Monthly Archives: August 2019

Major Market Buy/Sell Review: 12-09-19

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.

S&P 500 Index

  • With a “buy signal” triggered, there is a positive bias, however with both the price and “buy signal” very extended we expect a short-term correction for a better entry point to add exposure.
  • The correction on Monday and Tuesday was not enough to trigger an index “buy,” but was enough to require us to close out our “short S&P 500” index hedge for now in both the Equity and ETF portfolios. We took a small loss in the position but the rest of the portfolio continues to perform well. We will look to add the position back at a later date.
  • Given the deviation from the mean, and the more extreme overbought condition, it is advisable to wait for some consolidation/correction before increasing equity allocations.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position with a bias to add to holdings.
    • Stop-loss moved up to $290
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • DIA broke out to new highs with the reversal of the “buy” signal to the positive. However, that buy signal is pushing some of the higher levels seen historically so a correction is likely.
  • Despite the rally at the end of the week, DIA remains below its recent highs.
  • Hold current positions, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $265.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Like DIA, the technology heavy Nasdaq has broken out has did not get back above its recent at the end of the week. QQQ is pushing very extended levels.
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a consolidation or correction to add exposure.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $185
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • As noted previously, small-caps broke out above previous resistance but have been struggling.
  • Last week, small-caps successfully tested the breakout level, there is now a bias to add exposure.
  • However, as suggested, be patient as these historical deviations tend not to last long. SLY is extremely overbought and deviated from its longer-term signals.
  • We are actively looking for a trading opportunity that sets up.
  • 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 is holding up better than SLY and has not broken back down into its previous consolidation range.
  • MDY has now registered a short-term “buy” signal, but needs a slight correction/consolidation to reduce the extreme overbought and extended condition. The buy signal is very extended as well.
  • Look to add exposure to the market on a pullback that doesn’t violate support.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform and failed to hold its breakout.
  • With the “buy signal” extremely extended, the set up to add exposure here is not warranted. Watch the US Dollar for clues to EEM’s direction.
  • As we noted last week, PAY ATTENTION to the Dollar (Last chart). If the dollar is beginning a new leg higher, EEM and EFA will fail.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like MDY, EFA rallied out of its consolidation channel and is holding that level but is struggling with previous resistance.
  • Like EEM, it and the market are both EXTREMELY overbought.
  • Be patient for now and wait for a confirmed breakout before adding exposure, and again, watch the U.S. Dollar for important clues.
  • 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)

  • While commodities tend to perform well under liquidity programs due to their inherent leverage. Oil has continued to languish under the problems of over-supply and weak sector dynamics.
  • There is a short-term buy signal for oil, and oil prices finally rallied this week to the top of the downtrend channel. It is important for oil to break above $60 to set up a trade in the energy space.
  • We are starting to dig around the sector for some trading opportunities. Read our report on the site:
  • Collecting Tolls On The Energy Express
  • 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 got back to oversold and broke support at the 200-dma previously.
  • We are sitting on our stop-loss for the position currently, and had previously sold half our position.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. So, if we get stopped out of our holdings, we will look to buy them back at lower levels.
  • Short-Term Positioning: Neutral
    • Last week: Hold remaining position.
    • This week: Hold remaining position.
    • Stop-loss for whole position adjusted to $132.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices also broke support and triggered a sell-signal.
  • However, this past week, as “trade deal turbulence” returned, bonds rallied back to the top of its current downtrend channel and are still holding support.
  • Watch your exposure and either take profits or shorten your duration in your portfolio for now.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Despite much of the rhetoric 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 continues to hold support at the 200-dma and the bottom of the uptrend. If the dollar rallies back to the top of its trend, which is likely, this will take the wind out of the emerging market, international, and oil plays.
  • The “sell” signal is also turning up. If it triggers a “buy” the dollar will likely accelerate pretty quickly.

The Myth Of The “Great Cash Hoard” Of 2019

Tell me if you heard this one lately:

“There’s a trillion dollars in cash sitting on the sidelines just waiting to come into the market.” 

No.

Well, here it is directly from the Wall Street Journal:

“Assets in money-market funds have grown by $1 trillion over the last three years to their highest level in around a decade, according to Lipper data. A variety of factors are fueling the flows, from higher money-market rates to concerns over the health of the 10-year economic expansion and an aging bull market.

Yet some analysts say the heap of cash shows that investors haven’t grown excessively exuberant despite markets’ double-digit gains this year, and have plenty of money available to buy when lower prices prevail.”

See…there is just tons of “cash on the sidelines” waiting to flow into the market.

Except there isn’t.

The Myth Of Cash On The Sidelines

Despite 10-years of a bull market advance, one of the prevailing myths that seeming will not die is that of “cash on the sidelines.” To wit:

“’Cash always makes me feel good, both having it and seeing it on the sidelines,’ said Michael Farr, president of the money-management firm Farr, Miller & Washington.

