However, that consolidation broke to the upside leading to new highs.
  • We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That advice remains as XLRE is now back to EXTREME overbought.
  • Buy signal has been reduced which is bullish for now.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLP and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup. We haven’t gotten one as XLU continues to rally and last weeks surge is making owning this sector seriously more dangerous.
  • Long-term trend line remains intact but XLU is grossly deviated from longer-term means. A reversion will likely be swift and somewhat brutal.
  • Buy signal reversed, held, and is now back to extremely overbought. We took profits recently but will likely do more if performance continues to struggle.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has triggered a sell signal but has remained intact and is trying to recover with the market. If a buy signal is issued that may well support a higher move for the sector.
  • XLV continues to hold support levels but is lagging the overall market.
  • Healthcare will likely begin to perform better soon if money begins to look for “value” in the market. We are looking for entry points to add to current holdings and potentially some new holdings as well in the Equity portfolio.
  • We continue to maintain a fairly tight stop for now.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY has take the sector back to previous highs where resistance sits currently.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is close to reversing back to a buy signal which could signal higher-highs heading into the end of the year.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has been a trading nightmare for investors with a fairly broad and volatile range.
  • XTN is making another attempt at recent highs.
  • The good news is a “buy” signal has been triggered which, combined with the fact XTN is not overbought, may provide the setup needed to break out of this long consolidation.
  • We remain out of the position currently and will just wait to see what happens. If we get a breakout we will look to add, but there is not a rush to do anything.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: It’s Crazy, But We’re Adding Equity Risk

In last week’s update, I discussed the case of why it was “now or never” for the bulls to take control of the market. To wit:

  • The ECB announced more QE
  • The Fed reduced capital requirements and initiated QE
  • The Fed is cutting rates
  • A “Brexit Deal” has been reached.
  • Trump, as expected, caved into China
  • Economic data is improving
  • Stock buybacks

If you are a bull, what is there not to love? 

Despite a long laundry list of concerns, as stated, we remain equity biased in our portfolio models currently for two primary reasons:

  1. The trend remains bullishly biased, and;
  2. We are now entering into the historically stronger period of the investment year.

With the volatile summer now behind us, being underweight equities paid off. As I discussed in Trade War In May & Go Away:

“It is a rare occasion the markets don’t have a significant intra-year correction. But it is a rarer event not to have a correction in a year where extreme deviations from long-term moving averages occurs early in the year. Currently, the market is nearly 6% above its 200-dma. As noted, such deviations from the norm tend not to last long and “reversions to the mean” occur with regularity.”

Of course, we saw corrections occur in June, August, and September with little gain to show for it.  The point, of course, is the avoidance of risk, which tends to occur more often that not during the summer months, allows us to adhere to our longer-term investment goals.

The data bears out the risk/reward of summer months:

“The chart below shows the gain of $10,000 invested since 1957 in the S&P 500 index during the seasonally strong period (November through April) as opposed to the seasonally weak period (May through October).”

It is quite clear that there is little advantage to be gained by being aggressively allocated during the summer months. More importantly, there are few individuals that can maintain a strict discipline of only investing during seasonally strong periods consistently due to the inherent drag of psychology, leading to performance chasing. 

Seasonal Strong Period Approaches

Readers are often confused by our more bearish macro views on debt, demographics, and deflation, not to mention valuations, which will impair portfolio returns over the next decade versus our more bullish bias toward equities short-term. That is understandable since the media wants to label everyone either a “bull” or a “bear.”

However, markets are not binary. Being a bear on a macro-basis doesn’t mean you are only allowed to hold cash, gold, and stock in “beanie-weenies.” Conversely, being “bullish” on equities, doesn’t necessarily mean an exclusion of all other assets other than equities.

As we wrote to our RIAPRO Subscribers yesterday (30-day FREE Trial) there is a definitive positive bias to the markets currently.

“We are maintaining our core equity positions for now as the bullish trend remains intact. As noted in this past weekend’s newsletter, the bulls have control of the narrative for now. With the “sell signal” reversed, there is a positive bias. However, without the market breaking out to new highs, it doesn’t mean much, especially given the market is pushing back into an overbought condition. We will wait for a confirmation breakout to add to our core equity holdings as needed.

This doesn’t mean we have “thrown in the towel.”

We remain bearish on the long-term returns due to mountains of historical evidence that high valuations, coupled with excess leverage, and slow economic growth generate low returns over very long-periods of time. However, we are also short-term bullish on equity-risk because of stock buybacks, momentum, Central Bank interventions, and seasonality. Also, sentiment has gotten short-term very negative.

Money flows have also been negative even as the market has been climbing. This is due primarily to the surge in share repurchases, but still remains a contrarian indicator.

While it may seem “crazy,” it is for these reasons, despite the longer-term bearish backdrop, that we need to “gradually” and “incrementally” increase exposure for the next couple of months. Importantly, I did not say leverage up and buy speculative investments. I am suggesting a slight increase in exposure toward equity risk, as opportunity presents itself, until we have an allocation model that both hedges longer-term risks, but can take advantage of shorter-term bullish cycles.

There is no guarantee, of course, which is why investing is about managing risk. In the short-term the bulls have control of the market, and seasonal tendencies suggest higher asset prices by year-end.

Is that a guarantee? Absolutely not.

However, statistical analysis clearly suggests probabilities outweigh the possibilities. Longer-term, statistics also state prices will take a turn for the worse. However, as portfolio managers, we can’t sit around waiting for something to happen. We have to manage portfolios for what is happening now. It is always the timing that is the issue, and history shows there will be little warning, fanfare, or acknowledgment that something has changed.

That is why we manage for “risk.” The risk of the unknown, unexpected, exogenous event which unwinds markets in a sharp, and unforgiving fashion. This risk is increased by factors not normally found in “bullishly biased” markets:

  1. Weakness in revenue and profit growth rates
  2. Stagnating economic data
  3. Deflationary pressures
  4. High levels of margin debt
  5. Expansion of P/E’s (5-year CAPE)

How To Play It

With the markets currently in extreme intermediate-term overbought territory and encountering a significant amount of overhead resistance, it is likely that the current “hope driven” rally is likely near an intermediate-term top, which could be as high as 3300.

Assuming we are correct, and Trump does indeed ‘cave’ into China in mid-October to get a ‘small deal’ done, what does this mean for the market. 

The most obvious impact, assuming all ‘tariffs’ are removed, would be a psychological ‘pop’ to the markets which, given that markets are already hovering near all-time highs, would suggest a rally into the end of the year.”

For individuals with a short-term investment focus, pullbacks in the market can be used to selectively add exposure for trading opportunities. However, such opportunities should be done with a very strict buy/sell discipline just in case things go wrong.

Longer-term investors, and particularly those with a relatively short window to retirement, the downside risk still far outweighs the potential upside in the market currently. Therefore, using the seasonally strong period to reduce portfolio risk, and adjust underlying allocations, makes more sense currently. When a more constructive backdrop emerges, portfolio risk can be increased to garner actual returns rather than using the ensuing rally to make up previous losses. 

I know, the “buy and hold” crowd just had a cardiac arrest. However, it is important to note that you can indeed “opt” to reduce risk in portfolios during times of uncertainty.

For More Read: “You Can’t Time The Market?”

On a positioning basis, the market has been heavily skewed into defensive positioning, which is beginning to rotate back towards more cyclical exposures. Materials, Industrials, Healthcare, Small, and Mid-Caps will likely perform better. 

This is not a market that should be trifled with, or ignored. With the current market, and economic cycle, already very long by historical norms, the deteriorating backdrop is no longer as supportive as it has been.

Our portfolios have been primarily long-biased for the last few years. While it may seem a “little crazy” to be adding “equity risk” to the markets currently, we are doing so with a very strict buy/sell discipline in place and are carrying very tight stop-losses.

There is more than a significant possibility that I will be writing in a month, or two, about why we are reducing risk. But this is just how portfolio management works. No one can predict the future, we can only manage the amount of “risk” we undertake.

Major Market Buy/Sell Review: 10-21-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

This update focuses on the impact the “trade deal” announced on Friday will have on each market going forward.

S&P 500 Index

  • We are maintaining our core equity positions for now as the bullish trend remains intact. As noted in this past weekend’s newsletter, the bulls have control of the narrative for now.
  • With the “sell signal” reversed, there is a positive bias. However, without the market breaking out to new highs, it doesn’t mean much especially given the market is pushing back into an overbought condition.
  • We will wait for a confirmation breakout to add to our core equity holdings as needed.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position.
    • Stop-loss moved up to $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • Like the SPY, DIA broke above resistance but failed at previous highs. We are not set to test those highs once again, likely next week.
  • As with SPY, DIA has also reversed its previous “Sell signal” as well, but has failed to breakout to new highs and is back to more extreme overbought conditions.
  • We will wait for confirmation before adding more broad market exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $255.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • The technology heavy Nasdaq not only failed to test previous highs but failed at the previous highs from earlier this year.
  • While the “QE4” should bode well for QQQ, it continues to perform weaker than the overall S&P 500 Index.
  • The “Sell signal” is close to being reversed, but only barely so. QQQ needs to break out to new highs to confirm the bullish trend.
  • QQQ is back to very overbought short-term so remain a cautious adding exposure.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $175
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • One of the markets which historically perform the best under QE is small caps.
  • We suggested previously with SLY back to extreme overbought, and below previous resistance, and in a negative trend, that it looked like a better selling opportunity rather than a buy. That continues to be the advice for now until a breakout occurs.
  • We are looking to potentially add a trading position but need confirmation the recent rally isn’t just another trap.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss previously violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY, like SLY, is technically not in great shape, and also failed at the downtrend line and failed to hold above previous resistance.
  • MDY has now registered a short-term “buy” signal, but needs to be confirmed by a break above resistance. That has yet to occur. Be patient and take profits for now.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. However, QE4 will likely bleed into EEM if a performance chase begins for year-end positioning.
  • The current spurt higher also remains solidly confined to the overall downtrend.
  • The sell signal is reversing, but has failed to reverse. EEM so far. With EEM back to extreme overbought we are not convinced this rally will hold.
  • As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA continues to drag.
  • EFA remains in a downtrend and is testing the top of that range.
  • EFA has also triggered a buy signal, so a rally above the downtrend line will be needed to establish a tradeable opportunity.
  • \With EFA back to extreme overbought, it is likely this rally will fail. We will wait for confirmation before adding risk.
  • As with EEM, we closed out of previous trading positions due to lack of performance.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position.
    • Stop-loss was violated at $64
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • The week saw an uptick in oil prices as “speculation” returned to the markets from QE4. Commodities tend to perform well under liquidity programs due to their inherent leverage.
  • Don’t get too excited, there is not much going on with oil currently, but there is likely a tradeable opportunity approaching given the deeply oversold conditions.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position
    • Stop-loss for any existing positions is $54.
  • Long-Term Positioning: Bearish

Gold

  • Gold is back to a slight oversold and is holding important support, however, it is forming a bit of a downtrend from recent highs.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. We are moved our stops up and took half our position out of the portfolio last week.
  • Short-Term Positioning: Neutral
    • Last week: Sold 1/2 position
    • This week: Hold remaining position.
    • Stop-loss for whole position moved up to $137.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices finally cracked and have reversed a good chunk of the overbought condition.
  • As with GLD, we are also moving up our stop-loss to protect our gains if the “risk on” trade gets some real traction.
  • With the overbought condition being worked off, it is likely we will be able to further add to holdings as we head into the end of the year.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $137.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar had rallied to our $99 target which we laid out back in June of this year when we started tracking the dollar.
  • Despite hopes to the contrary, the dollar remains in a strongly rising uptrend. Given a “strong dollar” erodes corporate profits on exports (which makes up 40% of corporate profits overall) a strong dollar combined with tariffs isn’t great for corporate bottom lines. Watch earnings carefully during this quarter.
  • The dollar is back to the bottom of its uptrend and is very oversold. A rally in the dollar is likely from currently levels.
  • The “buy” signal keeps us dollar bullish for now.

CEO Confidence Plunges, Consumers Won’t Like What Happens Next

There is a disparity happening in the country.

No, it isn’t political partisanship, but rather “economic confidence.”

The latest release of the University of Michigan’s consumer sentiment survey rose to a three-month high of 96, beat consensus expectations, and remains near record levels. Conversely, CEO confidence in the economy is near record lows.

It’s an interesting dichotomy.

The chart below shows our composite confidence index, which combines both the University of Michigan and Conference Board measures. The chart compares the composite index to the S&P 500 index with the shaded areas representing when the composite index was above a reading of 100.

On the surface, this is bullish for investors. High levels of consumer confidence (above 100) have correlated with positive returns from the S&P 500.

However, high readings are also a warning sign as they then to occur just prior to the onset of a recession. As noted, apparently, consumers did not “get the memo” from CEO’s.

So, who’s right?

Is it the consumer cranking out work hours, raising a family, and trying to make ends meet? Or the CEO of a company who is watching sales, prices, managing inventory, dealing with collections, paying bills, and managing changes to the economic landscape on a daily basis?

Michael Arone, chief market strategist at State Street Global Advisors, recently told MarketWatch:

“I’m not sure if we’ve seen this disparity between positive consumer sentiment and negative business confidence at this level. From my perspective, something has to give. Either businesses have to be more confident, or you’re likely to see more rollover on the consumer data.”

Actually, a quick look at history shows this level of disparity is not unusual. It happens every time prior to the onset of a recession.

Take a closer look at the chart above.

Notice that CEO confidence leads consumer confidence by a wide margin. This lures bullish investors, and the media, into believing that CEO’s really don’t know what they are doing. Unfortunately, consumer confidence tends to crash as it catches up with what CEO’s were already telling them.

What were CEO’s telling consumers that crushed their confidence?

“I’m sorry, we think you are really great, but I have to let you go.” 

It is hard for consumers to remain “confident,” and continue spending, when they have lost their source of income. This is why consumer confidence doesn’t “go gently into night,” but rather “screaming into the abyss.”

UofM A Better Predictor

As noted above, our composite indicator is the average of both the University of Michigan and Conference Board measures. Of the two measures, the UofM index is the better index to pay attention to.

As shown above, while the Conference Board is near all-time highs suggesting the consumer is “strong”, the UofM measure is sending quite a different message. Not only has it turned lower, confirming the recent weakness in retail sales, but also has topped at a lower high than then previous two bull market peaks.

The chart below subtracts the UofM measure from the Conference Board index to show the historical divergence of the two measures. Importantly, the Conference Board measure is always overly optimistic heading into a recession and bear market, then “catches down” to the UofM measure.

Another way to analyze confidence data is to look at the consumer expectations index minus the current situation index in the consumer confidence report.

This measure also is signaling a recession is coming. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than prior to the “dot.com” crash. Recessions start after this indicator bottoms, which has already started happening.

Given that GDP is roughly 70% consumption, deterioration in economic confidence is a hugely important factor. The most significant factors weighing on that consumption, as noted above, are job losses which crushes spending decisions by consumers.

This starts a virtual spiral in the economy as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices, until the cycle is complete. Note, bear markets end when the negative deviation reverses back to positive.

Currently, the bottoming process, and potential turn higher, which signals a recession and bear market, appears to be in process.

None of this should be surprising as we head into 2020. With near record low levels of unemployment and jobless claims, combined with record high levels of sentiment, job openings, and near record asset prices, it seems to be just about as “good as it can get.”

However, that is also a point to consider, as I wrote previously:

“’Record levels” of anything are “records for a reason.”

As Ben Graham stated back in 1959:

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

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

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

He is right, of course, things are little different now than they were then.

For every “bull market” there MUST be a “bear market.” 

This time will not be “different.”

If the last two bear markets haven’t taught you this by now, I am not sure what will.

Maybe the third time will be the “charm.”

RIA PRO: For The Bulls, It’s Now Or Never


  • Now Or Never For The Bulls
  • Bearish Case Has Teeth
  • Sector & Market Analysis
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It’s Now Or Never For The Bulls

In April of 2018, I wrote an article discussing the 10-reasons the bull market had ended.

“The backdrop of the market currently is vastly different than it was during the ‘taper tantrum’ in 2015-2016, or during the corrections following the end of QE1 and QE2.  In those previous cases, the Federal Reserve was directly injecting liquidity and managing expectations of long-term accommodative support. Valuations had been through a fairly significant reversion, and expectations had been extinguished. None of that support exists currently.”

It mostly fell on “deaf ears” as the market rallied back to highs. Since then, the market has continued to “cling” to a “wall of worries” as noted in Tuesday’s missive by Doug Kass:

  •  The Fed Is Pushing On A String:
  • Untenable Debt Loads In The Private And Public Sectors.
  • An Unresolved Trade War With China.
  • The Global Manufacturing Recession Is Seeping Into The Services Sector.
  • The Market Structure Is Frightening.
  • We Are At An All-Time Low In Global Cooperation And Coordination.
  • We Are Already In An “Earnings Recession.”
  • Front Runner Status of Senator Warren (Market Unfriendly)
  • Valuations On Traditional Metrics (e.g., stock capitalizations to GDP) Are Sky High.
  • Few Expect That The Market Can Undergo A Meaningful Drawdown.
  • The Private Equity Market (For Unicorns) Crashes And Burns.
  • WeWork’s Problems Are Contagious

The reason I said “cling,” rather than “climb,” a “Wall of Worries” is that over the last 22-months the market really has not made much progress. With the market only marginally higher than it was in January of 2018, it has been mostly the ability for investors to withstand a heightened level of volatility.

The following is a WEEKLY chart of the S&P 500 as compared to its 4-year (200-week) moving average.

Here is the same chart on a MONTHLY basis as compared to its 5-year moving average.

Note the extremely long time frames of the underlying moving averages. We will revisit these in a moment.

For investors, it is important to understand the “bulls” maintain control of the market narrative for the moment, and, as noted last week, the “bullish wish list” was fulfilled over the last several weeks. To wit:

  • The ECB announced more QE and reduced capital constraints on foreign banks.
  • The Fed also reduced capital requirements on banks; and,
  • Initiated QE of $60 billion in monthly treasury purchases. (But it’s not QE)
  • The Fed is cutting rates as concerns over economic growth remain.
  • A “Brexit Deal” has been reached. (Just don’t read the subtext that says it likely won’t pass Parliament.)
  • Trump, as expected, caved into China and sets up an exit from the “trade deal” nightmare he got himself into. 
  • Economic data is improving on a comparative basis in the short-term.

  • Stock buybacks are running on pace to be another record year.  (As noted previously, stock buybacks have accounted for almost 100% of all net purchases over the last couple of years. See chart below.)

If you are a bull, what is there not to love? 

This is a critical point. Given the fact we are now moving into the “seasonally strong” period of the year, the “bulls” clearly have the advantage, for now.

This is why we continue to maintain a long-equity bias in our portfolios currently. We also recently slightly reduced our hedges, along with some of our more defensive positioning. We are still maintaining slightly higher than normal levels of cash.

Note: If you want to track our portfolios “real time,” receive buy/sell alerts on holdings, and have access to all of our data and analysis tools, check out RIAPro.net today for a 30-day FREE Trial.

The Bearish Case Still Has Teeth

“So, IF the “bulls” do indeed have control of the market, then why are allocations still somewhat hedged for risk?”

Great question.

The simple reason we still remain cautious is due to several reasons:

  • Despite the “bullish case” suggesting higher prices into the end of the year, there is still a not-insignificant possibility of failure. 
  • Even with the “bullish backdrop,” the markets have, at least for now, been unable to make, and sustain, new highs. (see chart)

  • The is a high level of complacency among speculators (see chart)

  • CEO confidence in economic expectations has fallen sharply to levels which have denoted lower market returns in the past (see chart)

The chart below is the S&P 500 as compared to its 5-year MONTHLY, moving average. With the market currently pushing one of the highest deviations from the long-term average, investors would do well to remember that reversions to the mean” occur with regularity. 

As is always the case, historically speaking, the “bull case” ALWAYS appears to be “correct,” until it isn’t.

Unfortunately, for most investors, by the time they realize that something has going wrong, and they find out just how much “risk” they have layered into their portfolios, it is often too late to do much about it.

This is why “risk management” is always vastly more important than chasing returns.

What To Watch Out For

The one thing about long-term trending bull markets is that they cover up investment mistakes. Overpaying for value, taking on too much risk, leverage, etc. are all things that investors inherently know will have negative outcomes. However, during a bull market, those mistakes are “forgiven” as prices inherently rise. The longer they rise, the more mistakes that investors tend to make as they become assured they are “smarter than the market.” 

Eventually, a bear market reveals those mistakes in the most brutal of fashions.

It is often said the religion is found in “foxholes.” It is also found in bear markets where investors begin to “pray” for relief.

Many investors have dismissed the lessons they learned in 2008. There are many more who have never actually seen a “bear market,” and understandably believe the current bull cycle will last indefinitely.

I can assure you it won’t, and “experience” is always a brutal teacher.

As I wrote in “The Exit Problem”  last December:

“My job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered ‘bearish’ to point out the potential ‘risks’ which could lead to rapid capital destruction; then I guess you can call me a ‘bear.’

Just make sure you understand I am still in ‘theater,’ I am just moving much closer to the ‘exit.’”