Stop it.

This is the age-old excuse why the current “bull market” rally is set to continue into the indefinite future. The ongoing belief is that at any moment investors are suddenly going to empty bank accounts and pour it into the markets. However, the reality is if they haven’t done it by now, following 4-consecutive rounds of Q.E. in the U.S., a 330% advance in the markets, and ongoing global Q.E., exactly what is it going to take?

But here is the other problem.

For every buyer there MUST be someone willing to sell. As noted by Clifford Asness:

“There are no sidelines. Those saying this seem to envision a seller of stocks moving her money to cash and awaiting a chance to return. But they always ignore that this seller sold to somebody, who presumably moved a precisely equal amount of cash off the sidelines.”

Every transaction in the market requires both a buyer and a seller with the only differentiating factor being at what PRICE the transaction occurs. Since this is required for there to be equilibrium in the markets, there can be no “sidelines.” 

Think of this dynamic like a football game. Each team must field 11 players despite having over 50 players on the team. If a player comes off the sidelines to replace a player on the field, the player being replaced will join the ranks of the 40 or so other players on the sidelines. At all times there will only be 11 players per team on the field. This holds equally true if teams expand to 100 or even 1000 players.

Furthermore, despite this very salient point, a look at the stock-to-cash ratios (cash as a percentage of investment portfolios) also suggest there is very little available buying power for investors currently. As we noted just recently with charts from Sentiment Trader:

As asset prices have escalated, so have individual’s appetite to chase risk. The herding into equities suggests that investors have thrown caution to the wind.

With cash levels at the lowest level since 1997, and equity allocations near the highest levels since 1999 and 2007, it suggests investors are now functionally “all in.” 

With net exposure to equity risk by individuals at historically high levels, it suggests two things:

  1. There is little buying left from individuals to push markets marginally higher, and;
  2. The stock/cash ratio, shown below, is at levels normally coincident with more important market peaks.

But it isn’t just individual investors that are “all in,” but professionals as well.

Importantly, while investors are holding very little ‘cash,’ they have taken on a tremendous amount of ‘risk’ to chase the market. It is worth noting the current levels versus previous market peaks.”

Even Ned Davis noted that investors remain more invested in riskier assets than has historically been the case.

“Cash is low, meaning households are fairly fully invested.” 

So, Where Is All This Cash Then?

The Wall Street Journal was correct in their statement that money market cash levels have indeed been climbing. The chart from the Office Of Financial Research shows this:

There are a few things we need to consider about money market funds.

  1. Just because I have money in a money market account, doesn’t mean I am saving it for investing purposes. It could be an emergency savings account, a down payment for a house, or a vacation fund on which I want to earn a higher rate of interest. 
  2. Also, money markets are used by corporations to store cash for payroll, capital expenditures, operations, and a variety of other uses not related to investing in the stock market. 
  3. Foreign entities also store cash in the U.S. for transactions processed in the United States which they may not want to immediately repatriate back into their country of origin.

The list goes on, but you get the idea.

If you take a look at the chart above, you will notice that the bulk of the money is in Government Money Market funds. These particular types of money market funds generally have much higher account minimums (from $100,000 to $1 million) which suggests that these funds are predominately not retail investors. (Those would be the smaller balances of prime retail funds.)

So, where is all that cash likely coming from?

Hoarding Cash

You are already most likely aware that Warren Buffett is hoarding $128 billion in cash, and that Apple is sitting on a cash trove of $100 billion, with Microsoft holding $136.6 billion, and Alphabet amassing $121 billion.

Yes, some of that cash has been used for share buybacks, but much of it is sitting there waiting for acquisitions, R&D, capital expenditures, etc. However, that cash is primarily sitting in short-term and longer-term dated treasuries, AND, you guessed it, money market funds.

However, as noted above, there is also a flood of money coming into U.S. Dollar denominated assets for better yield and safety than what is available elsewhere in the world.  

At RIAPRO.NET we regularly track the U.S. Dollar for our subscribers. (You can access these reports with a FREE 30-day Trial.)

  • Despite much of the rhetoric 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.
  • Furthermore, the dollar bounced off support of the 200-dma and the bottom of the uptrend. If the dollar rallies back to the top of its trend, which is likely, this will take the wind out of the emerging market, international, and oil plays.
  • The “sell” signal is also turning up. If it triggers a “buy” the dollar will likely accelerate pretty quickly.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE, but as shown above, that has yet to be the case. However, US Dollar positioning has been surging as of late as money has been flowing into US Dollar denominated assets. Importantly, it is worth watching positioning in the dollar as a reversal of dollar-longs are usually reflective of short- to intermediate-term market peaks.

As shown above, and below, such net-long positions have generally marked both a short to intermediate-term peak in the dollar. The bad news is that a stronger dollar will trip up the bulls, and commodities, sooner rather than later.

However, as it relates to foreign positioning, it is worth noting that EURO-DOLLAR positioning has been surging over the last 2-years. This surge corresponds with the surge in dollar-denominated money market assets.

What are Euro-dollars? The term Eurodollar refers to U.S. dollar-denominated deposits at foreign banks, or at the overseas branches, of American banks. Net-long Eurodollar positioning is at an all-time record as foreign banks are cramming money into dollar-denominated assets to get away from negative interest rates abroad.

Importantly, when positioning in the Eurodollar becomes NET-LONG, as it is currently, such has been associated with short- to intermediate corrections in the markets, including outright bear markets. 

What could cause such a reversal? A pick up of economic growth, a reversal of negative rates, a realization of over-valuation in domestic markets, which starts the decline in asset prices. Then, the virtual spiral begins of assets flowing out, lowers asset prices, leading to more asset outflows.

While the bulls are certainly hoping the “cash hoard” will flow into U.S. equities, the reality may be quite different.

That’s how the bear markets begin.

Slowly at first. Then all of a sudden.

RIA PRO: 2020 – The Year Decennial & Presidential Cycles Collide


  • Here Comes The Santa Claus Rally
  • When Presidential & Decennial Cycles Collide
  • New: Financial Planning Corner
  • Sector & Market Analysis
  • 401k Plan Manager

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Here Comes Santa Claus (Rally)

On Friday, the market rallied sharply on the back of a much better than expected employment report and comments from Larry Kudlow that a “trade deal” is near. Given we are now at the last stages of the year where mutual, pension, and hedge funds need to “window dress” for year-end reporting, we removed our small equity hedge from the portfolio for the time being.

A quick word about that employment report.

While the headline number was good, it remained primarily a story of auto workers returning to work and continued increases in lower wage-paying jobs and multiple jobholders. Such has been the story of the bulk of this recovery. However, more importantly, the bump did not change the overall dynamics of the job market cycle, which is clearly deteriorating as shown in the chart below.

The key to trend change is CEO confidence which is extremely negative and coincident with employment cycle turns. Note that the end of employment cycles, when compared to CEO confidence, looks very similar at the end of each decade.

Nonetheless, in the short-term, the market dynamics are positive suggesting the market can indeed rally into the end of the year. As noted above, we have removed our equity hedge for now to allow our long-positions to fully benefit from the expected “Santa Claus” rally.  (Or if you prefer the more PC version then it would be the expected “Jovial Full-Figured Holiday Person” rally.)

With the market back to short-term overbought, and the short-term “sell signal” still in place, it is possible we could see a bit of a correction next week. However, as we head into the last week of the year, a retest of highs is quite likely. 

In the longer-term, as we will discuss more in a moment, the risk remains to the downside. It is highly unlikely there will be a “trade deal” anytime soon, and with the upcoming election, there will likely be increased volatility going into 2020.

From a purely technical perspective, on a monthly basis, the market is exceedingly overbought and at the top of the long-term trend channel. When these two conditions have been filled previously, we have seen fairly sharp corrections within the confines of the bullish trend.

With QE-4 in play, the bias remains to the upside keeping our target of 3300 on the S&P 500 in place. This is particularly the case as we head further into the seasonally strong period combined with an election year cycle.

Currently, we are exploring the energy space in particular where there is value being generated after the long drought of interest in energy-related stocks.

We have just released a research report for our RIAPro Subscribers (30-Day Free Trial)  on where we are looking for opportunity. Here is a snippet:

A decline in the dividend yield to the norm, assuming the dividend payout is unchanged, would result in a price increase of 13.17% for AMLP. Alternatively, if oil declined about 20% in value, the current AMLP dividend yield would then be fairly priced. We consider this a significant margin of safety should the price of oil fall, as it likely would if the U.S. enters a recession in the near future.”

When Presidential & Decennial Cycle Collide

There have been quite a few articles out lately suggesting that in 2020 the 10-year bull market is set to continue because it is a presidential election year. This sounds great in theory, but Wall Street and the financial media always suggest that next year is going to be another bullish year.

However, there are a lot of things that will need to go “right” next year from:

  1. Avoidance of a recession
  2. A rebound in global economic growth
  3. The consumer will need to expand their current debt-driven consumption
  4. A marked improvement in both corporate earnings and corporate profitability
  5. A reduction or removal in current tariffs, and;
  6. The Fed continues to remain ultra-accommodative to the markets.

These are all certainly possible, but given we are currently into both the longest, and weakest, economic expansion in history, and the longest bull market in history, the risks of something going wrong have certainly risen.

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

However, what about the election coming up in less than a year?