After having trimmed out some of our gains in our equity holdings throughout the year, and having been a steady buyer of bonds (despite consistent calls for higher rates), we are well positioned to take advantage of a rally to new highs if it occurs.

8-Reasons To Hold Some Extra Cash

The cash we hold also protects us against a sudden sharp decline.

For the bulls, it’s now or never to make a final stand.

Just remember, getting back to even is not the same as growing wealth.

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet     


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Healthcare (XLV), Industrials (XLI), Energy (XLE)

The relative performance improvement of HealthCare relative to the S&P 500 regained some footing this past week as money has started a rotation into underperforming sectors. Energy, after having been thoroughly beaten up, has also shown some signs of life. It is a bit early to get aggressive in the sector, but the improvement in relative performance puts it on our radar. Industrials, which perform better when the Fed is active with QE, has also picked up steam.

Current Positions: Target weight XLV, 1/2 weight XLI

Outperforming – Staples (XLP), Utilities (XLU), Real Estate (XLRE)

Defensive and “value” positioning continues to outperform relative to the broader market. After taking some profits, we trimmed profits out of XLP previously and re-positioned the portfolio. We are remaining patient to see how the market responds to the trade announcement next week.

Real Estate, Staples, and Utilities all continue to flirt with highs but remain GROSSLY extended. We took profits in these two areas last week but remain fully exposed as the  trend remains positive.

Current Positions: Target weight XLP, XLU, XLRE

Weakening – Technology (XLK), Discretionary (XLY), Communications (XLC)

As noted last week, Technology, and Discretionary turned higher and are looking to test highs, but unfortunately, have not been able to actually MAKE new highs. Relative performance continues to lag the S&P 500 currently, and if the “bulls” are going to make an advance, they need to do so sooner, rather than later.

Current Position: Target weight XLY, XLK, XLC

Lagging – Basic Materials (XLB), and Financials (XLF)

We previously got stopped out of XLF, but will likely look to re-enter the position shortly with the Fed now engaged in increasing bank reserves. XLF is testing resistance and is overbought, so we need a bit of a pullback to add some exposure.

Current Position: None

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps popped up last week, and have cleared 200-dma’s. Unfortunately, they continue to drag overall performance and remain trapped below fairly significant resistance. However, we are watching for technical improvement as when the Fed is engaged in QE, small and mid-cap stocks tend to outperform. If we see a better entry point, we will look to add exposure accordingly.

Current Position: No position

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

The same advice goes for Emerging and International Markets which we have been out of portfolios for several weeks due to lack of performance. These markets rallied recently on news of “more QE.” However, the overall technical trend is not great so we need to see if this is sustainable or just another “head fake.” 

Current Position: No Position

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

Current Position: RSP, VYM, IVV

Gold (GLD) – The previous correction in Gold continued this week. We had noted previously that we were going to take profits and protect our gains. We did that this past week as we sold 1/2 the position. Gold is testing critical support, and is working off its overbought condition. We are now looking for our next entry point.

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

Bonds (TLT) – 

Bonds also took a hit on “trade deal” news as the “risk off” rotation turned back to “risk on.” We are holding our positions for now, but are tightening up our stops and are looking at potential trades to participate with a move higher in yields if they occur.

Stay long current positions for now, and look for an opportunity to add to holdings.

Current Positions: DBLTX, SHY, IEF

Sector / Market Recommendations

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

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

Portfolio/Client Update:

Please read the main body of this missive for a better understanding why we are adjusting exposures in portfolios. 

Given the fact the Federal Reserve is back to providing liquidity into the markets, we have to remain cognizant of the market’s “perception” of what will happen with QE, versus what we actually expect to the outcome to be.

In the short-term, the catalyst is likely a net positive to stocks so we need to adjust equity exposure slightly to take advantage of the potential upside bias as we head into the end of the year. 

We began last week by trimming exposures in some of our more “defensive” positions which have had large gains this year.

Step two will be to add exposure in areas which will likely benefit the most from QE which includes small and mid-capitalization markets, basic materials, industrials, financials and energy.

These additions will increase our overall allocation towards equity risk as we head into the end of the year. However, these are NOT permanent additions, but rather opportunistic positions to potentially add some “alpha generation” to portfolios over the next couple of months. We will be carrying tight stops and re-evaluating the holdings regularly for adjustments.

For newer clients, we have begun the onboarding process bringing portfolios up to 1/2 weights in our positions. We will begin moving these portfolios to model weights over the next few weeks on an opportunistic basis. We will continue to carry tight stop-losses to protect against a more severe decline.

As we move into next week, depending on how markets are acting, we will look to slowly increase our equity exposure modestly to “rent whatever rally” we may get from the “QE-4.” 

  • New clients: Please contact your adviser with any questions. 
  • Equity Model: Took profits in AEP, ABT, CHCT, DUK, GDX, IAU, PG, VMC, YUM
  • ETF Model: Took profits in XLP

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

401k-PlanManager-AllocationShift

QE-4 Officially Begins

Please read the main body of the newsletter this week. 

Given the “bulls” have the upper-hand heading into the end of the year, we will likely increase our portfolio exposures over the next couple of weeks once we get a handle on how the markets are going to react to all of the news.

In the meantime, you can prepare for the next moves by taking some actions if you haven’t already.

  • If you are overweight equities – Hold current positions but remain aware of the risk. Take some profits, and rebalance risk to some degree if you have not done so already. 
  • If you are underweight equities or at target – rebalance risks and hold positioning for now.

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

401k Plan Manager Beta Is Live

Become a RIA PRO subscriber and be part of our “Break It Early Testing Associate” group by using CODE: 401 (You get your first 30-days free)

The code will give you access to the entire site during the 401k-BETA testing process, so not only will you get to help us work out the bugs on the 401k plan manager, you can submit your comments about the rest of the site as well.

We are building models specific to company plans. So, if you would like to see your company plan included specifically, send me the following:

  • Name of the company
  • Plan Sponsor
  • A print out of your plan choices. (Fund Symbol and Fund Name)

I have gotten quite a few plans, so keep sending them and I will include as many as we can.

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

Current 401-k Allocation Model

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


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

#WhatYouMissed On RIA: Week Of 10-14-19

We know you get busy and don’t check on our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything that you might have missed.

The Week In Blogs


The Best Of “The Lance Roberts Show”

Video Of The Week

Excellent interview with Daniel LaCalle on “Freedom Or Equality.” This is a great video to share with kids who are buying into the ideas of “Socialism vs. Capitalism.”

Also Read: Capitalism Is The Worst, Except For All The Rest

Our Best Tweets Of The Week

Our Latest Newsletter


What You Missed At RIA Pro

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free)

See you next week!

UNLOCKED: Three Of Our Favorite Dividend Kings For Rising Income

This article was first available to our RIAPro Subscribers. Get access to all of our articles, daily buy/sell recommendations, and complete stock and ETF analysis by trying out a FREE 30-DAY MEMBERSHIP of RIAPro TODAY.

Dividend growth stocks can offer strong shareholder returns over the long term. One place to look for high-quality dividend growth stocks is the list of Dividend Kings, which have increased their dividends for at least 50 consecutive years.

In order for a company to raise its dividend for over five decades, it must have durable competitive advantages and consistent growth. It must also have a shareholder-friendly management team dedicated to raising its dividend.

The Dividend Kings have raised their dividends each year, no matter the condition of the broader economy. They have outlasted recessions, wars, and a variety of other challenges, while continuing to increase their dividends every year.

With this in mind, these three Dividend Kings are attractive for rising dividend income over the long term.

Dividend King #1: Genuine Parts Company (GPC)

Genuine Parts Company is a diversified distributor of auto and industrial parts, as well as office products. Its biggest business is its auto parts group, which includes the NAPA brand. Genuine Parts has the world’s largest global auto parts network, with over 6,700 NAPA stores in North America and over 2,000 stores in Europe. Genuine Parts generated over $18 billion of revenue in 2018.

Genuine Parts is benefiting from changing consumer trends, which is that consumers are holding onto their cars longer. Rather than buy new cars frequently, consumers are increasingly choosing to make minor repairs. At the same time, repair costs increase as a car ages, which directly benefits Genuine Parts. For example, Genuine Parts stats that average annual spend for a vehicle aged six to 12 years is $855, compared with $555 for a vehicle aged one to five years.

Vehicles aged six years or older now represent over 70% of cars on the road, and Genuine Parts has fully capitalized on the market opportunity. The company has reported record sales and earnings per share in seven of the past 10 years. As the total U.S. vehicle fleet is growing, and the average age of the fleet is increasing, Genuine Parts has a positive growth outlook.

Acquisitions will also help pave the way for Genuine Parts’ future growth, particularly in the international markets. In 2017, it acquired Alliance Automotive Group, a European distributor of vehicle parts, tools, and workshop equipment. The $2 billion acquisition gave Genuine Parts an instant foothold in Europe, as Alliance Automotive holds a top 3 market share position in Europe’s largest automotive aftermarkets.

The company has reported steady growth for decades. In fact, profits have increased in 75 years out of its 91-year history. This has allowed the company to raise its dividend every year since it went public in 1948, and for the past 63 consecutive years. The stock has a current dividend yield of 3.3%.

Dividend King #2: Altria Group (MO)

Altria is a tobacco giant with a wide variety of products including cigarettes, chewing tobacco, cigars, e-cigarettes and wine. The company also has a 10% equity stake in Anheuser Busch Inbev (BUD).

Altria is challenged by the continued decline in U.S. smoking rates. However, last quarter Altria still managed 5% revenue growth from the same quarter last year. Its core smokeable product segment reported 7.4% sales growth, as price increases more than offset volume declines. Adjusted earnings-per-share increased 9% for the quarter, and Altria expects 4%-7% growth in adjusted EPS for 2019.

This growth allowed Altria to raise its dividend by 5% in late August, marking its 50th consecutive year of dividend increases.

Altria has tremendous competitive advantages. It has the most valuable cigarette brand in the U.S., Marlboro, which commands greater than a 40% domestic retail share. This gives Altria the ability to raise prices to drive revenue growth, as it has done for many years.

Going forward, Altria is preparing for a continued decline in the U.S. smoking rate, primarily by investing in new product categories. In addition to its sizable investment stake in ABInbev, Altria invested nearly $13 billion in e-cigarette manufacturer Juul, as well as a nearly $2 billion investment in Canadian marijuana producer Cronos Group (CRON).

Altria also recently invested $372 million to acquire an 80% ownership stake in Swiss tobacco company, Burger Söhne Group, to commercialize its on! oral nicotine pouches. Lastly, Altria is preparing its own e-cigarette product IQOS, which is being readied for an imminent nationwide launch.

Like Coca-Cola, Altria is taking the necessary steps to respond to changing consumer preferences. This is how companies adapt, which is necessary to maintain such a long streak of annual dividend growth.

Dividend King #3: Dover Corporation (DOV)

Dover Corporation is a diversified global industrial manufacturer with annual revenues of ~$7 billion and a market capitalization of $14 billion. Dover has benefited from the steady growth of the global economy in the years following the Great Recession of 2008-2009. In the most recent quarter, Dover grew earnings-per-share by 20% excluding the spinoff of Dover’s energy business Apergy. Revenue from continuing operations increased 1%.

It may be a surprise to see an industrial manufacturer on the list of Dividend Kings. Indeed, companies in the industrial sector are highly sensitive to the global economy. Industrial manufacturers tend to struggle more than many other sectors when the economy enters recession. But Dover has maintained an impressive streak of 64 years of annual dividend increases, one of the longest streaks of any U.S. company. One reason it has done this despite the inherent cyclicality of its business model is because of the company’s diversified portfolio.

Dover spun off its energy unit, which is especially vulnerable to recessions. Of its remaining segments, many service industries that see resilient demand, even during recessions, such as refrigeration and food equipment.

Dover expects to generate adjusted earnings-per-share in a range of $5.75 to $5.85. At the midpoint, Dover would earn $5.80 per share for 2019. With a current annual dividend payout of $1.96 per share, Dover is projected to have a 34% dividend payout ratio for 2019. This is a modest payout ratio which leaves more than enough room for continued dividend increases next year and beyond.

Dover has a current dividend yield of 2.1%, which is near the average yield of the broader S&P 500 Index. While the stock does not have an extremely high yield, it makes up for this with consistent dividend increases each year.

Final Thoughts

It is not easy to become a Dividend King, which is why there are only 27 of them. Of the ~5000 stocks that comprise the Wilshire 5000, the most widely-used index of the total stock market, only 27 have increased their dividends for at least 50 consecutive years.

Because of this, the Dividend Kings are a suitable group of stocks for income investors looking for high-quality dividend growth stocks. In particular, the three stocks on this list have competitive advantages, future growth potential, and high dividend yields that make them highly attractive for income investors.

Should Tesla Bears Look To Hibernate

In May 2019, I published an article that outlined hope for TSLA bulls in which I suggested that $180 could provide an opportunity for a long position.  Since then, Tesla (TSLA) has established and strengthened along a new uptrend line.  There is now evidence of key resistance near the $260 and $280 levels.  The technical levels below show the key resistance trend lines, based upon weekly highs and lows since 2017. 

The prior five weeks saw TSLA trade in a narrowing technical triangle, and last week’s breakout, followed by this week’s strength, appears to be a breakout through the first level of technical resistance.  The current uptrend line is gaining strength and momentum.  If the price closes convincingly above $280 on a weekly basis, the Tesla bears may want to hibernate for the winter.  

Fundamentals and Markets

When it comes to valuing stocks and commodities, I call myself a “recovering fundamentalist.”  Having spent much of my career building private businesses, I am used to focusing primarily on EBITDA, discounted cash flows, and other fundamental metrics when evaluating stocks.  When it comes to TSLA, I tend to agree with the bears that TSLA’s share price is not justified by fundamentals.  In fact, TSLA’s market cap could be used as exhibit #1 to support the thesis that stocks are not valued upon fundamentals at all.

In the short run, stock and commodity prices are driven by human emotions (fear and greed) and subsequent money flows.  Fundamentals – positive or negative – can provide the narrative and longer-term trends by which investors become bullish or bearish.  I certainly don’t want to dissuade anyone from assessing TSLA weekly auto-deliveries or to research its accounting statements.  Nevertheless, this recommendation is based solely on my technical view of the current price action, regardless of Tesla’s bearish fundamental backdrop.   

The TSLA Options Market

The options market provides institutions and other large position holders an ability to hedge their TSLA exposure, whether the funds are invested long or short.  Since TSLA has a history of being difficult or expensive to short, the options market provides an outlet for those negative on the stock price. Due to the high demand, TSLA options tend to be liquid with high open interest.  There are many retail and institutional investors who short TSLA by buying puts.

The market makers who facilitate the options trading almost always hedge their exposure instantaneously and dynamically with delta-neutral strategies. 

What this means is the market makers perform combination trades to (theoretically) hedge their exposure to price while also profiting from options volatility.  The maximum profit for the market makers will occur if the price of the stock settles near the price level where their portfolio is delta neutral.  As a result, it can be instructive to track delta- and gamma-neutral levels in many different stocks, ETFs and commodities. For more on delta and gamma signals, you can download a quick presentation from this link.

Stock Price and Options Sentiment

Due to order flow, contract rollover, and hedging dynamics, there tends to be a convergence between stock prices and the point of delta- and gamma-neutral as option expiration comes nearer.  We can provide evidence for this convergence for many different stock indices, ETFs and commodities.  The chart below is TSLA stock price versus Delta Neutral and Gamma Neutral for the last several months.   Of particular note is the convergence between price (green) and Delta (red) and Gamma (blue) Neutral for each option expiry period (black square).

Not surprisingly, as TSLA broke through technical resistance last week, its Delta- and Gamma-Neutral levels followed price upward.  Our interpretation of this data is that the option market makers are also buying into the upward momentum.  Beyond the option expiration this coming Friday, additional data for November and December suggest that the options market will not necessarily be a headwind for continued advances in price.

The table below shows bullish put-call ratios and Gamma Neutral levels above $280 for the coming months.

Source: Viking Analytics

The basic theory behind the Delta Neutral and Gamma Neutral levels can be found by visiting our website www.viking-analytics.com.

Final Thoughts

Based upon the technical analysis and the Delta Neutral and Gamma Neutral levels, a long position in TSLA should be considered, preferably on a retest of $240. We would also advise limiting risk with a stop loss rule that would exit the trade on a weekly close below the key trend line.

This is for informational purposes only and is not trading advice.

The Bursting Bubble Of “B.S.”

On the surface, middle of the road performance for stocks in the quarter indicated relative calm. Especially coming off strong performance in the first half of the year, there was little cause for concern.

Performance was choppy in the quarter, however, as steady, modest gains were repeatedly undermined by significant losses. In addition, a quant quake came out of nowhere and led to massive outperformance of value over growth for a short period of time. Also, out of nowhere overnight repo rates spiked higher until the Fed intervened. Gold prices rose steadily. Under the surface, something seems to be amiss. What is that something and what does it mean for investors?

For a growing number of investors, the answer is a short one: Stocks have overshot their fundamentals and a market crash is imminent. Such concerns are serious partly because they come from some highly respected players and partly because if true, there would be serious consequences for investors. However, stocks have been highly valued for a long time and for the past ten years bumps in the road have always been smoothed over by central banks. Is anything different this time?

It helps to establish some perspective. One of the more prominent themes over the last ten years has been the outperformance of growth stocks relative to value stocks. Rick Friedman of GMO points out that “Over the past 12 years … value stocks have underperformed”. 

John Pease, Friedman’s colleague at GMO adds, “All in all, it has been a harrowing decade for those who have sought cheap stocks.”

This recent underperformance of value provides a notable break from its historical pattern. Friedman continues:

“Historically, buying companies with low price multiples has delivered substantially better returns than the overall market, with the added benefit of lower absolute volatility. From the inception of the Russell 3000 Value index through 2006, value stocks outperformed the broad market in the U.S. by 1.1% per year starting in 1978.”

Dan Rasmussen, founder and portfolio manager of Verdad Capital Management, described just how unusual this performance has been in the September 20, 2019 edition of Grant’s Interest Rate Observer:

“What has been abnormal … is the remarkable performance of growth stocks. That has really been driven by the very largecap tech companies, which have had this amazing combination of high growth, high profitability, high and sustained growth, high and sustained profitability (and starting to actually dividend out money). That historically is very, very anomalous. You don’t typically see the largest stocks grow the fastest.”

Indeed, Friedman explains that the reason value stocks tend to outperform is because they offer an attractive tradeoff:

“While value companies did in fact under-grow the market, their cheaper valuations, higher yields, and a number of other factors more than made up for their weaker fundamentals.”

The “engine of returns behind value portfolios is ‘the replacement process, whereby a formerly disappointing company sees its fortunes change and its prices respond (à la General Electric in the 80s).’

Investors systematically underestimate the ability of weaker and distressed companies to mean revert to profitability and reasonable growth levels. Instead, they overpay for growth by extrapolating relatively strong growth too far into the future.” notes Friedman.

Pease notes, “In the last 13 years,” however, “rebalancing has disappointed somewhat,” and with it, the primary mechanism by which value tends to outperform. Friedman adds that factors that typically inhibit the most outlandish expectations for growth have been unusually weak:

Of late, expensive stocks have remained expensive for longer than usual. Typically, high growth companies are unable to sustain excessive growth rates for long periods. In the last decade, however, the growth universe has been more retentive than in the past.

So, one thing that is amiss is exaggerated expectations for growth. One exercise I regularly perform is to identify market-implied growth rates by matching discounted cash flows with current market prices. A couple of patterns are clear. One is that the prices of a lot of companies assume growth rates that are much higher than those that can be sustained by internally generated cash flows. In other words, the company’s growth is entirely dependent on access to outside capital.

Another pattern that is evident is that many implied growth rates are so high as to defy all practical constraints on growth. Historical experience, competitive response, industry size, economic growth, regulatory response, input costs, input availability, discretionary income, changing tastes and preferences, and real cash flows (as opposed to non-gaap earnings) all provide practical limits on growth for various businesses. It usually doesn’t take a ton of math to identify a ballpark range of growth estimates that is reasonable for a company.

As it turns out, the top-down evidence of unrealistic growth expectations corroborates the bottom-up observations. Rasmussen notes:

“You’re at this point … where the spread between the valuations of growth stocks and the valuations of value stocks is near all-time highs. The two times it has been this high in the past 50 years are 2000—the height of the tech bubble—and 1973—the height of the Nifty Fifty boom.”

One implication for investors, then, is the risk of exposure to exaggerated growth expectations is high right now. That risk may well be greatest in the IPO arena. Grant’s surveys the “abnormal” IPO landscape by way of statistics from Jay R. Ritter, chaired professor at the Warrington College of Business at the University of Florida:

81% of firms that went public in 2018 showed GAAP losses. To date in 2019, 74% of companies debuting in the public-equity market have been similarly loss-making. Each figure is substantially higher than the 39% average of profitless new public companies that IPO-ed between 1980 and 2018.”  

While these numbers portray an exceptional level of enthusiasm for IPOs, cracks have been emerging. The high-profile offerings of Uber and Lyft have both performed poorly and more recently, Peloton fell immediately from its offering price and has remained weak. Obviously, something has changed. Richard Waters from the Financial Times ascribes such weakness to a diminishing desire to believe “airy promises”. In other words, the market finally seems to be pushing back on exaggerated claims for growth.