Presidential Cycle

With “hope” running high that things can continue going into 2020, the question becomes whether or not the Presidential election cycle can hold its performance precedent.  Since 1871, markets have gained in 35 of those years, with losses in only 11.

Since 1948, there have only been two losses during presidential election years which were 2000 and 2008. In fact, stocks have, on average, put in their second-best performance in the fourth year of a president’s term. (The third year has been best as we are seeing currently.) 

With a “win ratio” of 76%, the media has been quick to assume the bull market will continue unabated. However, there is a 24% chance a bear market will occur which is not entirely insignificant. Furthermore, given the duration, magnitude, and valuation issues associated with the market currently, a “Vegas handicapper” might increase those odds just a bit.

One thing to remember about all of this is that while the odds are weighted in favor of a positive 2020 from an election cycle standpoint – there have been NO cycles in history when the majority of the industrialized world was on the brink of a debt crisis all at the same time.

While the election of the next President will impact the market’s view towards policy stability; it is the world stage that will drive investor sentiment over the coming months and years. The biggest of those drivers is employment which has been weakening as of late. Importantly, there is an important correlation between consumer/investor sentiment, CEO confidence, and employment as noted above.

“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.’”

But there is another cycle that we need to consider which is colliding with the Presdential election cycle, and that is the 10-year or decennial cycle.

Decennial Cycle

Using the same data set going back to 1833 we find a little different outlook. While the 10th year of the decade (2020) is on average slightly positive, it’s win/loss ratio is only 56%, or not much better than a coin toss.

Furthermore, while presidential election years have a near 10% average annual return profile, the 10th-year of the decennial cycle is markedly weaker at just 1.91% on average.

The best year of the decade is the 5th which has been positive 79% of the time with an average return of 22%. The worst year is the 7th with only a 53% win rate but a negative average annual return. As noted, 2020 comes in as the second place for the worst of the annual returns.

With a win/loss record of 11-7 an investor betting heavily on a positive outcome for 2020 may be left short changed given the current political, economic, fundamental, and financial environment.

I have also overlaid the 1st-year of the new presidential cycle with the “orange boxes” above. You will notice that again, return parameters and win/loss percentages are low. This should suggest some caution for investors over the next 24-months given the length of the current bull market advance.

A Lot Of If’s

All of this analysis is fine but whether the market is positive or negative in 2020 comes down to a laundry list of assumptions:

  • If we can avoid a recession in the U.S. 
  • If we can avoid a recession in Europe. 
  • If corporate earnings can strengthen.
  • If the consumer can remain strong.
  • Etc.

Those are some pretty broad “if’s” and given the weakness is imports, which suggests a weakening domestic consumer, and struggling manufacturing, the risk of something going wrong is elevated.

As far as corporate earnings go – they peaked this year as the tax cut stimulus ran its course, and forward expectations are being sharply ratcheted lower. As we discussed on Tuesday:

“Since April, forward expectations have fallen by more than $11/share as economic realities continue to impale overly optimistic projections.”

This earnings boom cycle was skewed heavily by accounting rule changes, loan loss provisioning, tax breaks, massive layoffs, extreme cost cutting, suppression of wages and benefits, longer work hours, and massive share buybacks along with extraordinary government stimulus.

But when it comes to actual reported “profits,” which is what companies actually earned, reported, and paid taxes on, it is a vastly different story.

“Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

The chart below shows the real, inflation-adjusted, profits after-tax versus the cumulative change to the S&P 500. Here is the important point – when markets grow faster than profitability, which it can do for a while; eventually a reversion occurs. This is simply the case that all excesses must eventually be cleared before the next growth cycle can occur. Currently, we are once again trading a fairly substantial premium to corporate profit growth.

So, if, somehow, maybe, possibly, all these things can be sustained we should be just fine.

The problem is, however, all of the pillars that supported the earnings boom are now going away beginning next year, each of them to some degree, which throws into question the sustainability going into 2020-2021.

While doing statistical analysis on the Presidential and Decennial cycles certainly make for interesting articles, it is crucially important to remember what drives the financial markets the short-term which is psychology and sentiment.

In the next 12-18 months, there will be more than enough event risks to skew the potential outcomes of the markets. This doesn’t mean that you should go and hide all in cash or gold. It does suggest you need to actively pay attention to your money.

This idea plays into our allocation theme of higher quality income, hedged investments and precious metals as an alternative to direct market risk. With expectations of lower economic growth in the coming quarters, reduced earnings, and pressure on the consumer, the markets are likely to remain highly volatile with little overall progress.

While we are in the midst of prognostications, it has also been predicted the world will end in 2020, so anything other than that will be a “win.”

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

See you next week.


“NEW” – Financial Planning Corner

by Danny Ratliff, CFP®, ChFC®

10-Don’t Miss Year-End Financial Planning Tips

Let’s give thanks that Thanksgiving week and the numerous “big” shopping days have officially come to a close.  Christmas is fast approaching and now would be an easy time to push these year-end tips to 2020. Don’t. Spend 15 minutes and make sure you’re doing all you can to take advantage of 2019 and setting yourself up for a successful 2020.

  1. Evaluate this year’s financial plan progress: If you created a plan for 2019 how are you doing? What have you accomplished for the year and what do you still have time to complete? Many people just look at the investment returns and while that’s important don’t forget to look at your behaviors. How much have you spent and saved?
  2. Take another look at your 401(k): Does your employer match your 401(k) contributions? Now would be a good time to make sure you aren’t leaving any money on the table in the form of matching contributions. For 2019 you can contribute up to 19,000 to your 401(k) and an additional catch up of 6,000 if you turned 50 this year. Once the calendar turns to 2020 you won’t be able to go back and make up those missed contributions.
  3. Have access to a Health Savings Account (HSA,) max it out: HSA accounts are like the fountain of youth for the financial planning world. They’re almost too good to be true. This is the only account in the world that will give you a triple tax benefit. Money goes in tax free, grows tax free and if used for medical expenses comes out tax free. Think your medical expenses in retirement won’t be that bad? Thank again, Fidelity just did a study that shows the average 65-year-old couple will spend $280,000 in medical expenses.   In 2019 individuals can contribute $3,500 and a family can contribute $7,000. Here’s the kicker, if you really want to maximize these plans you need to try to pay for current medical expenses out of pocket and let these funds grow.
  4. Use the balance of your Flexible Spending Account (FSA): If you have an FSA, now is the time to spend that unspent balance. Some plans will allow you to carry over a small amount of the funds to next year, but many won’t. So, use it or lose it.
  5. Review your Insurance Coverage: If you have life, health, disability, homeowners or long- term care insurance make some time to review your policies. Has anything changed with your policies, have premiums gone up? In regard to your life insurance have you had any life events that would warrant a change in your coverage?
  6. Review or Create Estate Planning Documents: If you and I have had a face to face meeting this is something I’ve probably asked you. This is so important, but often overlooked or pushed to the back burner. Stop denying the inevitable, you’re going to die, make sure your loved ones are taken care of the way you wish.
  7. Review Expenses: Many people have no idea how much they spend each month or where they are spending their money. This goes back to #1 evaluating your progress in your plan.
  8. Have a Conversation with your Tax Advisor: Between now and Christmas is a great time to have a chat with your tax advisor to ensure you aren’t leaving any deductions on the table before we get into 2020 and it’s to late. Everyone likes to reduce their tax bill.
  9. Roth Conversions: While you’re talking with your CPA and Advisor find out if you have any room for a Roth conversion. We talk about these often and run many analyses, they’re not for everyone, but these can be a great tool to give you more flexibility in retirement.
  10. Sell Losers to offset Gains: Tax loss harvesting is an easy way to lower your taxes on a year to year basis. Do you have any gains for the year and hold positions with losses? Realize your losses to offset those gains. The losses will offset your gains dollar for dollar. You can also use an additional $3,000 to offset other income and if you have more than $3,000 in excess losses you can carry that over indefinitely until those losses are exhausted.

Achieving your financial goals is a never-ending process and staying on top of financial planning is imperative to your success. December is an ideal time to assess your current situation and ensure you’re taking advantage of all you can for 2019.

Need a financial partner to help keep you on track or looking for ways to fine tune your financial plan? Contact us to see how we can help create a financial plan that uses realistic data that will provide your family peace of mind and security.

Don’t hesitate to send me an email if you have any questions or if you, or someone you know, needs help. We encourage your feedback and look forward to hearing from you.


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 – Energy (XLE)

The improvement in Energy has stalled for now as as the rotation to “value” gave way back to momentum for the “QE Chase.” Energy needs to break above the downtrend to become an attractive candidate for portfolios. We are digging around this space currently, but haven’t executed a position just yet.

Current Positions: No holdings

Outperforming – Technology (XLK), Healthcare (XLV), Industrials (XLI), Financials (XLF)

Financials have been running hard on Fed rate cuts and more QE. The sector is extremely overbought and extended and due for a correction. Take profits and be patient to add exposure.

Industrials, which perform better when the Fed is active with QE, also broke out to new highs recently but has been consolidating at a very high level. Given they are still extremely overbought, we will look to add but will wait for this correction to play out first.

Technology and Healthcare have been the leaders as of late. Healthcare made a sharp recovery from weakening to leading relative to the overall market, and the sector is now grossly overbought and extended. Take profits and look for a better entry point later. Like everything else, XLK is extremely overbought so wait for a correction to add exposure.