“Airy promises” are not the only thing amiss in the IPO market, however. As Waters also notes, the easy cash available for many IPOs “has bred bad habits.”

The poster child for bad habits is WeWork. When WeWork started the IPO process, its valuation was targeted at $47 billion. After a great deal of pushback ahead of the roadshow and several price cuts, the IPO was finally pulled.

Not only is the company not going public, however, now it is in serious risk of going bankrupt. The FT reports, “Last week rating agency Fitch downgraded WeWork’s credit rating to CCC+, a level at which ‘default is a real possibility’. It said ‘the risk that the company is unable to restructure itself successfully has increased materially’.” How in the world can a company go from hot IPO prospect to bankruptcy candidate in a couple of months?

While WeWork provides plenty of entertaining drama, it also provides instructive lessons for the broader market. Importantly, all the information necessary to assess WeWork as a fragile financial proposition and a low-grade credit was available for all to see prior to its aborted IPO. There were no surprising revelations at the company. The only thing that changed was how people chose to evaluate the same body of information.

An important part of that body of information, as is the case with many younger companies, is the founder, Adam Neumann. Well known for his quirkiness, outlandish proclamations, and use of recreational drugs, Neumann also successfully crafted himself as a visionary. The balance between visionary and crackpot, however,  is often a very tenuous one as Scott Galloway describes:

“Since people want abnormal results, they try to find abnormal thinkers. But no one should be shocked when people who think about the world in unique ways you like also think about the world in unique ways you don’t like. If you want the party, you also get the hangover. Big, bold, visions are important and should be celebrated. But they have to be matched with stable, reality-based operators who have equal power if those visions are to have a fighting chance at surviving outside incubation.”

He elaborated on this tenuous balance in a separate interview in which he was blunter in his assessment:

The lines between vision, bullsh*t, and fraud are pretty narrow.

Galloway’s evaluation is not just that of some aggrieved tech investor who lost money either. He was actually a CEO during the internet boom of the 1990s and saw all-too-well what can happen when self-indulgence and fantasy are not only not constrained, but actively encouraged. As he puts it,

“If you tell a 30-year-old male he’s Jesus Christ, he’s inclined to believe you.”

Ostensibly, the task of constraining leaders who are naturally inclined to push limits is at least partly that of the board. Among the reasons to have a board is to ensure good decision making and to maintain corporate decorum. That didn’t happen with WeWork. According to Galloway:

“It’s safe to assume that board members already knew all of the details about Neumann’s antics … his hard partying and yoga babble were seen as features, not bugs, until the market threw up on it. Now, all of a sudden, the board is acting shocked. The board didn’t fire this guy; the board enabled him … Basically, as long as people were willing to buy into this charade, they [the board members] kept it going as long as the music kept playing.” 

Two other elements come into play in facilitating such excesses. One is the cyclical view towards charismatic leaders. There are times when dynamic founders are replaced by more experienced managers to run a business as it matures. Recently, however, founders have been allowed more latitude to stay in power longer.

The excesses are also partly a function of the marketplace as Galloway explains:

It’s frothy, and there’s more capital than operators. Any operator who has a vision and can promise the potential and convince people they can be the next Google or Facebook can attract billions of dollars right now. The reality is there’s more money out there.”

All of this provides useful context from which to evaluate market conditions. First, there are clear analogies with the subprime crisis. As long as things are working, the vast majority of actors are making money. As long as people are making money, there is little incentive to change things. Positive feedback loops ensure the good times run longer than they should.

This creates an interesting possibility. What if the thing that is amiss is simply an increasingly sober evaluation of existing conditions? What if investors have become less willing to dismiss math as some kind of weird science and more inclined to seriously apply it to growth expectations? What if, in the context of weakening growth, investors are less willing to believe in “vision” and “airy promises” and more inclined to manage downside risk?

What if a bubble is bursting, but it is not one of stocks per se, but one of bullsh*t?

This would have major implications for investors. First and foremost, any exposure to bold visions, airy promises, and barely credible growth expectations would need to be re-evaluated and re-calibrated. How many of those growth estimates are realistic? How many are off by a long shot? How many are not even possible? How many are only possible if funded indefinitely with free capital? Such scrutiny is even more likely to increase as earnings growth declines, global growth slows, geopolitical tensions rise, and as the credibility of central bankers fades. The result is likely to be a major rotation from growth into value.

Such a rotation would affect more than just growth investors; it would also have a disproportionate impact on broad index investors. Since capitalization weighted indexes overweight stocks that are overpriced and underweight stocks that are underpriced, broad indexes have become increasingly comprised of inflated growth stocks. That exposure becomes especially painful when the process reverses.

To the extent the primacy of bullsh*t diminishes or even vanishes as a determinant of stock prices, it will also have a significant impact on strategies for investors and advisers. When BS is ascendant, investors need only follow the same trends that everyone else does; it is no more complicated than that. Valuation, however, is a fundamentally different exercise. Determination of reasonable growth estimates is subject to all kinds of research, analysis, and judgment. This will create new opportunities for stock selection, but in doing so, will also leave a lot of people bereft of necessary analytical and investment tools.

Finally, the bursting bubble of BS also has implications for risk management. When the inflated expectations facilitated by BS are the norm, there is little reason to worry about how inflated the expectations are. Rather, the main concern is regarding the catalyst that could change things. The current environment provides many good examples including trade wars, election outcomes and the potential for a recession.

Focusing on a catalyst is a poor way to manage risk for a number of reasons, however. It is very hard to imagine all possible catalysts. Often, catalysts have a different effect than supposed. Thing can happen randomly. Further, the world is a complex place; oftentimes there is no particular, recognizable catalyst at all.

The thing that can usually be judged with far greater confidence than a catalyst is downside risk. You usually have a pretty good idea of what you can lose if things go bad. With that in mind, imagine playing a game of Russian roulette with your investment portfolio. You have one chamber of a gun loaded that you know can destroy your savings. Why would you focus on what might cause the barrel to stop spinning at the filled chamber rather than avoiding the inherent risk of the situation altogether? In other words, if stocks are significantly overvalued, why accept so much risk?

In sum, it is fair to say that something is amiss in the investment landscape. If that something is a bubble in BS rather than a bubble in stocks, the fallout will likely be different. Rather than one big, sudden crash, it will be more like a process of individual balloons popping over time as particular manifestations of BS get called out and re-calibrated.

As this happens, it will create a great deal of pain for sure, but there will be opportunities. The best vantage point will be that from security-specific analysis.

Equity Buy List: 10-17-19

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

Yesterday, we discussed the “profit taking process” we employed in our portfolios to raise some cash as we prepare for a reallocation and rebalancing process heading into the end of the year.

With cash raised we are now looking for positions we want to add to the Equity Portfolio. We will review each position with the entry points for purchase.

NOTE: These are positions we are currently CONSIDERING. Do not mistake this list as a recommendation to buy any of the securities listed below. IF we add any of these positions to our portfolio you will be emailed a alert accordingly.

Equity Buy List

AMZN – Amazon.com

  • Last week, we noted that “if the market is going to move higher into year-end, then AMZN should lead the way particularly as we head into holiday shopping season.”
  • The trade setup didn’t change much this past week, and with AMZN’s sell signal pretty deeply oversold there is a decent entry point.
  • We are looking for the buy signal to turn higher before adding to the portfolio.
  • Stop is adjusted to $1700 hard stop.

ABBV – AbbiVie Inc.

  • ABBV recently bounced off of critical support and has triggered a buy signal.
  • We are looking to add a position but would like to see a break above important overhead resistance first.
  • The secondary setup is a pullback to $70 that holds. We will add 1/2 of our position at that level and add the second 1/2 position on a break above overhead resistance.
  • Stop after initial entry is $64

MU – Micron Technology

  • We were previously long MU and got stopped out with a minor loss.
  • However, if trade is resolved and economic data begins to show some improvement, then MU should continue to push higher.
  • We are looking to buy on a pullback to support that holds without triggering a “sell signal.”
  • Stop loss after buy is $32.50

CRM – Salesforce.com

  • CRM has gotten pretty oversold and the sell-signal is very deep. Importantly, CRM has held a rising trendline support which is bullish.
  • CRM has a tendency to beat earnings and do well, so there is a decent trade setup here.
  • We will look to add CRM if support holds and we see the buy signal begin to improve.
  • Stop loss is set at $140

JNJ – Johnson & Johnson

  • JNJ has continued to hold a rising trendline and we have added to position previously.
  • We will look to overweight our portfolio position in JNJ if the buy signal is triggered and JNJ can holding above the 200-dma.
  • Stop loss is set at $127.50.

KSS – Kohls Corp.

  • The retail shopping season is approaching and KSS is in a good position to pick up on a cash-strapped consumer.
  • With a buy signal being triggered and being very oversold, we are interested in adding a small trading position to accounts to see if our thesis holds.
  • A pullback to $50 that holds should provide a reasonable entry point for 1/2 position with a break above the 200-dma clearing the way to add to the position further.
  • Stop-loss after entry is $46.

KHC – Kraft Heinz Co.

  • KHC has had the “dog snot” beat out of it over the last 2-years.
  • This is a super speculative position for the portfolio, and we will keep our initial sizing small. However, I love a good turnaround story and I think KHC may well be able to get themselves moving again.
  • KHC has triggered a buy signal but the stock is not responding. Therefore we will be patient and wait for the right opportunity.
  • Stop-loss after entry will be $25

FB – Facebook, Inc.

  • With a “sell signal” triggered at a fairly high level, downside risk remains decent so we are not in a hurry to add FB.
  • However, FB tends to do well during earnings season so there is a decent trading opportunity.
  • We would like to see a pullback that holds recent support and gives us a better entry point.
  • Stop-loss after entry will be $180

UNH – UnitedHealth Group

  • UNH had a good earnings report that led to a pop in the stock. We have been looking for an opportunity to add to our position and take it to overweight.
  • We need to see an improvement in the “buy signal” and a break above the 200-dma would give us a better entry point.
  • Stop loss remains $215

XOM – Exxon Mobil

  • We previously sold 1/2 our position in XOM back in April of this year. Since then we have bee looking for an entry point to rebuild our position.
  • XOM is extremely oversold and on a very deep sell signal. Support needs to hold at current levels, and the buy signal needs to show improvement to add to the position.
  • Stop-loss after adding to XOM is $66

Why The Measure Of “Savings” Is Entirely Wrong

In our recent series on capitalism (Read Here), we were discussing how the implementation of socialism, by its very nature, requires an ability to run unlimited deficits. In that discussion was the following quote:

Deficits are self-financing, deficits push rates down, deficits raise private savings.” – Stephanie Kelton

On the surface, there does seem to be a correlation between surging deficits and increases in private savings, as long as you ignore the long-term trend, or the reality of 80% of Americans in the U.S. today that live paycheck-to-paycheck.

The reality is the measure of “personal savings,” as calculated by the Bureau of Economic Analysis, is grossly inaccurate. However, to know why such is the case, we need to understand how the savings rate is calculated. The website HowMuch.com recently provided that calculation of us. 

As you can see, after the estimated taxes and estimated expenses are paid, there is $6,017 dollars left over for “savings,” or, as the Government figures suggest, an 8%+ savings rate. 

The are multiple problems with the calculation.

  1. It assumes that everyone in the U.S. lives on the budget outlined above
  2. It also assumes the cost of housing, healthcare, food, utilities, etc. is standardized across the country. 
  3. That everyone spends the same percentage and buys the same items as everyone else. 

The cost of living between California and Texas is quite substantial. While the median family income of $78,635 may raise a family of four in Houston, it is probably going to be quite tough in San Francisco.

While those flaws are apparent, the biggest issue is the saving rate is heavily skewed by the top 20% of income earners. This is the same problem that also plagues disposable personal income and debt ratios, as previously discussed  in “America’s Debt Burden Will Fuel The Next Crisis.” To wit:

“The calculation of disposable personal income (which is income less taxes) is largely a guess, and very inaccurate, due to the variability of income taxes paid by households. More importantly, the measure is heavily skewed by the top 20% of income earners, and even more so by 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.)”

The interactive graphic below from MagnifyMoney shows the disparity of income versus savings even more clearly.

When you look at the data in this fashion, you can certainly begin to understand the calls for “socialism” by political candidates. The reality is the majority of Americans are struggling just to make ends meet, which has been shown in a multitude of studies. 

“The [2019] survey found that 58 percent of respondents had less than $1,000 saved.” – Gobankingrates.com

Or, as noted by the WSJ:

“The American middle class is falling deeper into debt to maintain a middle-class lifestyle.

Cars, college, houses, and medical care have become steadily more costly, but incomes have been largely stagnant for two decades, despite a recent uptick. Filling the gap between earning and spending is an explosion of finance into nearly every corner of the consumer economy.

Consumer debt, not counting mortgages, has climbed to $4 trillion—higher than it has ever been even after adjusting for inflation.”

When looking at the data, it is hard to suggest that Americans are saving 8% or more of their income.

The differential between incomes and the actual “cost of living” is quite substantial. As Researchers at Purdue University found in their study of data culled from across the globe, in the U.S., $132,000 was found to be the optimal income for “feeling” happy for raising a family of four. (I can attest to this personally as a father of a family of six)

A Gallup survey found it required $58,000 to support a family of four in the U.S. (Forget about being happy, we are talking about “just getting by.”) 

So, while the Government numbers suggest the average American is saving 8% of their income annually, the majority of “savings” is coming from the differential in incomes between the top 20% and the bottom 80%.

In other words, if you are in the “Top 20%” of income earners, congratulations, you are probably saving a chunk of money.

If not, it is likely a very different story.

The “gap” between the “standard of living” and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the “gap.” However, following the “financial crisis,” even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $2654 annual deficit that cannot be filled.

That gap explains why consumer debt is at historic highs and growing each year. If individuals were saving 8% of their money every year, debt balances would at least be flat, if not declining, as they are paid off. 

We can see the inconsistency between the “saving rate” and the requirement to sustain the “cost of living” by comparing the two. Beginning in 2009, it required the entire income of wage earners plus debt just to maintain the standard of living. The gap between the reported savings rate, and reality, is quite telling.

While Stephanie Kelton suggests that running massive deficits increases saving rates, and pose not economic threat as long as their is no inflation, the data clearly suggests this isn’t the case.

Savings rates didn’t fall in the ’80s and ’90s because consumers decided to just spend more. If that was the case, then economic growth rates would have been rising on a year-over-year basis. The reality, is that beginning in the 1980’s, as the economy shifted from a manufacturing to service-based economy, productivity surged which put downward pressure on wage and economic growth rates. Consumers were forced to lever up their household balance sheet to support their standard of living. In turn, higher levels of debt-service ate into their savings rate.

The problem today is not that people are not “saving more money,” they are just spending less as weak wage growth, an inability to access additional leverage, and a need to maintain debt service restricts spending.

That is unless you are in the top 20% of income earners. 

Selected Portfolio Position Review: 10-16-19

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

With this basic tutorial, we will now review some of positions in our Equity Portfolio which are either a concern, an opportunity, or are doing something interesting.

PORTFOLIO UPDATE: Yesterday we took profits in our defensive positions as it appears a rotation back to offense is underway. Today we are going to cover the 8-sells and the 2-potential buys currently under consideration. We will update accordingly.

AEP – American Electric Power (Take Profits)

  • As noted last week, after taking profits out of the position previously, we reduced our position to 1% of the portfolio. Utilities have been a clear winner this year, and we are likely in for a correction or consolidation. We will look for an opportunity to add back to our holdings at later date.
  • With AEP currently on a “sell signal,” and overbought, prudent risk management required profit taking.
  • Stop is moved lower to $77.50.

CHCT – Community HealthCare Trust (Take Profits)

  • Like Utilities, Real estate has been one of the leading sectors this year, and in particular over the last several months.
  • As noted last week, CHCT is extremely overbought and extended, so we took some profits out of our position for now and will look for an opportunistic entry point later on.
  • Stop is moved lower to $36.

DUK – Duke Energy (Take Profits)

  • Another Utility with a big gain.
  • Taking profits to capture the run and allow for some portfolio rebalancing.
  • Will look to add back to the position on a retest of the previous breakout that holds.
  • Stop loss is moved up to $88

GDX – VanEck Gold Miners (Take Profits)

  • After buying gold and gold miners earlier this year, we are reducing our holdings and taking profits with the break of support yesterday.
  • We still like these positions on a longer-term basis, but with a sell signal approaching we are taking profits and reducing our holdings for now. We will add back on a successful retest of support that reduces the overbought conditions.
  • Stop loss is moved down to support at $23

IAU – IShares Gold Trust (Take Profits)

  • Along with GDX we also reduced IAU for all the same reasons.
  • A sell signal is approaching along with major overbought condition.
  • Taking some profits now, so we can add back into the position at potentially lower levels in the future.
  • Stop-loss moved down to $13

PG – Proctor & Gamble (Take Profits)

  • As noted last week:
    • “PG has been on a seemingly unstoppable advance. With a consumer staple conglomerate trading at 88x earnings, we have to take profits and reduce our valuation risk.”
  • We did exactly that for the same reason.
  • We will look to buy back into our position at lower levels.
  • Stop loss is moved down to $105

VMC – Vulcan Materials (Take Profits)

  • VMC has been a strong performer but I am a little worried about industrial exposure with the “tariffs” still weighing on the sector.
  • We have taken profits and reduced our holdings for now.
  • With a sell signal approaching and currently overbought, reducing risk as we head into earnings season makes sense.
  • We like the company longer-term, but we need a bigger correction to add to our position.
  • Stop-loss is moved down to $125

YUM – Yum Brands (Take Profits)

  • YUM moved from an uptrend in 2018 to an accelerated uptrend in 2019. As noted last week:
    • “YUM is grossly overbought and has recently triggered a sell signal.”
  • We took profits and reduced the position for now to protect our gains.
  • We will look to add back to the position at lower levels.
  • Stop loss is moved down to $100

XOM – Exxon Mobil Corp. (BUY)

  • Back in April of this year we sold 50% of our holdings in XOM and have been waiting for the right opportunity to add back to our position. We are getting there.
  • Energy shares actually have some value in them, and XOM is trading at a very long-term set of bottoms.
  • With the stock deeply oversold and on a very deep “sell signal,” there is a greatly reduced risk of adding back to our position opportunistically.
  • With a 5% yield, we can afford to hold the position with a wider stop-loss.
  • We will update our holdings when we add to the position.
  • Stop loss is at $63

UNH – United Healthcare (BUY)

  • UNH has struggled as of late but is deeply oversold on many levels.
  • With the recent earnings announcement and improved guidance we will add to our position opportunistically.
  • Stop loss is remains at $210

Other positions on our BUY/ADD list under evaluation currently:

  • ABBV – AbbVie, Inc.
  • MU – Micron Technologies
  • AMZN – Amazon
  • GOOG – Google
  • FB – Facebook
  • JPM – JP Morgan
  • NSC – Norfolk Southern
  • JNJ – Johnson & Johnson

In The Fed We TRUST – Part 2: What is Money?

Part one of this article can be found HERE.

President Trump recently nominated Judy Shelton to fill an open seat on the Federal Reserve Board. She was recently quoted by the Washington Post as follows: “(I) would lower rates as fast, as efficiently, and as expeditiously as possible.” From a political perspective there is no doubting that Shelton is conservative.

Janet Yellen, a Ph.D. economist from Brooklyn, New York, appointed by President Barack Obama, was the most liberal Fed Chairman in the last thirty years.

Despite what appears to be polar opposite political views, Mrs. Shelton and Mrs. Yellen have nearly identical approaches regarding their philosophy in prescribing monetary policy. Simply put, they are uber-liberal when it comes to monetary policy, making them consistent with past chairmen such as Ben Bernanke and Alan Greenspan and current chairman Jay Powell.

In fact, it was Fed Chairman Paul Volcker (1979 to 1987), a Democrat appointed by President Jimmy Carter, who last demonstrated a conservative approach towards monetary policy. During his term, Volcker defied presidential “advice” on multiple occasions and raised interest rates aggressively to choke off inflation. In the short-term, he harmed the markets and cooled economic activity. In the long run, his actions arrested double-digit inflation that was crippling the nation and laid the foundation for a 20-year economic expansion.

Today, there are no conservative monetary policy makers at the Fed. Since Volcker, the Fed has been run by self-described liberals and conservatives preaching easy money from the same pulpit. Their extraordinary policies of the last 20 years are based almost entirely on creating more debt to support the debt of yesteryear as well as economic and market activity today. These economic leaders show little to no regard for tomorrow and the consequences that arise from their policies. They are clearly focused on political expediency.

Different Roads but the Same Path –Government

Bernie Sanders, Alexandria Ocasio-Cortez, Elizabeth Warren, and a host of others from the left-wing of the Democrat party are pushing for more social spending. To support their platform they promote an economic policy called Modern Monetary Theory (MMT). Read HERE and HERE for our thoughts on MMT. 

In general, MMT would authorize the Fed to print money to support government spending with the intention of boosting economic activity. The idealized outcome of this scheme is greater prosperity for all U.S. citizens. The critical part of MMT is that it would enable the government to spend well beyond tax revenue yet not owe a dime.   

President Trump blamed the Fed for employing conservative monetary policy and limiting economic growth when he opined, “Frankly, if we didn’t have somebody that would raise interest rates and do quantitative tightening (Powell), we would have been at over 4 instead of a 3.1.” 

Since President Trump took office, U.S government debt has risen by approximately $1 trillion per year. The remainder of the post-financial crisis period saw increases in U.S. government debt outstanding of less than half that amount. Despite what appears to be polar opposite views on just about everything, under both Republican and Democratic leadership, Congress has not done anything to slow spending or even consider the unsustainable fiscal path we are on. The last time the government ran such exorbitant deficits while the economy was at full employment and growing was during the Lyndon B. Johnson administration. The inflationary mess it created were those that Fed Chairman Volcker was charged with cleaning up.

From the top down, the U.S. government is and has been stacked with fiscal policymakers who, despite their political leanings, are far too undisciplined on the fiscal front.

We frequently assume that a candidate of a certain political party has views corresponding with those traditionally associated with their party. However, in the realm of fiscal and monetary policy, any such distinctions have long since been abandoned.

TRUST

Now consider the current stance of Democratic and Republican fiscal and monetary policy within the TRUST framework. Government leaders are pushing for unprecedented doses of economic stimulus. Their secondary goal is to maximize growth via debt-driven spending. Such policies are fully supported by the Fed who keeps interest rates well below what would be considered normal. The primary goal of these policies is to retain power.

To keep interest rates lower than a healthy market would prescribe, the Fed prints money. When policy consistently leans toward lower than normal rates, as has been the case, the money supply rises. In the wake of the described Fed-Government partnership lies a currency declining in value. As discussed in prior articles, inflation, which damages the value of a currency, is always the result of monetary policy decisions.

If the value of a currency rests on its limited supply, are we now entering a phase where the value of the dollar will begin to get questioned? We don’t have a definitive answer but we know with 100% certainty that the damage is already done and the damage proposed by both political parties increases the odds that the almighty dollar will lose value, and with that, TRUST will erode. Recall the graph of the dollar’s declining purchasing power that we showed in Part 1.

Data Courtesy St. Louis Federal Reserve

Got Money? 

If the value of the dollar and other fiat currencies are under liberal monetary and fiscal policy assault and at risk of losing the valued TRUST on which they are 100% dependent, we must consider protective measures for our hard-earned wealth.

With an underlying appreciation of the TRUST supporting our dollars, the definition of terms becomes critically important. What, precisely, is the difference between currency and money? 

Gold is defined as natural element number 79 on the periodic table, but what interests us is not its definition but its use. Although gold is and has been used for many things, its chief purpose throughout the 5,000-year history of civilization has been as money.

In testimony to Congress on December 18, 1912, J.P. Morgan stated: “Money is gold, and nothing else.” Notably, what he intentionally did not say was money is the dollar or the pound sterling. What his statement reveals, which has long since been forgotten, is that people are paid for their labor through a process that is the backbone of our capitalist society. “Money,” properly defined, is a store of labor and only gold is money.

In the same way that cut glass or cubic zirconium may be made to look like diamonds and offer the appearance of wealth, they are not diamonds and are not valued as such. What we commonly confuse for money today – dollars, yen, euro, pounds – are money-substitutes. Under an evolution of legal tender laws since 1933, global fiat currencies have displaced the use of gold as currency. Banker-generated currencies like the dollar and euro are not based on expended labor; they are based on credit. In other words, they do not rely on labor and time to produce anything. Unlike the efforts required to mine gold from the ground, currencies are nearly costless to produce and are purely backed by a promise to deliver value in exchange for labor.

Merchants and workers are willing to accept paper currency in exchange for their goods and services in part because they are required by law to do so. We must TRUST that we are being compensated in a paper currency that will be equally TRUSTed by others, domestically, and internationally. But, unlike money, credit includes the uncertainty of “value” and repayment.

Currency is a bank liability which explains why failing banks with large loan losses are not able to fully redeem the savings of those who have their currency deposited there. Gold does not have that risk as there is no intermediary between it and value (i.e., the U.S. government or the Japanese government). Gold is money and harbors none of these risks, while currency is credit. Said again for emphasis, only gold is money, currency is credit.

There is a reason gold has been the money of choice for the entirety of civilization. The last 90 years is the exception and not the rule.

Despite their actions and words, the value of gold, and disTRUST of the dollar is not lost on Central Bankers. Since 2013, global central banks have bought $140 billion of gold and sold $130 billion of U.S. Treasury bonds. Might we say they are trading TRUST for surety?

Summary

To repeat, currency, whether dollars, pounds, or wampum, are based on nothing more than TRUST. Gold and its 5000 year history as money represents a dependable store of labor and real value; TRUST is not required to hold gold. No currency in the history of humankind, the almighty U.S. dollar included, can boast of the same track record.

TRUST hinges on decision makers who are people of character and integrity and willingness to do what is best for the nation, not the few. Currently, both political parties are taking actions that destroy TRUST to gain votes. While political party narratives are worlds apart, their actions are similar. Deficits do matter because as they accumulate, TRUST withers.

This article is not a call to action to trade all of your currency for gold, but we TRUST this article provokes you to think more about what money is.

3 Tips To Avoid A “Save Taxes NOW!” Mentality

We scramble to do whatever we can to save on taxes.

Unfortunately, there’s little firepower in the form of itemized deductions since the Tax Cuts and Jobs Act (TCJA) was initiated. The www.taxfoundation.org estimates that nearly 90% of taxpayers will continue to take the expanded standard deduction which has increased from $6,500 to $12,000 for single filers; $13,000 to $24,000 for those married filing jointly. If you recall, the income tax changes under TCJA expire at the end of 2025.

CPAs, professionals in the financial industry and the media constantly tout the advantages of pre-tax accounts like traditional 401ks and deductible IRAs to help consumers reduce their current tax liabilities.

The sole focus on tax reduction today could be a shortsighted mistake paid for dearly down the road.

I’ll explain:

Most financial professionals advise with an accumulation mindset. The emphasis is to help clients accumulate and invest primarily in tax-deferred accounts with little consideration to tax implications of this guidance when the day arrives to withdraw funds – most likely at retirement.

Rationale for this tax-deferred myopia is based on a compelling three-part story: First, the ‘snowballing’ of compounded investment returns which occurs as would-be annual tax dollars work 100% for the investor sheltered from taxation for years, perhaps decades. Second, a company retirement account contribution is generally a dollar-for-dollar reduction of gross income which ostensibly reduces taxable income.  Finally, the blanket statement about how households are going to drop to the lowest tax bracket in retirement is stubbornly alive and well. Only one component of this story remains valid.

The tax-deferred snowball story touted throughout the 80s and early 1990s made sense as ten-year annualized returns on the S&P 500 ranged consistently between 10 to 15%. What a snowball, right? From the mid-90s to today, returns on the large company index have been half or less than half what investors previously realized. If we’re correct at RIA about forward-looking stock returns closer to 3%, the attractiveness of socking every dollar away in tax-deferred accounts based on the compounding story is as small as a snowball in Texas.

But Rich, what if marginal tax rates do indeed move higher? Wouldn’t it be worth maximizing my savings in tax-deferred accounts while I’m still working? Well, that is clearly the conventional wisdom – worry about taxes today, never tomorrow (and tomorrow arrives sooner than you think!)

However, unless there’s a proactive strategy to the invest tax dollars that are saved by maxing out pre-tax accounts, (in an after-tax account or Roth IRA), why not bite the bullet, pay taxes now while you’re a career-driven, human capital earnings machine, as opposed to the time when you are no longer in the workplace and need every tax-friendly dollar to live comfortably?

If we consider taxation on Social Security benefits and couple that with future disappointing investment returns, it makes sense that investors should place greater focus on tax-free account vehicles such as Roth vs. traditional pre-tax choices which just postpone future tax pain.

If you’re a rare breed of taxpayer who believes marginal tax rates will fall in the future, taxation on Social Security benefits is not eventually headed higher and Medicare IRMAA surcharges will only increase down the road for higher-income households, then there’s no reason to consider a change to your current focus on pre-tax retirement accumulation.

If you believe taxes have one direction to go (and that’s up), then read on.

With the proliferation of exchange-traded funds, investors now have a great opportunity to invest tax-efficiently in after-tax brokerage accounts. The inherent tax-efficiency of ETFs allows investors to still buy in to the snowball compounding tale (if they must), of stocks, but in a tax-friendly manner.

The advantage would be the reduction of ordinary income tax liability and increase in long-term capital gains, which are currently taxed at lower rates. For example, a married retiree with income at the 22% marginal tax rate (married filing jointly with taxable income of $19,401-$78,950), would pay a more palatable 0 – 15% on long-term capital gains on the sale of investments held for a year or longer.

Keep in mind, short-term capital gains (gains from a sale on assets held for a year or less), are currently taxed as ordinary income. Noted, there’s always a risk that favorable long-term capital gain rates are not as tax-friendly in the future. Personally, I’m willing to take the risk as I believe long-term capital gain rates will always be taxed favorably vs. current income as the wealthiest Americans (including members of Congress), don’t survive paycheck-to-paycheck. They thrive off capital gains.

At the least, maintaining pre-tax, after-tax and tax-free accounts allows for greater lifetime tax control. It’s especially important throughout the retirement income distribution phase.

At RIA, we teach the importance of ‘diversification of accounts’ whereby a retiree is able to maintain greater distribution flexibility and control over tax liabilities when unexpected expenses arise or ordinary-income distributions risk placing a retiree in the next highest marginal tax bracket.

Recently, a client required $50,000 to pay off the mortgage on his primary residence. Because he believes in account diversification, we were able to withdraw $20,000 from his pre-tax rollover IRA, $10,000 from his Roth conversion IRA and the remainder from his after-tax brokerage account which helped minimize the overall taxes he would have incurred if the entire $50,000 needed to be distributed solely from his pre-tax rollover IRA.   

Unless you’ve undertaken holistic financial planning that includes tax-friendly retirement income distribution planning modeled for the sunset of current tax laws in 2025, and then know for a fact you’re going to be in the lowest tax bracket in retirement, here are several other tax-friendly ideas to consider:

Maximize annual contributions to ROTH IRAs.

A Roth comes in two flavors: Contributory and conversion. People tend to mix them up. So, let’s start with the smarter, more handsome sibling of the traditional IRA: The contributory Roth IRA. Roth accounts overall offer tax-free growth and most important: Tax free withdrawals.

The annual contribution limit per individual is $6,000 for 2019; $7,000 if you’re 50 or older.  Roth IRA contribution levels phase out based on household adjusted gross income. For example, if your filing status is married filing jointly and modified adjusted gross income is less than $193,000, you may contribute up to the limit. Once MAGI is greater than $193,000 but less than $203,000, contribution levels are reduced. Based on the generous AGI phaseout levels, most wage earners will have no excuse and should be able to fund Roth IRAs every year.

Since Roth IRAs are funded with after-tax dollars obviously, a current tax deduction is not available (remember my commentary about focusing on taxes tomorrow vs. taxes today?). After a five-year period, which begins January 1st of the year a contribution is made, earnings may be distributed 100% tax free. If younger than 59 1/2, unfortunately, a 10% premature distribution penalty applies to withdrawn earnings.

Contributions, which are after-tax, may be withdrawn at any time without taxes or penalties. For many investors, the five-year waiting period for earnings is a quick walk in the park as funds should be considered long-term for retirement.

Keep in mind, a Roth IRA is not subject to required minimum distribution rules where at 70 1/2, distributions from traditional retirement accounts must begin or a retiree may face a draconian 50% penalty on the amount that should have been withdrawn.

Another benefit to Roth IRAs and Roth 401(k) options: Withdrawals are not included in the provisional income formula used to tax Social Security; distributions will not add to income that may generate Medicare IRMAA surcharges.

Keep this in mind if you follow a Pay Yourself First strategy: In almost every case a Roth is a better choice. I’m not concerned about your current tax bracket; nor am I worried about your possible tax bracket in retirement. I do care about how you’re going to gain more consumption dollars in retirement and the impact of taxation on Social Security benefits.

John Beshears a behavioral economist and assistant professor of business administration at Harvard Business School in a study – “Does Front-Loading Taxation Increase Savings?: Evidence from Roth 401k Introductions,” along with co-authors, outlines that plan participants who place their retirement savings on auto-pilot and direct a percentage of gross income, say 10%, into a Roth vs. a traditional pre-tax 401k, will wind up with more dollars to spend in retirement.

 It’s rare when a financial rule-of-thumb is a true benefit. And you don’t need to do much to receive it! The reason the strategy works is front loading of taxes. In other words, sacrificing tax savings today (when working and paying the taxes isn’t as much of a burden as it would be in retirement when earning power drops dramatically), and failing to adjust the percentage of auto-pilot savings to compensate for the current tax impact of switching from pre-tax to Roth, allows for additional future consumption dollars. 

From Lauren Lyons Cole Business Insider article on the study:

“If a worker saves $5,000 a year in a 401(k) for 40 years and earns 5% return a year, the final balance will be more than $600,000. If the 401(k) is a Roth, the full balance is available for retirement spending. If the 401(k) is a traditional one, taxes are due on the balance. Let’s say the person’s tax rate is 20% in retirement. That makes for a difference of $120,000 in spending power, which a life annuity will translate into about $700 a month in extra spending.” John Beshears

 Switch to a ROTH 401(k) at work.

I know. Sounds weird. We’ve been so brainwashed to invest in traditional pre-tax 401k plans; it just feels odd to consider a Roth alternative. Most likely, your place of employment offers a Roth 401k; you just never bothered to check – they never bothered to make a big deal about offering it.

A Roth 401k operates the same as the traditional brethren with several important differences – contributions are after-tax; there is no current tax benefit for paycheck contributions. In other words, if you decide to max your employee contributions (and I hope you do), then $19,000 ($25,000 if 50 or older), will not reduce your household income. Employer-matched contributions remain pre-tax and deposited in your traditional, pre-tax 401k.  

But Rich, this is painful! I get it. As you recall, tax savings realized in the current can be a tax enemy in waiting when retirement arrives and you require every tax-free dollar to maintain a lifestyle. Let’s consider a compromise (and I do need to make this deal. Sometimes the tax-deferred story is too deeply ingrained to discount completely).  

You decide to ignore my advice. I have no idea what I’m talking about. Fine. So, you make the maximum contribution to a pre-tax 401(k). Hey, I’m just happy you’re saving money! Now, please go ahead and ask your tax advisor how much was saved in current taxes due to the contribution. Whatever that sum turns out to be, I want you to please contribute 100% of it if possible, in a Roth contributory IRA. See? I’m all about compromise. At the least, you’ll be working on diversification of accounts. For that, I commend you.

I’m proud of how we’ve helped attendees at our Right Lane Retirement Classes and clients to realize the long-term benefits of Roth. So much so, we have many clients who max their Roth 401k AND Roth contributory accounts on a consistent basis.

If your company doesn’t have a Roth retirement plan option, I’d suggest you speak to your benefits department to inquire as to why one isn’t offered. In the meantime, my recommendation is to invest up to the match in your tax-deferred plan and continue the remainder of your savings in an after-tax brokerage account.

Consider annual surgical ROTH conversions.

People ask me about the viability of Roth in light of massive federal government deficits. I’m not concerned about the government changing the tax-free status of Roth. Why? They’re like J.G. Wentworth! They need cash now! However, I’m extremely concerned how political parties envision tax-deferred accounts as fatted calves – all too tempting not to bring to eventual tax slaughter.

The $100,000 AGI ceiling on Roth conversions was removed years ago to allow traditional IRA owners to convert to Roth without limitation (J.G Wentworth!).

A Roth conversion allows withdrawals from a pre-tax retirement account, most likely a rollover IRA, and subsequent conversion to Roth. Withdrawals are taxed as ordinary income. Therefore, careful analysis and discussion with a financial and tax advisor is crucial.

I partner with a ‘young’ retiree, a client for over a decade now – 57 years old, on a surgical Roth conversion plan. If you recall from previous blog posts, I’ve written how the fortunate few who still have pensions, employer-based retirement healthcare pre-Medicare, and are disciplined savers to boot, earn the luxury of retirement in their 50s.

I outlined a five-year surgical Roth conversion strategy to fully maximize the 22% tax bracket. Considering a 37-year life expectancy, we were able to estimate an increase in his lifetime withdrawal and/or legacy plan by $871,466 compared to conventional wisdom whereby we remain passive and just distribute money every year from his tax-deferred accounts beginning at age 60, to meet specific spending goals. With the surgical Roth strategy, we were also able to reduce overall tax liability and loss of tax control that comes with required minimum distribution requirements.

In addition, years ago we initiated a process where our client proactively made an effort to NOT sock every investment dollar away into tax-deferred accounts. Ostensibly, we now have cash to pay all taxes on Roth conversions from his after-tax source. This allows 100% of his IRA dollars to be directed into the Roth. Having the money available from an outside source to pay taxes on the conversion instead of withheld from the traditional IRA, avoids the 10% premature distribution penalty he would have incurred before 59 1/2.

A trusted tax advisor with a bit of fine tuning was able to validate the plan before we moved forward.

There are times when pervasive financial dogma is harmful to your wealth. For some reason, Roth is not discussed often enough.

I’m no conspiracy theorist. However, I do believe there’s a profit incentive behind it all for Wall Street and the financial industry which prevents Roth from becoming the popular choice.

As a reader of RIA, now you know better.

Sector Buy/Sell Review: 10-15-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • As noted previously:
    • “There are multiple tops that are providing tough resistance for the sector to get through, so while the buy signal has turned back up, which is bullish, XLB has to get above resistance before considering adding to our position.”
  • The bad news is that XLB not only failed at resistance, a “sell signal” has also now been triggered.
  • Given the “trade deal” wasn’t really a “deal” at all, we are remaining underweight the sector for now, unless performance begins to improve.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • The good news is that XLC worked off its overbought condition, and the correction is holding above short-term support at $48.50
  • There are two support levels between $47.50 and $48.50. A violation of the lower support level will take us out of our position for now.
  • XLC has a touch of defensive positioning from “trade wars” and given the recent pullback to oversold, a trading position was placed in portfolios.
  • One concern of the overall market is that the former “generals” of the market, namely AMZN, NFLX, and GOOG, have been not be performing well.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $47.50
  • Long-Term Positioning: Bearish

Energy

  • As we noted previously, the failed test of the 200-dma put $58 as the next target of support, which has now also failed.
  • XLE is now testing that previous support, now resistance, and needs to move higher other a potential break of recent lows becomes a real possibility.
  • The “sell signal” was in the process of being reversed, but that has failed also as stated last week.
  • While there is “value” in the sector, there is no need to rush into a position just yet. The right opportunity and timing will come, it just isn’t right now.
  • We were stopped out of our position previously.
  • Short-Term Positioning: Bearish
    • Last week: Stopped out.
    • This week: Stopped out.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF is another sector trapped below multiple highs.
  • XLF has reversed its “sell” signal” on a short-term basis, but is threatening to turn lower.
  • The good news is that XLF held support above the previous downtrend line. If we get a reversal to a buy signal we can review adding back into a position.
  • We previously closed out of positioning as inverted yield curves and Fed rate cuts are not good for bank profitability.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • XLI also, after failing a breakout, remains trapped below multiple highs.
  • The breakout failed, and as we suggested might be the case, the retracement back to initial support has occurred.
  • XLI did work off some of the overbought condition but has triggered a “sell signal.” While it appears that XLI wants to make another attempt at all-time highs, it is going to take some work to move above that resistance.
  • We have adjusted our stop-loss for the remaining position.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $72
  • Long-Term Positioning: Neutral

Technology

  • XLK is back to an overbought condition, and is testing previous broken support which is now resistance.
  • The buy signal has reversed to a “sell,” which increases holding risk currently.
  • It is likely not a bad idea to take some profits on current holdings and rebalance risk accordingly.
  • A retest of $75 is likely the market doesn’t improve very quickly.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $75.00
  • Long-Term Positioning: Neutral

Staples

  • Defensive sectors continue to perform well, and we suggested taking profits previously.
  • XLP continues to hold its very strong uptrend but is threatening to break that support. If it does, it could lead to a rather abrupt sell off.
  • The “buy” signal (lower panel) is still in place but has been worked off to a good degree. Risk is clearly elevated.
  • We previously took profits in XLP and reduced our weighting from overweight. We will likely look to reduce further when opportunity presents itself.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $58
    • Long-Term Positioning: Bullish

Real Estate

  • As with XLP above, XLRE is consolidating its advance within a very tight pattern. If that consolidation breaks to the downside we will see a quick retracement to $37
  • Be careful adding new positions and keep a tight stop for now. A pullback to $37-38 would be a better entry.
  • We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That advice remains.
  • Buy signal has been reduced which is bullish for now.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLRE and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup. We haven’t gotten one as XLU continues to rally and last weeks surge is making owning this sector seriously more dangerous.
  • Long-term trend line remains intact but XLU is grossly deviated from longer-term means. A reversion will likely be swift and somewhat brutal.
  • Buy signal reversed, held, and is now back to extremely overbought. Take profits and reduce risks accordingly.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has triggered a sell signal but has remained intact and is trying to recover with the market. If a buy signal is issued that may well support a higher move for the sector.
  • XLV continues to hold support levels but is lagging the overall market.
  • Healthcare will likely begin to perform better soon if money begins to look for “value” in the market. We are looking for entry points to add to current holdings and potentially some new holdings as well in the Equity portfolio.
  • We continue to maintain a fairly tight stop for now.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY failed at previous highs where resistance sits currently.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY has reversed its “buy signal” to a “sell” which could pressure prices lower in the near-term so take profits and watch support a the current uptrend line.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has been a trading nightmare for investors with a fairly broad and volatile range.
  • As we noted previously:
    • “This rally is most likely going to fail at the previous highs for the range. It is now make or break for the sector.”
  • The rally failed and XTN is clinging to initial support.
  • XTN has is close to reversing its “buy” signal which could pressure prices back to previous lows.
  • We remain out of the position currently.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: Bulls Get QE & Trade, Remain “Stuck In The Middle”

“Clowns to the left of me,
Jokers to the right, here I am,
Stuck in the middle with you” – Stealers Wheels

__________________________

The lyrics seem apropos considering we have Trump, China, Mnuchin, the Fed, along with a whole cast of colorful characters making managing money a difficult prospect recently. 