Current Positions:  1/2 weight XLI, Full weight XLK, XLV

Weakening – Utilities (XLU)

Utilities have not made a lot of ground, but haven’t lost much either but has corrected a big chunk of their previous overbought condition. Positions can be added on a break above the 50-dma.

Current Position: Target weight XLU

Lagging – Real Estate (XLRE), Staples (XLP), Discretionary (XLY), Communications (XLC), Materials (XLB

Staples have been a surprising winner over the last couple of weeks as money is still seeking a bit of defensive positioning. However, Discretionary other the other hand, has been a real laggard as of late which I suspect has more to deal with the “real economy,” rather than just a sector lagging the market currently. Watch XLY, a failure at support will likely suggest a larger corrective process. Communications broke out to new highs, but is still lagging the overall market. Given the sector is very overbought, be patient for a better entry point.

Current Position: Target weight XLC, XLY, XLP, XLRE, 1/2 weight XLB

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – While Small- and Mid-caps broke out of the previous ranges the rotation to risk finally regained some strength over the last week. Both sectors are very overbought so look for any weakness that holds support to add positions to portfolios.

Current Position: No position

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

Emerging and International Markets, rallied recently on news of “more QE,” and finally broke above important resistance. However, these markets are sensitive to the US Dollar which is showing some strength. With both markets EXTREMELY overbought currently, be patient for the right entry point.

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.

Be aware that all of our core positions are EXTREMELY overbought. A short-term correction or consolidation is likely before a further advance can be made.

Current Position: RSP, VYM, IVV

Gold (GLD) – Gold broke support at the $140 level but held support at $136. Stops should be placed on all positions at $132. Gold is very oversold and a break above the 50-dma will be a tradeable opportunity.

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

Bonds (TLT) – 

Bonds rallied back to the 50-dma but failed on Friday as the chase for stocks resumed. Support continues to hold so look for this correction to provide an oversold reading to buy bonds into.

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:

As we discussed previously, we hedged our portfolios against a short-term market correction due to the extreme overbought condition which existed at the time. This past week, the market mildly corrected on Monday and Tuesday, but then a strong employment report and a litany of “trade deal” headlines quickly reversed the entire correction before it was complete. Regardless, given the minor correction that occurred, it cleared the market for a year-end rally. Therefore, we have temporarily removed the hedge until after the year-end performance chase is complete.

We will likely need to re-add the short position back to portfolios in January as the markets remain grossly overbought and, after the rise in the markets this past year, we will likely see a bout of selling to take in gains and defer the taxes until 2021.  We will wait, watch, and act accordingly.

As noted in the main body of this missive, the market remains extremely overbought which limits our ability to add “broad market” exposures. However, we are looking to selectively add exposure to ETF Models in small and mid-capitalization markets, basic materials, industrials, financials and energy.

As noted previously, we have been “picking through the ruble” of the energy sector looking for a couple of tradeable ideas in the sector as well. We have identified an interesting yield play that we are looking for the right entry point for. You can read the research note here.

However, whatever actions we wind up taking in the short-term remains a “rent the rally” for now.

  • New clients: We are holding off onboarding new client assets until we see some corrective action or consolidation in the market.
  • Equity Model: We sold SDS. Looking add to some core equity positions opportunistically. 
  • ETF Model: Same as Equity Model.

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


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.)

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

Click Here For The “LIVE” Version Of The 401k Plan Manager

See below for an example of a comparative model.


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. 

401k Plan Manager Live Model

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

 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)

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

Collecting Tolls On The Energy Express

The recent surge in passive investment strategies, and corresponding decline in active investment strategies, is causing strong price correlations amongst a broad swath of equities. This dynamic has caused a large majority of stocks to rise lockstep with the market, while a few unpopular stocks have been left behind. It is these lagging assets that provide an opportunity. Overlooked and underappreciated stocks potentially offer outsized returns and low correlation to the market. Finding these “misfits” is one way we are taking advantage of a glaring market inefficiency.

In July 2019, we recommended that investors consider a specific and underfollowed sector of REITs that pay double-digit dividends and could see reasonable price appreciation. In this article, we shed light on another underfollowed gem that also offers a high dividend yield, albeit with a vastly different fundamental profile.

The Case for MLP’s

Master Limited Partnerships (MLPs) are similar in legal structure to REITs in that they pass through a large majority of income to investors. As such, many MLP’s tend to pay higher than average dividends. That is where the similarities between REITs and MLPs end. 

The particular class of MLPs that interest us are called mid-stream MLPs. We like to think of these MLPs as the toll booth on the energy express. These MLPs own the pipelines that deliver energy products from the exploration fields (upstream) to the refiners and distributors (downstream). Like a toll road, these MLPs’ profitability is based on the volume of cars on the road, not the value of the cars on it. In other words, mid-stream MLPs care about the volume of energy they carry, not the price of that energy. That said, low oil prices can reduce the volume flowing through the pipelines and, provide energy producers, refiners, and distributors leverage to renegotiate pipeline fees.