However, the good news is that over the last month, the bulls have had their wish list fulfilled.

  • The ECB announces more QE and reduces capital constraints on foreign banks.
  • The Fed reduces capital requirements on banks and initiates $60 billion in monthly treasury purchases.
  • The Fed is also in the process of cutting rates as concerns over economic growth remain.
  • Trump, as expected, caves into China and sets up an exit from the “trade deal” nightmare he got himself into. 
  • Economic data is improving on a comparative basis in the short-term.
  • Stock buybacks are running on pace to be another record year.  (As noted previously, stock buybacks have accounted for almost 100% of all net purchases over the last couple of years.)

If you are a bull, what is there not to love?

However, as I noted in this past weekend’s newsletter. (Subscribe for free e-delivery)

“Despite all of this liquidity and support, the market remains currently confined to a downtrend from the September highs. The good news is there is a series of rising lows from June. With a ‘risk-on’ signal approaching and the market not back to egregiously overbought, there is room for the market to rally from here.”

As the tug-of-war between the “bulls” and “bears” continues, the toughest challenge continues to be understanding where we are in the overall market process. The bulls argue this is a “consolidation” process on the way to higher highs. The bears suggest this is a “topping process” which continues to play out over time. 

As investors, and portfolio managers, our job is not “guessing” where the market may head next, but rather to “navigate” the market for what is occurring. 

This is an essential point because the majority of investors are driven primarily by two psychological behaviors: herding and confirmation bias. (Read this for more information.)

Since the market has been in a “bullish trend” for the last decade, we tend to only look for information that supports our “hope” the markets will continue to go higher. (Confirmation Bias) 

Furthermore, as we “hope” the market will go higher, we buy the same stocks everyone else is buying because they are going up. (Herding)

Here is a perfect example of these concepts in action. The chart below shows the 4-week average of the spread between bullish and bearish sentiment according to the respected AAII investor survey. Currently, investors are significantly bearish, which has historically been an indicator of short-term bottoms in the market. (contrarian indicator)

If you assumed that with such a level of bearishness, most investors would be sitting in cash, you would be wrong. Over the last couple of months as concerns of trade, earnings, and the economy were brewing, investors actually “increased” equity risk in portfolios with cash at historically low levels.

This is a classic case of “bull market” conditioning.  

We can also see the same type of “bullish” positioning by looking at Rydex mutual funds. The chart below compares the S&P 500 to various measures of Rydex ratios (bear market to bull market funds)

Note that during the sell-off in December 2018, the move to bearish funds never achieved the levels seen during the 2015-2016 correction. More importantly, the snap-back to “complacency” has been quite astonishing. 

While investors are “very concerned” about the market (ie bearish in their sentiment) they are unwilling to do anything about it because they are afraid of “missing out” in the event the market goes up. 

Therein lies the trap.

By the time investors are convinced they need to sell, the damage has historically already been done. 

Stuck In The Middle

Currently, the market is continuing to wrestle with a rising number of risks. My friend and colleague Doug Kass recently penned a nice laundry list:

  1.  The Fed Is Pushing On A String: A mature, decade old economic recovery will not likely be revived by more rate cuts or by lower interest rates. The cost and availability of credit is not what is ailing the U.S. economy. Market participants are likely to lose confidence in the Fed’s ability to offset economic weakness in the year ahead.
  2. Untenable Debt Loads in the Private and Public Sectors: Katie Bar The Doors should rates rise and debt service increase. (As I noted all week, the corporate credit markets are already laboring and, in some cases, are freezing up).
  3. An Unresolved Trade War With China: This will produce a violent drop in world trade, a freeze in capital spending, and a quick deterioration in business and consumer sentiment.
  4. The Global Manufacturing Recession Is Seeping Into The Services Sector: After years of artificially low rates, the consumer is no longer pent up and is vulnerable to more manufacturing weakness.
  5. The Market Structure is Frightening: The proliferation of popularity of ETFs when combined with quantitative strategies (e.g., risk parity) have everyone on the same side on the boat and in the same trade (read: long). The potential for a series of “Flash Crashes” hasn’t been so high as since October, 1987.
  6. We Are at an All Time Low in Global Cooperation and Coordination: In our flat and interconnected world, what happens to global economic growth when the wheels fall off?
  7. We Are Already In An “Earnings Recession”: I expect a disappointing 3Q reporting period ahead. What happens when the rate of domestic and global economic growth slows more dramatically and a full blown global recession emerges?
  8. Front Runner Status of Senator Warren: Most view a Warren administration as business, economy and market unfriendly.
  9. Valuations on Traditional Metrics (e.g., stock capitalizations to GDP) Are Sky High: This is particular true when non GAAP earnings are adjusted back to GAAP earnings!
  10. Few Expect That The Market Can Undergo A Meaningful Drawdown: There is near universal belief that there is too much central bank and corporate liquidity (and other factors) that preclude a large market decline. It usually pays to expect the unexpected.
  11. The Private Equity Market (For Unicorns) Crashes and Burns: Softbank is this cycle’s Black Swan.
  12. WeWork’s Problems Are Contagious: The company causes a massive disruption in the U.S. commercial real estate market.

Don’t take this list of concerns lightly. 

The market rallied from the lows of December on “hopes” of Fed rate cuts, QE, and a “trade deal.” As we questioned previously, has the fulfillment of the bulls “wish list” already been priced in? However, since then, the market has remained stuck within a fairly broad trading range between previous highs and the 200-dma. 

Notice the negative divergence between small-capitalization companies and the S&P 500. This is symptomatic of investors crowding into large-cap, highly liquid companies, as they are “fearful” of a correction in the market, but are “more fearful” of not being invested if the market goes up. 

This is an important point when managing money. The most important part of the battle is getting the overall “trend” right. “Buy and hold” strategies work fine in rising price trends, and “not so much” during declines.

The reason why most “buy and hold” supporters suggest there is no alternative is because of two primary problems:

  1. Trend changes happen slowly and can be deceptive at times, and;
  2. Bear markets happen fast.

Since the primary messaging from the media is that “you can’t miss out” on a “bull market,” investors tend to dismiss the basic warning signs that markets issue. However, because “bear markets” happen fast, by the time one is realized, it is often too late to do anything about it.

The chart below is one of my favorites. It is a quarterly chart of several combined indicators which are excellent at denoting changes to overall market trends. The indicators started ringing alarm bells in early 2018, when I begin talking about the end of the “bull market” advance. However, that correction, as noted, was quickly reversed by the Fed’s changes in policy and “hopes” of an impending “trade deal.”

Unfortunately, what should have been a larger corrective process to set up the next major bull market, instead every single indicator has reverted back to warning levels.

If the bull market is going to resume, the market needs to break above recent highs, and confirm the breakout with expanding volume and participation in both small and mid-capitalization stocks which have been sorely lagging over the past 18-months.

However, with earnings and economic growth weakening, this could be a tough order to fill in the near term.

So, for now, with our portfolios underweight equity, over-weight cash, and target weight fixed income, we remain “stuck in the middle with you.”

Major Market Buy/Sell Review: 10-14-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

This update focuses on the impact the “trade deal” announced on Friday will have on each market going forward.

S&P 500 Index

  • We are maintaining our core equity positions for now as the bullish trend remains intact.
  • The bullish news is that the “sell signal” has been reversed. However, without the market breaking out to new highs, it doesn’t mean much especially given the market is pushing back into an overbought condition.
  • We will wait for a confirmation breakout to add to our core equity holdings as needed.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position.
    • Stop-loss moved up to $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • Like the SPY, DIA broke above resistance but failed at previous highs. We are not set to test those highs once again, likely next week.
  • As with SPY, DIA has also reversed its previous “Sell signal” as well, but has failed to breakout to new highs and is back to more extreme overbought conditions.
  • We will wait for confirmation before adding more broad market exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $255.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • The technology heavy Nasdaq not only failed to test previous highs but failed at the previous highs from earlier this year.
  • While the “trade deal” should bode well for QQQ, it continues to perform weaker than the overall S&P 500 Index.
  • The “Sell signal” is close to being reversed, but only barely so. QQQ needs to break out to new highs to confirm the bullish trend.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $175
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • The trade deal didn’t do much for small caps which are less affected by the deal and more affected by current tariffs which will remain,.
  • We suggested previously with SLY back to extreme overbought, and below previous resistance, and in a negative trend, that it looked like a better selling opportunity rather than a buy. That was good advice.
  • However, as we have repeatedly stated, there are a lot of things going wrong with small-caps currently so the risk outweighs the reward of a trade at this juncture.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss previously violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY, like SLY, is technically not in great shape, and also failed at the downtrend line and failed to hold above previous resistance.
  • MDY has now registered a short-term “buy” signal, but needs to be confirmed by a break above resistance. That has yet to occur. Be patient and take profits for now.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. Event the trade deal was unable to get EEM above resistance at the 200-dma.
  • The current spurt higher also remains solidly confined to the overall downtrend.
  • The sell signal remains and has failed to reverse. EEM needs to move above the downtrend line to become of interest again. The failure to hold above the 200-dma is not encouraging.
  • As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA continues to drag.
  • EFA remains in a downtrend and is testing the top of that range.
  • EFA has also triggered a buy signal, so a rally above the downtrend line will be needed to establish a tradeable opportunity. That has failed to occur so far.
  • As with EEM, we closed out of previous trading positions due to lack of performance.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position.
    • Stop-loss was violated at $64
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • The week saw an uptick in oil prices as “speculation” returned to the markets on the completion of the “trade deal.”
  • Don’t get too excited, there is not much going on with oil currently, but there is likely a tradeable opportunity approaching given the deeply oversold conditions.
  • Short-Term Positioning: Neutral
    • Last Week: No position
    • This Week: No position
    • Stop-loss for any existing positions is $54.
  • Long-Term Positioning: Bearish

Gold

  • Gold is back to a slight oversold and is holding important support, however, it is forming a bit of a downtrend from recent highs.
  • With the “trade deal” done, the “safety trade” may be off the table for a while. We are going to move up our stops to protect profits.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
    • Stop-loss for whole position move up to $137.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices finally cracked and have reversed a good chunk of the overbought condition.
  • As with GLD, we are also moving up our stop-loss to protect our gains if the “risk on” trade gets some real traction.
  • With the overbought condition being worked off, it is likely we will be able to further add to holdings as we head into the end of the year.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $137.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar had rallied to our $99 target which we laid out back in June of this year when we started tracking the dollar.
  • Despite hopes to the contrary, the dollar remains in a strongly rising uptrend. Given a “strong dollar” erodes corporate profits on exports (which makes up 40% of corporate profits overall) a strong dollar combined with tariffs isn’t great for corporate bottom lines.
  • Watch earnings carefully over the next quarter.
  • It is highly likely the dollar will continue its bullish trend with negative rates spreading all over Europe.
  • The rally has now triggered a “buy” signal which keeps us dollar bullish for now.

Capitalism Is The Worst, Except For All The Rest – Part 3

Part 1 – How Wall Street Destroyed Capitalism

Part 2 – The Myths Of “Broken Capitalism”


In Part 1, we discussed how “Capitalism” was distorted by Wall Street. In Part 2, we reviewed some of the “myths” of capitalism, which are used to garner “votes” by politicians but are not really true. Most importantly, we discussed the fallacy that “more Government” is the answer in creating equality as it impairs economic opportunity.

I want to conclude this series with a discussion on the fallacy of socialism and equality, and provide a some thoughts on how you can capitalize on capitalism.

Socialism Requires Money

The “entire premise” of the socialist agendas assumes money is unlimited. Since there is only a finite amount of money created through taxation of citizens each year the remainder must come from the issuance of debt.

Therefore, to promote an agenda which requires unlimited capital commitments to fulfill, the basic premise has to be “debt doesn’t matter.” 

Enter “Modern Monetary Theory” or MMT.

Kevin Muir penned “Everything You Wanted To Know About MMT” which delves into what MMT proposes to be. To wit:

“Modern Monetary Theory is a macroeconomic theory that contends that a country that operates with a sovereign currency has a degree of freedom in their fiscal and monetary policy which means government spending is never revenue constrained, but rather only limited by inflation.”

In other words, debts and deficits do not matter as long as the Government can print the money it needs, to pay for what it wants to pay for.

Deficits are self-financing, deficits push rates down, deficits raise private savings.” – Stephanie Kelton

It is the proverbial “you can have your cake and eat it too” theory. It just hasn’t exactly worked out that way.

Deficits Are Not Self-Financing

The premise of MMT is that government “deficit” spending is not a problem because the spending into “productive investments” pay for themselves over time.

But therein lies the problem – what exactly constitutes “productive investments?”

For that answer, we can turn to Dr. Woody Brock, an economist who holds 5-degrees in math and economics and is the author of “American Gridlock” for the answer.

“The word ‘deficit’ has no real meaning. 

‘Country A spends $4 Trillion with receipts of $3 Trillion. This leaves Country A with a $1 Trillion deficit. In order to make up the difference between the spending and the income, the Treasury must issue $1 Trillion in new debt. That new debt is used to cover the excess expenditures, but generates no income leaving a future hole that must be filled.

Country B spends $4 Trillion and receives $3 Trillion income. However, the $1 Trillion of excess, which was financed by debt, was invested into projects, infrastructure, that produced a positive rate of return. There is no deficit as the rate of return on the investment funds the ‘deficit’ over time.’

There is no disagreement about the need for government spending. The disagreement is with the abuse, and waste, of it.

For government “deficit” spending to be effective, the “payback” from investments made through debt must yield a higher rate of return than the interest rate on the debt used to fund it.

The problem, for MMT and as noted by Dr. Brock, is that government spending has shifted away from productive investments, like the Hoover Dam, which creates jobs (infrastructure and development) to primarily social welfare, defense, and debt service which has negative rates of return.

In other words, the U.S. is “Country A.” 

However, there is clear evidence that increasing debts and deficits DO NOT lead to either stronger economic growth or increasing productivity. As Michael Lebowitz recently showed:

“Since 1980, the long term average growth rate of productivity has stagnated in a range of 0 to 2% annually, a sharp decline from the 30 years following WWII when productivity growth averaged 4 to 6%. While there is no exact measure of productivity, total factor productivity (TFP) is considered one of the best measures. Data for TFP can found here.

“The graph below plots 10-year average productivity growth (black line) against the ratio of total U.S. credit outstanding to GDP (green line).”

“This reinforces the message from the other debt related graphs – over the last 30 years the economy has relied more upon debt growth and less on productivity to generate economic activity.”

As noted above, since the bulk of the debt issued by the U.S. has been unproductively squandered on increases in social welfare programs and debt service, there is a negative return on investment. Therefore, the larger the balance of debt becomes, the more economically destructive it is by diverting an ever-growing amount of dollars away from productive investments to service payments.

Another way to view the impact of debt on the economy is to look at what “debt-free” economic growth would be. In other words, without debt, there has been no organic economic growth.

For the 30-years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Today, with the economy expected to grow at just 2% over the long-term, the economic deficit has never been greater, and continues to grow.

MMT is not a free lunch. MMT is paid for by reducing the value of the dollar, and is a hidden tax by reducing the purchasing power of everyone holding dollars. The problem is that inflation tends to harm the poor and middle class, but benefits the wealthy.

While MMT promises “free college,” “healthcare for all,” “free childcare,” and “jobs for all” with no consequences, it will deliver inflation, generate further wealth/income inequality, and greater levels of social instability and populism.

How do we know this? Because it is the same outcome seen in every other country that endeavored in programs of unbridled debts and deficits.

MMT sounds great at the conversational level, but so does “communism” and “socialism.”

In practice, the outcomes have been vastly different than the theory.

Why Wealth Inequality Is A Good Thing

Just recently, Aaron Back accidentally made the case for why we should foster “capitalism” over “socialism.” 

What Aaron exposed in his rush to jump on the “inequality bandwagon” was what capitalism provided. Let’s break down his statement:

  1. Introduction of capitalism lifts millions out of poverty. (This is a good thing)
  2. Yes, inequality was created as those that took advantage of capitalism prospered versus those that didn’t. (How capitalism works)
  3. If capitalism lifted millions out of poverty, which suggests everyone was poor under communism. 

Point 3 is the most important.

Capitalism gets its power—and has created the greatest increase in social welfare in history—from embracing human ingenuity and the positive forces of innovation, open markets and competition. Perhaps the greatest strength of free markets is their ability to nimbly adjust to new ideas and situations and find the most efficient system. Markets are always looking to do things better. We can apply that same logic to capitalism itself to improve capitalism further so that it can provide even greater social welfare.”Daniel LaCalle

Let me clarify something for you.

The ‘American Dream’ isn’t going into debt to buy a home. The ‘American Dream’ is the ability for ANY person, regardless of race, religion, or means, to achieve success, and in many cases great success, through hard work, dedication, determination, and sacrifice.

Capitalism Is The Worst, Except For All The Rest

One thing is for certain. Life isn’t fair.

“The rich have everything, and all I have is a mountain of student debt and a crappy job.”

Capitalism isn’t perfect as Howard Marks recently noted:

Capitalism is an imperfect economic system, because differential performance in the pursuit of economic success – as well as luck – results in there being (a) some people who are less successful as well as some who are more and (b) a few who are glaringly successful.

I’m 100% convinced that the capitalist system has produced the most aggregate gains for our society, exceptional overall progress, and a better life for most. 

In the same way, I’m convinced that capitalism is the worst economic system . . . except for all the rest.”

Capitalism is the only system that will provide you the ability to achieve unbridled success.

Yes, the Government can pay for anything you want. The problem is that it requires those who are succeeding to pay for it.

Think about it.

Do you want to work hard, sacrifice, and take on an exceeding amount of risk to achieve success only to pay for those who don’t?

This is why socialism always fails.

The greater good can only be achieved by making the good greater.” Daniel LaCalle

RIA PRO: Trade Deal Done? Is 3300 The Next Stop For The Market?


  • Trade Deal Done
  • QE, Not QE, But It’s QE
  • Sector & Market Analysis
  • 401k Plan Manager

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Trade Deal Done

On Thursday and Friday, the market surged on hopes that a “trade deal” was coming to fruition. This was not a surprise to us, as we detailed this outcome two weeks ago:

‘For Trump, he can spin a limited deal as a ‘win’ saying ‘China is caving to his tariffs’ and that he ‘will continue working to get the rest of the deal done.’ He will then quietly move on to another fight, which is the upcoming election, and never mention China again. His base will quickly forget the ‘trade war’ ever existed.

Kind of like that ‘Denuclearization deal’ with North Korea.'”

As we discussed in that missive, a limited “trade deal” would potentially set the markets up for a run to 3300. To wit:

Assuming we are correct, and Trump does indeed ‘cave’ into China in mid-October to get a ‘small deal’ done, what does this mean for the market. 

The most obvious impact, assuming all ‘tariffs’ are removed, would be a psychological ‘pop’ to the markets which, given that markets are already hovering near all-time highs, would suggest a rally into the end of the year.” 

This is not the first time we presented our analysis for a “bull run” to 3300.

Every week, we review the major markets, sectors, portfolio positions specifically for our RIA PRO subscribers (You can check it out FREE for 30-days)Here was our note for the S&P 500 previously.

  • We are still maintaining our core S&P 500 position as the market has not technically violated any support levels as of yet. However, it hasn’t been able to advance to new highs either.
  • There is likely a tradeable opportunity approaching for a reflexive bounce given the depth of selling over the last couple of weeks.

This is the outcome we expected.

  • There is no “actual” deal.
  • The “excuse” will be this deal lays the groundwork for a future deal.
  • No one will discuss a trade deal ever again.

It is almost as if Bloomberg read our work:

“The U.S. and China reached a partial agreement Friday that would broker a truce in the trade war and lay the groundwork for a broader deal that Presidents Donald Trump and Xi Jinping could sign later this year.

As part of the deal, China would agree to some agricultural concessions and the U.S. would provide some tariff relief. The deal under discussion, which is subject to Trump’s approval, would suspend a planned tariff increase for Oct. 15. It also may delay — or call off — levies scheduled to take effect in mid-December.”

So, who won?

China.

  • China gets to buy agricultural and pork products they badly need.
  • The U.S. gets to suspend tariffs.

Who will like the deal?

  • The markets:  the deal removes a potential escalation in tariffs.
  • Trump supporters: Fox News will “spin” the “no deal” into a Trump “win” for the 2020 election. 
  • The Fed: It removes one of their concerns potentially impacting the economy.

By getting the “trade deal” out of the headlines, this clears the way for the market to rally potentially into the end of the year. Importantly, it isn’t just the trade deal providing support for higher asset prices short term:

  • There now seems to be a pathway forward for “Brexit”
  • The Fed is injecting $60 billion a month in liquidity into 2020 (More on this below)
  • The Fed has cut rates and is expected to cut again by year end.
  • ECB back into easing mode and running negative rates
  • Fed and ECB loosening capital requirements for banks (Because they are so healthy after all.)

This is also a MAJOR point of concern.

Despite all of this liquidity and support, the market remains currently confined to a downtrend from the September highs. The good news is there is a series of rising lows from June. With a “risk-on” signal approaching and the market not back to egregiously overbought, there is room for the market to rally from here. 

Let me repeat what we wrote back in July:

“As we face down the last half of 2019, we can once again run some projections on the bull and bear case going into 2021, as shown in the chart below:”

The Bull Case For 3300

  • Momentum
  • Stock Buybacks
  • Fed Rate Cuts
  • Stoppage of QT
  • Trade Deal

However, while the case for a push higher is likely, the risk/reward still isn’t great for investors over the intermediate term. A failure of the market to make new highs, given the amount of monetary support, will be a very bearish signal. 

The Fed’s “Not QE”, “QE”

Sure thing, Brian.

As I noted previously:

“Then there are the tail-risks of a credit-related event caused by a dollar funding shortage, a banking crisis (Deutsche Bank), or a geopolitical event, or a surge in defaults on “leveraged loans” which are twice the size of the “sub-prime” bonds linked to the “financial crisis.”  (Read more here)

Just remember, bull-runs are a one-way trip. 

Most likely, this is the final run-up before the next bear market sets in. However, where the “top” is eventually found is the big unknown question. We can only make calculated guesses.”

Think about this logically for a moment.

  1. The yield curve inverts which puts pressure on bank loans and funding.
  2. The Fed cuts rates, which puts pressure on banks net interest margins.
  3. The banks are chock full of leverage loans, risky energy-related debt, subprime auto loans, etc. 
  4. The Fed begins reducing excess reserves.
  5. All of a sudden, banks have a problem with overnight funding.
  6. Fed reduces liquidity regulations (put in place after Lehman to protect the financial system)
  7. Fed now has to commit to $60 billion in funding through January 2020 to increase reserves.

The last point was detailed in a recent FOMC release:

“In light of recent and expected increases in the Federal Reserve’s non-reserve liabilities, the Federal Open Market Committee (FOMC) directed the Desk, effective October 15, 2019, to purchase Treasury bills at least into the second quarter of next year to maintain over time ample reserve balances at or above the level that prevailed in early September 2019. The Committee also directed the Desk to conduct term and overnight repurchase agreement operations (repos) at least through January of next year to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.”


NOTE: If you don’t understand what has been happening with overnight lending between banksREAD THIS.


The Fed is in QE mode because there is a problem with liquidity in the system. Given the Fed was caught “flat-footed” with the Lehman bankruptcy in 2008, they are trying to make sure they are in front of the next crisis.

The reality is the financial system is NOT healthy. 

If it was, then we would:

  1. Not still be using “emergency measures” to support banks for the last decade. (QE, LTRO, Etc.)
  2. Not be pushing $17 trillion in negative interest rates on a global basis.
  3. Have reinstated FASB Rule 157 in 2012-2013 requiring banks to mark-to-market the assets on their books. (A defaulted asset can be marked at 100% of value which makes the bank look healthy.)
  4. Not be needing to reduce liquidity requirements.
  5. Not be needing $60 billion a month in QE.

Oh, but that’s right, Jerome Powell denies this is “QE.”

“I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy. In no sense, is this QE,” – Jerome Powell

It’s QE. 

Just so you can understand the magnitude of the balance sheet increase over the last couple of weeks, the largest single week increase from 2009 to September 20th, 2019 was $39.97 billion.

The last two weeks were $58.2 and $83.87 billion respectively. 

But, it’s not Q.E.

So, what was it then?

This was not about covering unexpected cash draws to pay quarterly taxes, which was one of the initial excuses for the funding shortfalls. 

Nope.

This was bailing out a bank that is in serious financial trouble. It started with the ECB a month ago loosening requirements on banks, then proceeded to the Fed reducing capital reserve requirements and flooding the system with reserves. 

Who was the biggest beneficiary of all of these actions? Deutsche Bank.

Which is about 4x as large as Lehman was in 2008 and is currently following the same price path as well. Let me repeat, the Fed is terrified of another “Lehman Crisis” as they do not have the tools to deal with it this time.

(Courtesy of ZeroHedge)

The problem for the Fed, is that while they insist recent rate cuts are “mid-cycle” adjustments, as was seen in 1995 to counter the risk of the Orange County bankruptcy, the reality is the “mid-cycle” has long been past us.

With the Fed cutting rates, injecting weekly records of liquidity into the system, at a time where economic data has clearly taken a turn for the worse, the situation may “not be in as good of a place” as we have been told. 

Being a little more cautious, taking in some profits, and rebalancing risks continues to be our recipe for navigating the markets currently. 

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet  


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Healthcare (XLV), Industrials (XLI)

The relative performance improvement of HealthCare relative to the S&P 500 regained some footing this past week as money still sought safety. Industrials, have also been performing much better on hopes for a trade deal, and picked up steam on Friday with the announcement. We remain underweight until a breakout occurs. 

Current Positions: Target weight XLV, 1/2 weight XLI

Outperforming – Staples (XLP), Utilities (XLU), Real Estate (XLRE)

As noted, our more defensive positioning continues to outperform relative to the broader market. After taking some profits, we trimmed profits out of XLP previously and re-positioned the portfolio. We are remaining patient to see how the market responds to the trade announcement next week.

Real Estate, Staples, and Utilities all continue to flirt with highs but remain GROSSLY extended. Trend overall remains positive so we are holding the position for now.

Current Positions: Target weight XLP, XLU, XLRE

Weakening – Technology (XLK), Discretionary (XLY), Communications (XLC)

As noted last week, Technology, and Discretionary turned higher and are looking to test highs and performed well on Friday as the removal of tariffs directly benefit this sector. Relative performance has improved, and we will likely see these sectors breakout to new highs if the market continues to rally.

Current Position: Target weight XLY, XLK, XLC

Lagging – Energy (XLE), Basic Materials (XLB), and Financials (XLF)

We were stopped out of XLE previously. XLE failed to clear above important downtrend resistance and turned lower as oil prices have dropped. Basic materials picked up performance with the trade deal announcement but has some work to do before providing the right opportunity to increase our weightings. We previously got stopped out of XLF, but will likely look to re-enter the position shortly with the Fed now engaged in increasing bank reserves. 

Current Position: 1/2 weight XLB

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps popped sharply on the announcement of the trade deal but have not dramatically improved their overall technical damage. We have seen these pops before which have quickly failed so we will need to give these markets some room to consolidate and prove up performance. 

Current Position: No position

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

The same advice goes for Emerging and International Markets which we have been out of for several weeks due to lack of performance. These markets rallied recently on news of a “trade resolution,” and the Fed jumping back into QE. However, the overall technical trend is not great so we need to see if this is sustainable or just another “head fake.” 

Current Position: No Position

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

Current Position: RSP, VYM, IVV

Gold (GLD) – The previous correction in Gold continued this week. We may look to take profits here soon, as we digest what the “trade deal” and “more QE” means for “risk adversity.” Gold is testing critical support and is working off its overbought condition. We will be patient but with a tighter stop.

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

Bonds (TLT) – 

Bonds also took a hit on “trade deal” news as the “risk off” rotation turned back to “risk on.” We are holding our positions for now, but are tightening up our stops and are looking at potential trades to participate with a move higher in yields if they occur. 

Stay long current positions for now, and look for an opportunity to add to holdings.

Current Positions: DBLTX, SHY, IEF

Sector / Market Recommendations

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

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

Portfolio/Client Update:

Over the last 16-months we have been wrestling with the on again, off again, on again “trade deal.” As discussed in detail above, Trump finally caved into China and game them a “deal” to get it out of the way before the election. 

At the same time, the Federal Reserve has started to once again aggressively increase their balance sheet, while cutting rates to stimulate economic growth. 

Despite the fact none of this really changes much on the economic front, we suspect it will get the bulls excited in the short-term and put pressure on stocks to move higher. 

For newer clients, we have begun the onboarding process bringing portfolios up to 1/2 weights in our positions. This is always the riskiest part of the portfolio management process as we are stepping into positions in a very volatile market. However, by maintaining smaller exposures, we can use pullbacks to add to holdings as needed. We also are carrying stop-losses to protect against a more severe decline. 

As we move into next week, depending on how markets are acting, we may look to increase our equity exposure modestly to “rent whatever rally” we may get from the “trade deal.” 

  • New clients: Please contact your adviser with any questions. 
  • Equity Model: No change this week. 
  • ETF Model: No change this week. 

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

401k-PlanManager-AllocationShift

Trade Deal Done?

As we stated last week:

“The market rallied on at the end of last week on “bad news” which gave the market “hope” the Fed would more aggressively cut rates. This is a short-term boost with a long-term negative outcome. Low rates are not conducive to economic growth, and the Fed cutting rates aggressively cuts financial incentive in the economy and leads to recessions in the economy.

We advise caution, but suggest remaining weighted toward equity exposure for now. Despite the rally this week, there is some risk heading into the ‘trade deal’ next week. As noted, we expect a deal to be completed which will provide a lift to equities but we recommend weighting for the news before adding to risk.”

Once we get a handle on how the markets are going to react to all of the news, please read the main body of the missive above, we will look to increase overall equity exposure accordingly. In the meantime, you can prepare for the next moves by taking some actions if you haven’t already.

  • If you are overweight equities – Hold current positions but remain aware of the risk. Take some profits, and rebalance risk to some degree if you have not done so already. 
  • If you are underweight equities or at target – rebalance risks and hold positioning for now.

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

401k Plan Manager Beta Is Live

Become a RIA PRO subscriber and be part of our “Break It Early Testing Associate” group by using CODE: 401 (You get your first 30-days free)

The code will give you access to the entire site during the 401k-BETA testing process, so not only will you get to help us work out the bugs on the 401k plan manager, you can submit your comments about the rest of the site as well.

We are building models specific to company plans. So, if you would like to see your company plan included specifically, send me the following:

  • Name of the company
  • Plan Sponsor
  • A print out of your plan choices. (Fund Symbol and Fund Name)

I have gotten quite a few plans, so keep sending them and I will include as many as we can.

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

Current 401-k Allocation Model

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


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

 

 

#WhatYouMissed On RIA: Week Of 10-07-19

We know you get busy and don’t check on our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything that you might have missed.

The Week In Blogs


The Best Of “The Lance Roberts Show”

Video Of The Week

Our Best Tweets Of The Week

Our Latest Newsletter


What You Missed At RIA Pro

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free)

See you next week!

Non-QE QE and How to Trade It

“I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.” He then stated: “In no sense is this QE.” –Federal Reserve Chairman Jerome Powell 10/8/2019

Jerome Powell can call balance sheet growth whatever he wants, but operationally and in its effect on the bond markets, it is QE. For more on the Fed’s latest iteration of QE, what we dub the non-QE QE, please read our article QE By Any Other Name.

Non-QE = QE4

It is increasingly likely the Fed will announce an asset purchase operation at the FOMC meeting on October 30, 2019. Given Powell’s comments, the asset purchases will differ somewhat from QE 1, 2, and 3 in that the Fed will add needed reserves to the banking system to help alleviate recent bouts of stress in overnight funding markets. Prior versions of QE added excess reserves to the system as a byproduct. The true benefit of prior rounds of QE was the reduction of Treasury and mortgage-backed securities in the marketplace, which pushed investors into riskier stocks and bonds.  

Since the Feds motivation seems to be stress in the short term funding markets, we believe the Fed will purchase short-term notes and Treasury bills instead of longer-term bonds. QE1 also involved the purchase the short term securities, but these securities were later sold and the proceeds used to purchase longer term bonds, in what was called Operation Twist.

Trading Non QE QE4

In Profiting From a Steepening Yield Curve and in a subsequent update to the article, we presented two high dividend stocks (AGNC and NLY) that should benefit from a steeper yield curve. When we wrote the articles, we did not anticipate another round of QE, at least not this soon. Our premise behind these investments was weakening economic growth, the likelihood the Fed would cut rates aggressively, and thus a steepening yield curve as a result.

The Fed has since cut rates twice, and Wall Street expects them to cut another 25bps at the October 30th meeting and more in future meetings. This new round of proposed QE further bolsters our confidence in this trade.

If the Fed purchases shorter-term securities, the removal of at least $200 to $300 billion, as is being touted in the media, should push the front end of the curve lower in yield. Short end-based QE in conjunction with the Fed cutting rates will most certainly reduce front-end yields. The rate cuts combined with QE will likely prevent long term yields from falling as much as they would have otherwise. On balance, we expect the combination of QE and further rate cuts to result in a steeper yield curve.

The following graph shows how the 10yr/2yr Treasury yield curve steepened sharply after all three rounds of QE were initiated. In prior QE episodes, the yield curve steepened by 112 basis points on average to its peak steepness in each episode.  

Data Courtesy: Federal Reserve

New Trade Idea

In addition to our current holdings (AGNC/NLY), we have a new recommendation involving a long/short bond ETF strategy. The correlation of performance and shape of the yield curve of this trade will likely be similar to the AGNC/NLY trade, but it should exhibit less volatility.

Equity long/short trades typically involve equal dollar purchases and sales of the respective securities, although sometimes they are also weighted by beta or volatility. Yield curve trades are similar in that they should be dollar-weighted, but they must also be weighted for the bond’s respective durations to account for volatility. This is because the price change of a two-year note is different than that of a 5 or 10-year note for the same change in yield, a concept called duration. Failing to properly duration weight a yield curve trade will not provide the expected gains and losses for given changes in the shape of the yield curve. 

Before presenting the trade, it is important to note that the purest way to trade the yield curve is with Treasury bonds or Treasury bond futures. Once derivative instruments, like the ETFs we discuss, are introduced, other factors such as fees, dividends, and ETF rebalancing will affect performance.  

The duration for SHY and IEF is 2.17 and 7.63, respectively. The ratio of the price of SHY to IEF is .74. The trade ratio of SHY shares to IEF shares is accordingly 4.75 as follows: [(1/.74)*(7.63/2.17)]. As such one who wishes to follow our guidance should buy 5 shares for every 1 share of IEF that they short.

Because we cannot buy fractions of shares, we rounded up the ratio to 5:1. This slight overweighting of SHY reflects our confidence that the short end of the yield curve will fall as the Fed operates as we expect.

Summary

In Investors Are Grossly Underestimating the Fed, we highlighted that every time the Fed has raised and lowered rates, the market has underestimated their actions. To wit:

“If the Fed initiates rate cuts and if the data in the graphs prove prescient, then current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see. Taking it a step further, it is not farfetched to think that that Fed Funds rate could be back at the zero-bound, or even negative, at some point sooner than anyone can fathom today.”

Despite the Fed’s guidance earlier this year of one or two cuts and their characterization of it as a “mid-cycle adjustment”, the Fed has already lowered rates twice and appears ready to cut rates a third time later this month. If, in fact, the market is once again underestimating the Fed, the Fed Funds rate and short term Treasury yields will ultimately fall to 1% or lower.

In an environment of QE and the Fed actively lowering rates, we suspect the yield curve will steepen. That is in no small part their objective, as a steeper yield curve also provides much needed aid to their constituents, the banks. If we are correct that the curve steepens, the long-short trade discussed above along with AGNC and NLY should perform admirably.  AGNC and NLY are much more volatile than IEF and SHY; as such, this new recommendation is for more risk-averse traders.  

Mauldin: Social Security Is Screwing Millennials

Social Security is a textbook illustration of how government programs go off the rails.

It had a noble goal: to help elderly and disabled Americans, who can’t work, maintain a minimal, dignified living standard.

Back then, most people either died before reaching that point or didn’t live long after it. Social Security was never intended to do what we now expect, i.e., be the primary income source for most Americans during a decade or more of retirement.

Life expectancy when Social Security began was around 56. The designers made 65 the full retirement age because it was well past normal life expectancy.

No one foresaw the various medical and technological advances that let more people reach that age and a great deal more, or the giant baby boom that would occur after World War II, or the sharp drop in birth rates in the 1960s, thanks to artificial birth control.

Those factors produced a system that simply doesn’t work.

A few modest changes back then might have avoided today’s challenge. But now, we are left with a crazy system that rewards earlier generations at the expense of later ones.

Screwing Millennials

I am a perfect example.

I’ve long said I never intend to retire, if retirement means not working at all. I enjoy my work and (knock on wood) I’m physically able to do it.

Social Security let me delay collecting benefits until now, for which I will get a higher benefit—$3,588 monthly, in my case.

Now, that $3,588 I will be getting each month isn’t random. It comes from rules that consider my lifetime income and the amount of Social Security taxes I and my employers paid.

That amount comes to $402,000 of actual dollars, not inflation-adjusted dollars. (I also paid $572,000 in Medicare taxes. Again, actual dollars, not inflation-adjusted dollars.)

What did those taxes really buy me? In other words, what if I had been allowed to invest that same money in an annuity that yielded the same benefit? Did I make a good “investment” or not?

That is actually a very complicated question, one that necessarily involves a lot of assumptions and will vary a lot among individuals.

In my case, if I live to age 90 and benefits stay unchanged, the internal real rate of return on my Social Security “investment” will be 3.84%. If I only make it to 80, that real IRR drops to 0.75%.

While this may not sound like much, it actually is. Even 1% real return (i.e., above inflation) with no credit risk is pretty good and 3.84% is fantastic. If I live past 90 it will be even better.

But this is not due to my investment genius. Four things explain my high returns.

  • Double indexing of benefits in the early 1970s (thank you, Richard Nixon).
  • I delayed claiming benefits until age 70, which I could afford to do but isn’t an option for many people.
  • I will probably live longer than average, due to both genetic factors and maintaining good health (thank you, Shane!).

But maybe most of all because

  • The system is massively screwing the next generation. From a Social Security benefit standpoint, being an early Boomer is a pretty good deal.

Social Security structurally favors its earliest users. The big winners are not the Baby Boomers like me, but our parents.

They paid less and received more. But we Boomers are still getting a whale of a deal compared to our grandchildren.

Now, consider a male who is presently age 25, and who earns $50,000 every year from now until age 67, his full retirement age.

Such a person is not going to get anything like the benefits I do, especially with benefit cuts, which my friend Larry estimates will be as high as 24.5%.

So, if this person lives an average lifespan and gets only those reduced benefits, his real internal rate of return will be -0.23%.

I suspect very few in the Millennial generation know this and they’re going to be mad when they find out. I don’t blame them, either.

The Next Quadrillion

The reason Millennials won’t see anything like the benefits today’s retirees get is simple math. The money simply isn’t there.

The so-called trust fund (which is really an accounting fiction, but go with me here) exists because the payroll taxes coming into the system long exceeded the benefits going to retirees.

That is no longer the case.

Social Security is now “draining” the trust fund to pay benefits. This can only continue for so long. Projections show the surplus will disappear in 2034. A few tweaks might buy another year or two. Then what?

Well, the answer is pretty simple. If Congress stays paralyzed and does nothing, then under current law Social Security can only pay out the cash it receives via payroll taxes. That will be only 77% of present benefits—a 23% pay cut for millions of retirees.

And please understand, there is no trust fund. Congress already spent that money and must borrow more to make up the difference.

This IS going to happen. Math guarantees it.

Missing Opportunities

These problems would be less serious if more people saved for their own retirements and viewed Social Security as the supplement.

There are good reasons many haven’t done so. Worker incomes have stagnated while living costs keep rising.

But more important, telling people to invest their own money presumes they have investment opportunities and the ability to seize them. That may not be the case.

The prior generations to whom Social Security was so generous also had the advantage of 5% or better bond yields or bank certificates of deposits at very low risk.

That is unattainable now. And let’s not even talk about mass numbers of uninformed people buying stocks at today’s historically high valuations. That won’t end well.

So, if your solution is to put people in private accounts and have them invest their own retirement money, I’m sorry but it just won’t work.

It will have the same result as those benefit cuts we find so dreadful: millions of frustrated and angry retirees.

So, what is the answer if you are in retirement or approaching it? The easiest answer is to raise the retirement age. Yes, that’s really just a disguised way to cut benefits, but making it 70 or 75 would get the program a lot closer to its original intent.

Today’s 65-year-olds are in much better shape than people that age were in 1936 or even 1970.

(Note, I would still leave the option for people who are truly disabled to retire younger. I get that not everybody is a writer and/or an investment adviser who makes their living in front of the computer or on the phone. Some people wear out their bodies and really deserve to retire earlier.)