Because the income of MLPs is the result of the volume of products flowing through their pipelines and not the cost of the products, their sales revenue, income, and dividend payouts are not well correlated to the price of oil or other energy products. Despite a different earnings profile than most energy companies, MLP stock prices have been strongly correlated to the energy sector. This correlation has always been positive, but the correlation is even greater today, largely due to the surge of passive investment strategies.

Passive investors tend to buy indexes and sectors containing stocks with similar traits. As passive investors become a larger part of the market, the prices of the underlying constituents’ trade more in line with each other despite variances in their businesses, valuations, outlooks, and risks. As this occurs, those marginal active investors that differentiate between stocks and their associated fundamentals play a lesser role in setting prices. With this pricing dynamic, inefficiencies flourish.

The graph below compares the tight correlation of the Alerian MLP Infrastructure Index (MLPI) and the State Street Energy Sector ETF (XLE).

Data Courtesy Bloomberg

Before further discussing MLP’s, it is worth pointing out the value proposition that the entire energy sector affords investors. While MLP cash flows and dividends are not necessarily similar to those companies in the broad energy sector, given the strong correlation, we must factor in the fundamental prospects of the entire energy sector.

The following table compares valuation fundamentals, returns, volatility, and dividends for XLE and the S&P 500. As shown, XLE has traded poorly versus the S&P 500 despite a better value proposition. XLE also pays more than twice the dividend of the S&P 500. However, it trades with about 50% more volatility than the index.  

The following table compares two valuation metrics and the dividend yield of the top 6 holdings of Alerian MLP ETF (AMLP) and the S&P 500. A similar value story emerges.

As XLE has grossly underperformed the market, so have MLPs. It is important for value investors to understand the decline in MLP’s is largely in sympathy with the gross underperformance of the energy sector and not the fundamentals of the MLP sector itself. The graph below shows the steadily rising earnings per share of the MLP sector versus the entire energy sector.

Data Courtesy Bloomberg

Illustrating the Value Proposition

The following graphs help better define the value of owning MLPs at current valuations.

The scatter graph below compares 60-day changes to the price of oil with 60-day changes in AMLP’s dividend yield. At current levels (the orange dot) either oil should be $10.30 lower given AMLP’s current dividend yield, or the dividend yield should be 1.14% lower based on current oil prices. A decline in the dividend yield to the norm, assuming the dividend payout is unchanged, would result in a price increase of 13.17% for AMLP. Alternatively if oil declined about 20% in value, the current AMLP dividend yield would then be fairly priced. We consider this a significant margin of safety should the price of oil fall, as it likely would if the U.S. enters a recession in the near future.   

Data Courtesy Alerian and Bloomberg

The graph below highlights that AMLP’s dividend yield is historically high, albeit below three short term spikes occurring over the last 25 years. In all three cases oil fell precipitously due to a recession or a sharp slowdown of global growth.

Data Courtesy Alerian and Bloomberg

Due to their high dividend yields and volatility, MLP’s are frequently compared to higher-yielding, lower-rated corporate debt securities. The graph below shows that the spread of AMLP’s dividend yield to the yield on junk-rated BB corporate bonds is the largest in at least 25 years. The current spread is 5.66%, which is 5.18% above the average since 1995.

Data Courtesy Alerian and St. Louis Federal Reserve

To help us better quantify the pricing of MLPs, we created a two-factor model. This model forecasts the price of MLPI based on changes to the price of XLE and the yield of U.S. Ten-year Treasury Notes. The model below has an R-squared of .76, meaning 76% of the price change of MLPI is attributable to the price changes of energy stocks and Treasury yields. Currently the model shows that MLPI is 20% undervalued (gray bars).  The last two times MLPI was undervalued by over 20%, its price rose 49% (2016) and 15% (2018) in the following three months.

The following summarizes some of the more important pros and cons of investing in MLPs.

Pros

  • Dividend yields are very high on an absolute basis and versus other higher-yielding securities
  • Valuations are cheap
  • Earnings are growing in a dependable trend
  • Balance sheets are in good shape
  • Potential for stock buybacks as balance sheets improve and stock prices offer value

Cons

  • Strong correlation to oil prices and energy stocks
  • “Peak oil demand” – electric cars/solar
  • Sensitivity to global trade, economy, and broad asset prices
  • Political uncertainty/green movement
  • High volatility

Summary

The stronger the market influence that passive investors have, the greater the potential for market dislocations. Simply, as individual stock prices become more correlated with markets and each other, specific out of favor companies are punished. We believe this explains why MLP’s have traded so poorly and why they are so cheap today.