The Great Reset: The Collapse of the Biggest Bubble in History

New York Times best seller and renowned financial expert John Mauldin predicts an unprecedented financial crisis that could be triggered in the next five years. Most investors seem completely unaware of the relentless pressure that’s building right now. Learn more here.

Will Monetary or Fiscal Stimulus Turnaround the Next Recession?

A recession is emerging with interest rate curves inverted, the end of the business cycle at hand, world trade falling, and consumers and businesses beginning to pull back on spending.  The question is: will monetary or fiscal stimulus turn around a recession? 

In this post, we find both stimulus alternatives likely to be too weak to have the necessary economic impact to lift the economy out of a recession. Finally, we will identify the key characteristics of a coming recession and the implications for investors.

Our economy is at the nexus of several major economic trends formed over decades that are limiting monetary and fiscal options. The monetary policy of central banks has caused world economies to be abundant in liquidity, yet producing limited growth. Central bankers in Japan and Europe have been trying to revive growth with $17 trillion injections using negative interest rates.  Japan can barely keep its economy growing with an estimate of GDP at .5 % through 2019. The Japanese central bank holds 200 % of GDP in government debt.  The European Central Bank holds 85 % of GDP in debt and uses negative interest rates as well. Germany is in a manufacturing recession with the most recent PMI in manufacturing activity at 47.3 and other European economies contracting toward near-zero GDP growth.  

Lance Roberts notes that the world economy is not running on a solid economic foundation if there is $17 trillion in negative-yielding debt in his blog, Powell Fails, Trump Rails, The Failure of Negative Rates. He questions the ability of negative interest policies to stabilize world economies,

You don’t have $17 Trillion in negative-yielding sovereign debt if there is economic and fiscal stability.”

Negative interest rates and extreme monetary stimulus policies have distorted financial relationships between debt and risk assets. This financial distortion has created a significantly wider gap between the 90 % and the top 1 % in wealth.

Roberts outlines in the six panel chart below how personal income, employment, industrial production, real consumer spending, real wages, and real GDP are all weakening in the U.S.:

Source: RIA – 8/23/19

Trillions of dollars of monetary stimulus have not created prosperity for all. The chart below shows how liquidity fueled a dramatic increase in asset prices while the amount of world GDP per money supply declined by about 25 %:

Sources: The Wall Street Journal, The Daily Shot – 9/23/19

Low interest rates have not driven real growth in wages, productivity, innovation, and services development that create real wealth for the working class. Instead, wealth and income are concentrated in the top 1 %. The concentration of wealth in the top one percent is at the highest level since 1929. The World Inequality Report notes inequality has squeezed the middle class between emerging countries and the U.S. and Europe. The top 1 % has received twice the financial growth benefits as the bottom 50 % since 1980:

Source: World Inequality Lab, Thomas Piketty, Gabriel Zucman et al – 2018

There are several reasons monetary stimulus by itself has not lifted the incomes of the middle class. One of the big causes is that stimulus money has not translated into wage increases for most workers.  U.S. real earnings for men have essentially been flat since 1975, while earnings for women have increased though basically flat since 2000:

Source: U.S. Census Bureau – 9/10/19

If monetary policy is not working, then fiscal investment from private and public sectors is necessary to drive an economic reversal.  But, will the private and public sector sectors have the necessary tools to bring new life to an economy in decline?

Wealth Creation Has Gone to the Private Sector

The last 40 years have seen the rise of private capital worldwide while public capital has declined. In 2015, the value of net public wealth (or public capital) in the US was negative -17% of net national income, while the value of net private wealth (or private capital) was 500% of national income. In comparison to 1970, net public wealth amounted to 36% of national income, while net private wealth was at 326 %.

Source: World Inequality Lab, Thomas Piketty, Gabriel Zucman et al – 2018

Essentially, world banks and governments have built monetary and fiscal economic systems that increased private wealth at the expense of public wealthThe lack of public capital makes the creation of public goods and services nearly impossible. The development of public goods and services like basic research and development, education and health services are necessary for an economic rebound. The economy will need a huge stimulus ‘lifting’ program and yet the capital necessary to do the job is in the private sector where private individuals make investment allocation decisions.  

Why is building high levels of private capital a problem?  Because, as we have discussed, private wealth is now concentrated in the top 1 %, while 70 % of U.S GDP is dependent on consumer spending.  The 90 % have been working for stagnant wages for decades, right along with diminishing GDP growth.  There is a direct correlation between wealth creation for all the people and GDP growth.

Corporations Are Not In A Position to Invest

Some corporations certainly have invested in their businesses, people, and technology.  The issue is the majority of corporations are now financially strapped.  Many corporate executives have made profit allocation decisions to pay themselves and their stockholders well at the expense of workers, their communities and the economy. 

S & P 500 corporations are paying out more cash than they are taking in, creating a cash flow crunch at a – 15 % rate (that’s right they are burning cash) to maintain stock buyback and dividend levels:

Source: Real Investment Advice

Sources: Compustat, Factset, Goldman Sachs – 7/25/19

In 2018 stock buybacks at $1.01 trillion were at the highest level they have ever been since buybacks were allowed under the 1982 SEC safe harbor provision decision. It is interesting to consider where our economy would be today if corporations spent the money they were wasting on boosting stock prices and instead invested in long term value creation.  One trillion dollars invested in raising wages, research, and development, cutting prices, employee education, and reducing health care premiums would have made a significant impact lifting the financial position of millions. This year stock buybacks have fallen back slightly as debt loads increase and sales fall:

Source: Dow Jones – 7/2019

Many corporations with tight cash flows have borrowed to purchase shares, pay dividends and keep their stock price elevated causing corporate debt to hit new highs as a percentage of GDP (note recessions followed three peaks):

Source: Federal Reserve Bank of Dallas – 3/6/2019

Corporate debt has ballooned to 46 % of GDP totaling $5.7 trillion in 2018 versus $2.2 trillion in 2008.  While the bulk of these nonfinancial corporate bonds have been investment grade, many bond covenants have become weaker as corporations seek more funding. Some bondholders may find their investment not as secure as they thought resulting in significantly less than 100 % return of principal at maturity.

In a recession, corporate sales fall, cash flow goes negative, high debt payments become hard to make, employees are laid off and management tries to hold on.  Only a select set of major corporations have cash hoards to ride out a recession, and others may be able obtain loans at steep interest rates, if at all.  Other companies may try going to the stock market which will be problematic with low valuations.  Plus, investors will be reluctant to buy stock in negative cash flow companies.

Thus, most corporations will be hard pressed to invest the billions of dollars necessary to turnaround a recession. Instead, they will be just trying to keep the doors open, the lights on, and maintain staffing levels to hold on until the day sales stop falling and finally turn up.

Public Sector is Also Tapped Out

In past recessions, federal policy makers have turned to fiscal policy – public spending on infrastructure projects, research development, training, corporate partnerships, and public services to revive the economy.  When the 2008 financial crisis was at its peak the Bush administration, followed by the Obama government pumped fiscal stimulus of $983 billion in spending over four years on roads, bridges, airports, and other projects. The Fed funds interest rate before the recession was at 5.25 % at the peak allowing lower rates to have plenty of impact. Today, with rates at 1.75-2.00 %, the impact will be negligible. In 2008, it was the combined massive injection of monetary and fiscal stimulus that created a V-shaped recession with the economy back on a path to recovery in 18 months. It was not monetary policy alone that moved the economy forward.  However, the recession caused lasting financial damage to wealth of millions. Many retirement portfolios lost 40 – 60 % of their value, millions of homeowners lost their homes, thousands of workers were laid off late in their careers and unable to find comparable jobs.  The Great Recession changed many people’s lives permanently, yet it was relatively short-lived compared to the Great Depression.

As noted in the chart above, public sector wealth has actually moved to negative levels in the U.S. at – 17 % of national income.  Our federal government is running a $1 trillion deficit per year.  In 2007, the federal government debt level was at 39 % of GDP. The Congressional Budget Office projects that by 2028 the Federal deficit will be at 100 % of GDP

Source: CBO – 4/9/19

We are at a different time economically than 2008. Today with Federal debt is over 100% of GDP and expected to grow rapidly. The Feds balance sheet is still excessive and they formally stopped reducing the size (QT).  In a recession federal policymakers will likely make spending cuts to keep the deficit from going exponential. Policy makers will be limited by the twin deficits of $22.0 trillion national debt and ongoing deficits of $1+ trillion a year, eroding investor confidence in U.S. bonds. The problem is the political consensus for fiscal stimulus in 2008 – 2009 does not exist today, and it will probably be even worse after the 2020 election. Our cultural, social and political fabric is so frayed as a result of decades of divisive politics it is likely to take years to sort out during a recession. Our political leaders will be fixing the politics of our country while searching for intelligent stimulus solutions to be developed, agreed upon and implemented.

What Will the Next Recession Look Like?

We don’t know when the next recession will come. Yet, present trends do tell us what the structure of a recession might look like, as a deep U- shaped, slow recovery measured in years not months:

  • Corporations Short of Cash – Corporations already strapped are short on cash, will lay off workers, pull back spending, and are stuck paying off huge debts instead of investing.
  • Federal Government Spending Cuts – The federal government caught with falling revenues from corporations and individuals, is forced to make deep cuts first in discretionary spending and then social services and transfer funding programs. The reduction of transfer programs will drive slower consumer spending.
  • Consumers Pull Back Spending – Consumers will be forced to tighten budgets, pay off expensive car loans and student debt, and for those laid off seeking work anywhere they can find a job.
  • World Trade Declines – World trade will not be a source of rebuilding sales growth as a result of the China – US trade war, and tariffs with Europe and Japan.  We expect no trade deal or a small deal with the majority of tariffs to stay in place. In other words, just reversing some tariffs will not be enough to restart sales. New buyer – seller relationships are already set, closing sales channels to US companies. New country alliances are already in place, leaving the US closed out of emerging high growth markets.  A successor Trans Pacific Partnership (TPP) agreement with Japan and eleven other countries was signed in March, 2018 without the US. China is negotiating a new agreement with the EU. EU and China trade totals 365 billion euros per year. China is working with a federation of African countries to gain favorable trade access to their markets.
  • ­Pension Payments in Jeopardy – Workers dependent on corporate and public pensions may see their benefits cut from pensions, which are poorly funded today with markets at all-time highs. GE just announced freezing pensions for 20,000 employees, the harbinger of a possible trend that will  reduce consumer spending
  • Investment Environment Uncertain – Uncertainty in investments will be extremely high, ‘get rich quick’ schemes will flourish as they did in 2008 – 2009 and 2000.
  • Fed Implements Low Rates & QE – The Fed is likely to implement very low interest rates (though not negative rates), and QE with liquidity in abundance but the economy will have low inflation, and declining GDP feeling like the Japanese economic stasis – ‘locked in irons’.

Implications for Investors

The following recommendations are intended for consideration just prior or during a recession with a sharp decline in the markets, not necessarily for today’s markets.

Cash – It is crucial to maintain a significant cash hoard so you can purchase corporate stocks when they cheapen. The SPX could decline by 40 – 50 % or more when the economy is in recession.  Yet, good values in some stocks will be available.  At the 1500 level, there is an excellent opportunity to make good long term growth and value investments based on sound research.

CDs – as Will Rogers noted during the Depression, “I’m more interested in Return of my Capital than Return on my Capital”, a prudent investor should be too.  CDs are FDIC insured while offering lower interest rates than other investments. Importantly, they provide return of capital and allow you to sleep at night.

Bonds – U.S. Treasuries certainly provide safety, return of principal, and during a recession will provide better overall returns than high-risk equity investments. Corporate bonds may come under greater scrutiny by investors even for so-called ‘blue chips’ like General Electric. The firm is falling on hard times with $156 billion in debt. GE is seeking business direction and selling off assets. The major conglomerate’s bonds have declined in value by 2.5 % last year with their rating dropped to BBB. Now with new management the price of GE bonds is climbing up slightly.

Utilities – are regulated to have a profit.  While they may see declining revenues due to less energy use by corporations and individuals, they still will pay dividends to shareholders as they did in 2008.  Consumer staple companies are likely to be cash flow strained; most did not pay dividends to investors during the 2008 – 2009 recession. REITs need to be evaluated on a company by company basis to determine how secure their cash streams are from leases. During the 2008 – 2009 downturn, some REITs stopped paying dividends due to declining revenues from lease defaults.

Growth & Value Equities– invest in new sectors that have government support or emerging demand based on social trends like climate change: renewables, water, carbon emission recovery, environmental cleanup. From our Navigating A Two Block Trade World – US and China post, we noted possible investments in bridge companies between the two trade blocks; services, and countries that act as bridges like Australia. Look for firms with good cash positions to ride out the recession, companies in new markets with sales generated by innovations, or problem solving products that require spending by customers.  For example, seniors will have to spend money on health services. Companies serving an increasingly aging population with innovative low cost health solutions are likely to see good demand and sales growth.

The intelligent investor will do well to ‘hope for the best, but plan for the worst’ in terms of portfolio management in a coming recession.  Asking hard questions of financial product executives and doing your own research will likely be keys to survival.

In the end, Americans have always pulled together, solved problems, and moved ahead toward an even better future. After a reversion to the mean in the capital markets and an economic recession things will improve.  A reversion in social and culture values is likely to happen in parallel to the financial reversion. The complacency, greed, and selfishness that drove the present economic extremes will give way to a new appreciation of values like self-sacrifice, service, fairness, fair wages and benefits for workers, and creation of a renewed economy that creates financial opportunities for all, not just the few.

Patrick Hill is the Editor of The Progressive Ensign, https://theprogressiveensign.com/ writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.

Three Of Our Favorite Dividend Kings For Rising Income

This is a guest contribution by Bob Ciura with Sure Dividend.  Sure Dividend helps individual investors build and maintain their high quality dividend growth portfolios rising passive income over the long run.

Dividend growth stocks can offer strong shareholder returns over the long term. One place to look for high-quality dividend growth stocks is the list of Dividend Kings, which have increased their dividends for at least 50 consecutive years.

In order for a company to raise its dividend for over five decades, it must have durable competitive advantages and consistent growth. It must also have a shareholder-friendly management team dedicated to raising its dividend.

The Dividend Kings have raised their dividends each year, no matter the condition of the broader economy. They have outlasted recessions, wars, and a variety of other challenges, while continuing to increase their dividends every year.

With this in mind, these three Dividend Kings are attractive for rising dividend income over the long term.

Dividend King #1: Genuine Parts Company (GPC)

Genuine Parts Company is a diversified distributor of auto and industrial parts, as well as office products. Its biggest business is its auto parts group, which includes the NAPA brand. Genuine Parts has the world’s largest global auto parts network, with over 6,700 NAPA stores in North America and over 2,000 stores in Europe. Genuine Parts generated over $18 billion of revenue in 2018.

Genuine Parts is benefiting from changing consumer trends, which is that consumers are holding onto their cars longer. Rather than buy new cars frequently, consumers are increasingly choosing to make minor repairs. At the same time, repair costs increase as a car ages, which directly benefits Genuine Parts. For example, Genuine Parts stats that average annual spend for a vehicle aged six to 12 years is $855, compared with $555 for a vehicle aged one to five years.

Vehicles aged six years or older now represent over 70% of cars on the road, and Genuine Parts has fully capitalized on the market opportunity. The company has reported record sales and earnings per share in seven of the past 10 years. As the total U.S. vehicle fleet is growing, and the average age of the fleet is increasing, Genuine Parts has a positive growth outlook.

Acquisitions will also help pave the way for Genuine Parts’ future growth, particularly in the international markets. In 2017, it acquired Alliance Automotive Group, a European distributor of vehicle parts, tools, and workshop equipment. The $2 billion acquisition gave Genuine Parts an instant foothold in Europe, as Alliance Automotive holds a top 3 market share position in Europe’s largest automotive aftermarkets.

The company has reported steady growth for decades. In fact, profits have increased in 75 years out of its 91-year history. This has allowed the company to raise its dividend every year since it went public in 1948, and for the past 63 consecutive years. The stock has a current dividend yield of 3.3%.

Dividend King #2: Altria Group (MO)

Altria is a tobacco giant with a wide variety of products including cigarettes, chewing tobacco, cigars, e-cigarettes and wine. The company also has a 10% equity stake in Anheuser Busch Inbev (BUD).

Altria is challenged by the continued decline in U.S. smoking rates. However, last quarter Altria still managed 5% revenue growth from the same quarter last year. Its core smokeable product segment reported 7.4% sales growth, as price increases more than offset volume declines. Adjusted earnings-per-share increased 9% for the quarter, and Altria expects 4%-7% growth in adjusted EPS for 2019.

This growth allowed Altria to raise its dividend by 5% in late August, marking its 50th consecutive year of dividend increases.

Altria has tremendous competitive advantages. It has the most valuable cigarette brand in the U.S., Marlboro, which commands greater than a 40% domestic retail share. This gives Altria the ability to raise prices to drive revenue growth, as it has done for many years.

Going forward, Altria is preparing for a continued decline in the U.S. smoking rate, primarily by investing in new product categories. In addition to its sizable investment stake in ABInbev, Altria invested nearly $13 billion in e-cigarette manufacturer Juul, as well as a nearly $2 billion investment in Canadian marijuana producer Cronos Group (CRON).

Altria also recently invested $372 million to acquire an 80% ownership stake in Swiss tobacco company, Burger Söhne Group, to commercialize its on! oral nicotine pouches. Lastly, Altria is preparing its own e-cigarette product IQOS, which is being readied for an imminent nationwide launch.

Like Coca-Cola, Altria is taking the necessary steps to respond to changing consumer preferences. This is how companies adapt, which is necessary to maintain such a long streak of annual dividend growth.

Dividend King #3: Dover Corporation (DOV)

Dover Corporation is a diversified global industrial manufacturer with annual revenues of ~$7 billion and a market capitalization of $14 billion. Dover has benefited from the steady growth of the global economy in the years following the Great Recession of 2008-2009. In the most recent quarter, Dover grew earnings-per-share by 20% excluding the spinoff of Dover’s energy business Apergy. Revenue from continuing operations increased 1%.

It may be a surprise to see an industrial manufacturer on the list of Dividend Kings. Indeed, companies in the industrial sector are highly sensitive to the global economy. Industrial manufacturers tend to struggle more than many other sectors when the economy enters recession. But Dover has maintained an impressive streak of 64 years of annual dividend increases, one of the longest streaks of any U.S. company. One reason it has done this despite the inherent cyclicality of its business model is because of the company’s diversified portfolio.

Dover spun off its energy unit, which is especially vulnerable to recessions. Of its remaining segments, many service industries that see resilient demand, even during recessions, such as refrigeration and food equipment.

Dover expects to generate adjusted earnings-per-share in a range of $5.75 to $5.85. At the midpoint, Dover would earn $5.80 per share for 2019. With a current annual dividend payout of $1.96 per share, Dover is projected to have a 34% dividend payout ratio for 2019. This is a modest payout ratio which leaves more than enough room for continued dividend increases next year and beyond.

Dover has a current dividend yield of 2.1%, which is near the average yield of the broader S&P 500 Index. While the stock does not have an extremely high yield, it makes up for this with consistent dividend increases each year.

Final Thoughts

It is not easy to become a Dividend King, which is why there are only 27 of them. Of the ~5000 stocks that comprise the Wilshire 5000, the most widely-used index of the total stock market, only 27 have increased their dividends for at least 50 consecutive years.

Because of this, the Dividend Kings are a suitable group of stocks for income investors looking for high-quality dividend growth stocks. In particular, the three stocks on this list have competitive advantages, future growth potential, and high dividend yields that make them highly attractive for income investors.

Long-Short Idea List: 10-10-19

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

LONG CANDIDATES

AMZN – Amazon.com

  • Last week, we noted that “if the market is going to move higher into year-end, then AMZN should lead the way particularly as we head into holiday shopping season.”
  • The trade setup didn’t change much this past week, and with AMZN’s sell signal pretty deeply oversold there is a decent entry point.
  • Buy at current levels.
  • Stop is adjusted to $1700 hard stop.

ABBV – AbbiVie Inc.

  • ABBV recently bounced off of critical support and has triggered a buy signal.
  • We are looking to add a position to both the Equity and Long-Short portfolios as we like the almost 6% yield in this environment.
  • With the buy signal in place, we are looking for a pullback to $70 that holds to add 1/2 of our position. We will add the second 1/2 position on a break above resistance.
  • Stop after initial entry is $64

CAT – Caterpillar, Inc.

  • I am not crazy about this trade but CAT has been consistently holding support and is deeply oversold at this juncture.
  • Buy at current levels with a very tight stop at $115
  • Take profits at $130.

CRM – Salesforce.com

  • CRM has gotten pretty oversold and the sell-signal is very deep. Importantly, CRM has held a rising trendline support which is bullish.
  • CRM has a tendency to beat earnings and do well, so there is a decent trade setup here.
  • Buy CRM at current levels.
  • Stop loss is set at $142.50

DE – Deere & Co.

  • Both DE and CAT should do well if there is some sort of trade deal.
  • However, DE has been in a long-term consolidation and is close to breaking out to the upside.
  • Buy a position in DE only IF it breaks above current resistance at $170.
  • Stop loss is set at $150.

SHORT CANDIDATES

AVY – Avery Dennison Corp.

  • Last week, we suggested AVY for a long-trade on a breakout above $117.50. That didn’t happen and the “sell signal” has now been triggered.
  • We had originally suggested a short of AVY on a break below the previous stop of $112.50
  • That level has been triggered.
  • Target for trade is initially $100
  • Stop-loss is $115

AMD – Advanced Micro Devices

  • We recently suggested a short-position on AMD if it broke below its consolidation pattern and triggered a sell signal. Both have occurred.
  • Sell short at current levels.
  • Target for trade is $22
  • Stop-loss is $30

FB – Facebook, Inc.

  • Last week, we discussed shorting FB which had been consolidating in a tightening pattern over the last couple of months.
  • With a “sell signal” now triggered at a fairly high level, downside risk remains decent.
  • Sell short FB at current levels.
  • Target for trade is $160
  • Stop-loss is set to $185

BUD – Anheuser-Busch InBev

  • BUD had a very good run this year but that now appears to be over.
  • With the break of the bullish uptrend line, the risk is currently to the downside.
  • Short BUD on any failed rally to $95
  • Stop loss is $97.50 after entry.
  • Target for trade is $80

STZ – Constellation Brands, Inc.

  • STZ has been in a choppy uptrend from the December 24th lows. We actually like the company and will probably add it back to the portfolio at lower levels.
  • However, for now, it has broken important support and looks to go lower.
  • Sell Short at current levels.
  • Target for trade is $170
  • Stop-loss after shorting the position is set at $195

The Myths Of “Broken Capitalism” – Part 2

Read Part 1 – The Distortion Of Capitalism By Wall Street

Read Part 3 – Capitalism Is The Worst, Except For The Rest


In the introduction to this series, we discussed the bit of the history leading us to the outcry against capitalism. As I concluded:

“The important point is that ‘capitalism’ isn’t broken, but there is one aspect of the system which has morphed into something no one intended. As you hear candidates promising to ‘eat the rich,’ remember ‘political narratives’ designed to win votes is not always representative of what is best for you in the long run.”

In every economy, throughout history, there have always been those individuals who aspire to wealth and privilege and those that beg on street corners for scraps. The battle between “haves” and “have nots” has been going on since men lived in caves.

“Did you see Ugg’s new cave? He’s got a T-Rex floor covering by the fire pit.”

Likewise, throughout history, there have also been the subsequent revolts where the oppressed have stormed the castle walls with “pitchforks and torches” to change the balance of inequity. Unfortunately, those changes only lasted for a little while. Eventually, the system imbalances always return due to our basic human nature:

  • Aspiration (the will to take risks, determination, and drive),
  • Education, and socio-economic factors (access to capital, connections, etc.), and;
  • Greed

However, it is our human nature of greed and competition, which lifts individuals out of poverty. Inequality should not be viewed as a negative, but rather as a driver of prosperity and innovation. As Daniel LaCalle recently wrote in his new book “Freedom, Equality, & Prosperity Through Capitalism:”

“By contrast, the U.S. has historically been a clear example of positive inequality. ‘Mimic inequality’—where you want to do your best and make it seem to others that ‘you’ve made it’–is a positive force. That’s what we all call The American Dream. The reason why millions emigrate to the U.S. is the promise of equal opportunity, not equality. Very few ever emigrate to socialist countries. In fact, governments in those regimes spend large sums of money trying to prevent their citizens from escaping”

This is a vastly important statement. We should be seeking to foster is equal opportunity, not wealth equality.

Fortunately, the United States is rich with opportunity. All you have to do is take advantage of it.

Myth: The System Is Unfair, You Have To Be Rich To Start With

Jeff Bezos, the creator of the world’s largest online retailer and one of the richest men in the world, took advantage of capitalism. Now he has become villainized for it.

What did he have that allowed him to generate billions in personal wealth that others didn’t?

Nothing.

  1. He had an idea. (We all have ideas.)
  2. He took on the “risk of failure.” (Would you quit your job to start a business that could fail?)
  3. He had an educational background. (Princeton University. But education isn’t everything. Bill Gates dropped out of college. Education can provide access to potential contacts and resources.)
  4. He had access to capital. (His dad loaned him $250,000 to seed the company. However, this is why private equity and venture capital firms exist which can fund startup projects.)
  5. He dedicated himself to the project to see it to completion. (Determination and drive in the face of potential failure.)

There is nothing extraordinary about Jeff Bezos. Any person in the U.S. could achieve the same outcome. We see it occur every day with products and services that we use from Grubhub to Uber. FedEx is another great example of capitalism at work.

“Fred Smith developed the idea of a global logistics company when he was a student at Yale University with other notable students such as future President George W. Bush and Democratic presidential candidate John Kerry.” – Education and Contacts

“Smith submitted a paper that proposed a new concept where one logistics company is responsible for a piece of cargo from local pickup to ultimate delivery, while operating its own aircraft, depots, posting stations, and ubiquitous delivery vans.” – Innovative Idea

“Smith began Federal Express in 1971 with a $4 million inheritance from his father and $91 million of venture capital.” – Access to capital

“The first three years of operation saw the company lose money despite being the most highly financed new company in U.S. history in terms of venture capital. It was not until 1976 that the company saw its first profit of $3.6 million based on handling 19,000 packages a day.” – Dedicated to an idea in the face of adversity, risk of loss of his inheritance.

Here are a few others who started with nothing, took risks, and built substantial wealth:

  • Jan Koum, CEO and Founder Of WhatsApp, who once lived on food stamps.
  • Kenny Troutt, founder of Excel Communications, paid his way through college selling life insurance.
  • Howard Schultz grew up in a housing complex for the poor.
  • Investor Ken Langone’s parents worked as a plumber and cafeteria worker.
  • Oprah Winfrey was born into poverty.
  • Billionaire Shahid Kahn washed dishes for $1.20 an hour.
  • Kirk Kerkorian dropped out of school in the 8th grade to be a boxer.
  • John Paul DeJoria, founder of Paul Mitchell, once lived in a foster home and out of his car.
  • Do Won Chang, founder of Forever 21, worked as a janitor and a gas station attendant when he first moved to America.
  • Ralph Lauren was a clerk at Brooks Brothers.
  • Francois Pinault quit high school in 1974 after being bullied because he was so poor. 

So, what exactly is your excuse? It is easy to make excuses for “why you CAN’T do something.”

The only difference between you, and Jeff Bezos, is that Jeff didn’t make excuses.

Myth: The Rich Don’t Pay Their “Fair Share”

Bernie Sanders suggests “billionaires” shouldn’t exist; such implies we should confiscate all their wealth to support the public good. This seems fair, considering the ongoing “claims” the rich don’t pay their “fair share of taxes.” The data below clearly shows the issue.

“By contrast, the lower 60% of households, who have income up to about $86,000, receive about 27% of income. As a group, this tier will pay NO net federal income tax in 2018 vs. 2% of it last year. Roughly one million households in the top 1% will pay for 43% of income tax,up from 38% in 2017. These filers earn above about $730,000.”

Since we are currently running a trillion-dollar annual deficit, we should probably think twice about keeping the rich in a position to continue feeding the public coffers.

As Daniel Lacalle noted:

“In effect, the message of taxing the rich to solve multibillion-dollar spending problems is simply a way of advancing total control, creating clients in low-income voters and creating a group of industries that benefit from being close to the government—in other words, cronyism. This is why governments always use the fallacy of taxing the rich to obtain total control and destroy freedom.

This doesn’t mean that high earners shouldn’t pay their fair share. It means that the magic trick played on us all is to make us look at one hand (the rich) when the trick is in the other (excess spending and increased intervention and government control)

If taxing the rich were the solution to high debt, inequality, and excess spending, the world would have no such problems by now.”

Myth: The Rich Don’t Share

According to Giving USA, in 2017, total donations to charity clocked in at $410 billion, a figure (in current dollars) that has increased almost every year for four decades. The 50 largest families gave $7.8 billion in disclosed donations in 2018 alone, and $14.7 billion to nonprofits the year prior. (2017 was skewed due to Gates donation of $4.8 billion to their charity.) 

Those donations support everything from United Way to the St. Jude’s Hospital, which provides free healthcare to children and housing for their parents. Without those billions in donations, charities which support everything from art, to music, education, research, healthcare, etc. would all cease to exist.

Unintended consequences are very important to consider.

Myth: More Government Is The Answer

“Who cares? No one deserves to have that much wealth. The Government would do a better job.”

The following are the two most high profile proposals of Democratic candidates.

So, we need $4.5 trillion to pay for those two proposals in Year 1, and $3 trillion more annually to pay for “Medicare-For-All” going forward – forever. (This doesn’t include the current $70 trillion unfunded liability of the social welfare system currently.)

According to the Center On Budget & Policy Priorities, roughly 75% of every tax dollar currently goes to non-productive spending. 

In 2018, the Federal Government spent $4.48 trillion, which was equivalent to 22% of the nation’s entire nominal GDP. Of the total spending, ONLY $3.5 trillion was financed by Federal revenues. The shortfall of $986 billion was financed through debt.

In other words, if 75% of all expenditures is social welfare and interest on the debt, those payments required $3.36 Trillion of the $3.5 Trillion (or 96%) of the total revenue coming in. 

Do you see the problem here? (In the financial markets, when you borrow from others to pay obligations you can’t afford it is known as a “Ponzi-scheme.”)

In 2018, Forbes identified the 585 U.S. billionaires which had $3.1 trillion in net worth combined.

So, if we confiscated 100% of the wealth from those 585 billionaires we could:

  1. We pay off all the student debt, and;
  2. We can pay for 1/2 of “Medicare-For-All” in year one

This leaves a shortfall of $1.5 trillion in the first year, plus the existing $1 trillion deficit, or $2.5 trillion further in debt in year one. In year 2, and beyond, assuming no increase in the current deficit, the shortfall would grow to $4 trillion annually.

But therein lies the problem.

Who pays the most in taxes?

Since we confiscated all the wealth of the billionaires, tax revenue is going to fall markedly, further increasing the annual deficit.

Moreover, since those billionaires made their wealth by building Fortune 500 companies, they will reconsider exactly what they are doing operating within the confines of a country that has now taken all their wealth.

So, which companies created the most jobs in the U.S.?

Importantly, each of those companies have:

  1. Created thousands of other companies,
  2. Which employee millions of people,
  3. Who sell to, support, or sell the products and services of those companies.

The economy is a living organism that creates hosts and parasites, which feed upon each other for survival.

“The inequality debate is often an excuse to intervene. Politicians don’t want the poor to be less poor, so long as the middle and upper classes are less wealthy. That’s because interventionism assumes that inequality is a perverse effect that can be solved by state intervention.

But the truth is interventionism perpetuates bad inequality–inequality in opportunity, in job availability and in access to a better life. In fact, it deepens it. What matters to us is equality of opportunity, and that is what the state has to focus on, not on penalizing success.” – Daniel LaCalle

So, you may want to consider the consequences of “killing the ‘Golden Goose.'”


Part 3, How To Take Advantage Of “Capitalism” To Realize The American Dream

Selected Portfolio Position Review: 10-09-19

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

With this basic tutorial, we will now review some of positions in our Equity Portfolio which are either a concern, an opportunity, or are doing something interesting.

AEP – American Electric Power

  • After taking profits out of the position previously, we are likely going to do it again soon. Utilities have been a clear winner this year, but that run will end at some point.
  • AEP is currently on a “sell signal” but remains overbought.
  • There is risk to the position, so we are looking to sell 10% of the holding when we rebalance the portfolio.
  • Stop is set at $87.50.

CHCT – Community HealthCare Trust

  • Real estate has been one of the leading sectors this year, and in particular over the last several months.
  • CHCT is extremely overbought and extended, so we will likely take some profits very soon.
  • Stop is at $40.

MSFT – Microsoft

  • MSFT has been consolidating its large gain this year.
  • Currently on a “sell signal” but still overbought, there is risk of a larger correction in the market begins to markedly weaken MSFT.
  • We are looking to take profits, but continue to watch the consolidation closely.
  • Stop loss is moved up to $130

MDLZ – Mondelez International

  • I hate writing about this position because it makes me crave “Oreo’s.”
  • However, after taking profits previously, we have been watching the position consolidate its breakout gains from early this year.
  • Currently on a “sell signal” and overbought, support needs to hold. There are two levels very close to each other; the uptrend line from the January lows, and support along recent bottoms.
  • We are likely take profits again soon as we rebalance.
  • Stop loss is moved up to support at $52

PEP – Pepsico, Inc.

  • PEP recently consolidated its gains, held support and then broke out to new highs. This is very bullish for the company.
  • However, PEP is overbought and the “buy signal” is at risk of turning.
  • We will take profits on a rebalance, and look for our next entry point.
  • Stop-loss moved up to $132.50

PG – Proctor & Gamble

  • PG has been on a seemingly unstoppable advance. With a consumer staple conglomerate trading at 88x earnings, we have to take profits and reduce our valuation risk.
  • The stock is grossly overbought and extended.
  • We will likely sell up to 20% of the position to reduce risk.
  • Stop loss is moved up to $117.50

V – Visa Inc.

  • V has been consolidating its previous advance and has been holding important support at the 32.8% Fibonacci retracement level.
  • The sell signal has been triggered and the overbought condition is being worked off.
  • We like the company longer-term, as consumers are going to keep going into debt, but we need a bigger correction to add to our position.
  • We will likely take profits when we rebalance.
  • Stop-loss is set at $160

WELL – Welltower Inc.

  • Same as with CHCT, real estate holdings have continued to perform well. WELL in particular has traded in a fairly tight channel.
  • Not surprisingly, we are looking to take profits, and rebalance risk accordingly.
  • The buy signal is extremely extended and CHCT is grossly overbought.
  • Stop-loss is moved up to $82.50

XOM – Exxon Mobil Corp.

  • Back in April of this year we sold 50% of our holdings in XOM and have been waiting for the right opportunity to add back to our position. We are getting there.
  • Energy shares actually have some value in them, and XOM is trading at a very long-term set of bottoms.
  • With the stock deeply oversold and on a very deep “sell signal,” there is a greatly reduced risk of adding back to our position opportunistically.
  • With a 5% yield, we can afford to hold the position with a wider stop-loss.
  • We will update our holdings when we add to the position.
  • Stop loss is at $63

YUM – Yum Brands, Inc.

  • YUM moved from an uptrend in 2018 to an accelerated uptrend in 2019.
  • YUM is grossly overbought and has recently triggered a sell signal.
  • We are looking to take profits and reduce the position by 10% when we rebalance the portfolio.
  • Stop loss is moved up to $107.50

The Voice of the Market- The Millennial Perspective

Those who cannot remember the past are condemned to repeat it.” – George Santayana

Current investors must be at least 60 years old to have been of working age during a sustained bond bear market. The vast majority of investment professionals have only worked in an environment where yields generally decline and bond prices increase. For those with this perspective, the bond market has been very rewarding and seemingly risk-free and easy to trade.

Investors in Europe are buying bonds with negative yields, guaranteeing some loss of principal unless bond yields become even more negative. The U.S. Treasury 30-year bond carries a current yield to maturity of 2.00%, which implies negative real returns when adjusted for expected inflation unless yields continue to fall. From the perspective of most bond investors, yields only fall, so there’s not much of a reason for concern with the current dynamics.

We wonder how much of this complacent behavior is due to the positive experience of those investors and traders driving the bond markets. It is worth exploring how the viewpoint of a leading investor archetype(s) can influence the mindset of financial markets at large.

Millennials

The millennial generation was born between the years 1981 and 1996, putting them currently between the ages of 23 and 38. Like all generations, millennials have unique outlooks and opinions based on their life experiences.

Millennials represent less than 25% of the total U.S. population, but they are over 40% of the working-age population defined as ages 25 to 65. Millennials are quickly becoming the generation that drives consumer, economic, market, and political decision making. Older millennials are in their prime spending years and quickly moving up corporate ladders, and they are taking leading roles in government. In many cases, millennials are the dominant leaders in emerging technologies such as artificial intelligence, social media, and alternative energy.

Their rise is exaggerated due to the disproportionately large baby boomer generation that is reaching retirement age and witnessing their consumer, economic, and political impact diminishing. An additional boost to millennials’ influence is their comfort with social media and technology. They are digital natives. They created Facebook, Twitter, Snapchat, Instagram, and are the most active voices on these platforms. Their opinions are amplified like no other generation and will only get louder in the years to come.

Given millennial’s rising influence over national opinion, we examine their experiences so we can better appreciate their economic and market perspectives.

Millennial Economics

In this section, we focus on the millennial experience with recessions. It is usually these trying economic experiences that stand foremost in our memories and play an important role in forming our economic behaviors. As an extreme example, anyone alive during the Great Depression is generally fiscally conservative and not willing to take outsized risks in the markets, despite the fact that they were likely children when the Depression struck.

The table below shows the number of recessions experienced by population groupings and the number of recessions experienced by those groupings when they were working adults, defined as 25 or older.

Data Courtesy US Census Bureau – Millennial Generation 1981-1996

About two-thirds of the Millennials, highlighted in beige, have only experienced one recession as an adult, the financial crisis of 2008. The recession of 1990/91 occurred when the oldest millennial was nine years old. More Millennials are likely to remember the recession of 2001, but they were only between the ages of 5 and 20.

Unlike most prior recessions, the recession of 2008 was borne out of a banking and real-estate crisis. Typically, recessions occur due to an excessive buildup in inventories that cause a slowing of new orders and layoffs. While the market volatility of the Financial Crisis was disturbing, the economic decline was not as severe when viewed through the lens of peak to trough GDP decline. As shown in the table below, the difference between the cycle peak GDP growth and the cycle trough GDP growth during the most recent recession was only the eighth largest difference of the last ten recessions.

Data Courtesy St. Louis Federal Reserve

One of the reasons the 2008 experience was not more economically challenging was the massive fiscal and monetary stimulus provided by the federal government and Federal Reserve, respectively. In many ways, these actions were unprecedented. When the troubles in the banking sector were arrested, consumer and business confidence rose quickly, helping the economy and the financial markets. Although it took time for the fear to subside, it set the path for a smooth decade of uninterrupted economic growth. A decade later, with the expansion now the longest since at least the Civil War, the financial crisis is a fleeting memory for many.

The market crisis of 2008 was harsh, but it did not last long. It is largely blamed on poor banking practices and real-estate speculation issues that have been supposedly fixed. Most Millennials likely believe the experience was a black swan event not likely to be repeated. One could argue there’s a large contingent of non-millennials who feel likewise.  Given the effectiveness of fiscal and monetary policy to reverse the effects of the crisis,  Millennials might also believe that recessions can be avoided, or greatly curtailed. 

Half of the millennial generation were teenagers during the financial crisis and have few if any, memories of the economic hardships of the era. The oldest of the Millennials were only in their early to mid-20s at the time and are not likely to be as financially scarred as older generations. In the words of Nassim Taleb, they had little skin in the game.

No one in the millennial generation has experienced a classical recession, which the Federal Reserve is not as effective at stopping. With only one recession under their belt, and minimal harm occurring as a result of their relatively young age, recession naivete is to be expected from the millennial generation.

Millennial Financial Markets

As stated earlier, the dot com bust, steep equity market decline, and the ensuing recession of 2001 occurred when the millennial generation was very young.

The financial crisis of 2008-2009 occurred when millennials were between the ages of 12 and 27. More than half of them were teenagers with little to no investing experience during the crisis. Some older Millennials may have been trading and investing, but at the time they were not very experienced, and the large majority had little money to lose. 

What is likely more memorable for the vast majority of the generation is the sharp rebound in markets following the crisis and the ease in executing a passive buy and hold strategy that has worked ever since.  

Millennial investors are not unlike bond traders under the age of 60 – they only know one direction, and that is up. They have been rewarded for following the herd, ignoring the warnings raised by excessive valuations, and dismissing the concerns of those that have experienced recessions and lasting market downturns.

Are they ready for 2001?

The next recession and market decline are more likely to be traditional in character, i.e. based on economic factors and not a crisis in the financial sector. Current equity valuations argue that a recession could result in a 50% or greater decline, similar to what occurred in  2008 and 2001. The difference, however, may be that the amount of time required to recover losses will be vastly different from 2008-2009. The two most comparable instances were 1929 and 2001 when valuations were as stretched as they are today. It took the S&P 500 over 20 years to recover from 1929. Likewise, the tech-laden NASDAQ needed 15 years to set new record highs after the early 2000’s dot com bust.

Those that were prepared, and had experienced numerous recessions were able to protect their wealth during the last two downturns. Some investors even prospered. Those that believed the popular narrative that prices would move onward and upward forever paid dearly.

Today, the narrative is increasingly driven by those that have never really experienced a recession or sharp market decline. Is this the perspective you should follow?

Summary

 “Those who cannot remember the past are condemned to repeat it.

We would add, “those who remember the past are more likely to avoid it.”

The millennial generation has a lot going for it, but in the case of markets and economics, it has lived in an environment coddled by monetary policy. Massive amounts of monetary stimulus have warped markets and created a dangerous mindset for those with a short time perspective.

If you fall into this camp, you may want to befriend a 60-year old bond trader, and let them explain what a bear market is.

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