We urge caution as buying MLPs in today’s environment is a “catching the falling knife” trade. AMLP has fallen nearly 25% over the last few months and may continue to fall further, especially as tax selling occurs over the coming weeks. It has also been in a longer-term downtrend since 2017.  We are unlikely to call the market bottom in MLPs and therefore intend to scale into a larger position over time. We will likely buy our first set of shares opportunistically over the next few weeks or possibly in early 2020. Readers will be alerted at the time. We may possibly use leveraged MLP funds in addition to AMLP.

It is worth noting this position is a small part of our portfolio and fits within the construct of the entire portfolio. While the value proposition is great, we must remain cognizant of the current price trend, the risks of owning MLPs, and how this investment changes our exposure to equities and interest rates.

This article focuses predominately on the current pricing and value proposition. We suggest that if you are interested in MLPs, read more on MLP legal structures, their tax treatment, and specific risks they entail.

AMLP does not require investors to file a K-1 tax form. Many ETFs and all individual MLPs have this requirement.

*MLPI and AMLP were used in this article as a proxy for MLPs. They are both extremely correlated to each other. Usage was based on the data needed.

#WhatYouMissed On RIA: Week Of 12-02-19

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

Hedge Fund Telemetry founder Thomas Thornton reveals his secret sauce for tracking the markets, indicators he likes best, and what the charts are saying about the 2020 elections.

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)

The QE-4 Report below was released to our subscribers 3-weeks ago. Subscribe today for a FREE trial and get the UPDATED version of this report.

See you next week!

Is Inflation Really Under Control

Recently, analysts have been discussing the pros and cons of using negative interest rates to keep the U.S. economy growing.  Despite this, Fed Chairman Jerome Powell has said that he does not anticipate the Federal Reserve will implement a policy of negative interest rates as it may be detrimental to the economy.  One argument against negative interest rates is that they would squeeze bank margins and create more financial uncertainty. However, upon examining the actual rate of inflation we are likely already in a ‘de facto’ negative ­­interest rate environment. Multiple inflation data sources show that actual inflation maybe 5%. With the ten year Treasury bond at 1.75%, there is an interest rate gap of – 3.25%. Let’s look at multiple inflation data points to understand why there is such a divergence between the Fed assumptions that inflation is under control versus the much higher rate of price hikes consumers experience.

In October, the Bureau of Labor Statistics (BLS) reported that the core consumer price index (CPI) grew by 2.2% year over year.  The core CPI rate is the change in the price of goods and services minus energy and food.  Energy and food are not included because they are commodities and trade with a high level of volatility.  However, the Median CPI shows a ten year high at 2.96% and upward trend as we would expect, though it starts at a lower level than other inflation indicators. The Median CPI excludes items with small and large price changes.

Source: Gavekal Data/Macrobond, The Wall Street Journal, The Daily Shot – 11-29-19

Excluding key items that have small and large price changes is not what a consumer buying experience is like. Consumers buy based on immediate needs. When a consumer drives up to a gas pump, they buy at the price listed on the pump that day.  Consumers buying groceries don’t wait for food commodity prices to go down; they have to pay the price when they need the food. Recent consumer purchase research shows that prices of many goods and services continue to increase at a rate much higher than 2.2%.

Gordon Haskett Research Advisors conducted a study by purchasing a basket of 76 typical items consumers buy at Walmart and Target.  The study showed that from June 2018 to June 2019, prices increased about 5%. 

Sources: Gordon Haskett Research Advisors, Bloomberg – 8/10/19

Walmart and Target are good proxies for consumer buying experiences. Walmart is the largest retailer in the U.S. with over 3,000 locations marketing to price-conscious consumers. Target has 1,800 locations in the U.S. and is focused on a similar consumer buyer profile, though a bit less price sensitive. Importantly, both Walmart and Target have discount food sections in their stories.

Housing has been rapidly increasing in cost as well.  Rental costs have soared in 2019 as the following chart shows a month over month shift to .45%, which is an annualized rate of 5.4%.

Sources: Bureau of Labor Statistics, Nomura – 5/13/19


The costs of other services like health care and education have increased dramatically as well. Service sectors, which make up 70% of the U.S. economy, are where wages are generally higher than in manufacturing sectors. Techniques to increase service productivity have been slow to implement due to service complexity. Without productivity gains, prices have continued to rise in most services sectors.

Sources: Deutsche Bank – 11/14/19

Medical care costs have increased by 5.2% per year, and education costs have risen 6.8 % per year. Wages of non-supervisory and production workers have fallen behind at 3.15 % increase per year. Note that the overall CPI rate significantly underestimates the rate of costs in these basic consumer services, likely due to underweighting of services in the cost of living calculation.

For many consumers, housing, utilities, health care, debt payments, clothing, and transportation comprise their major expenses. Utility and clothing costs have generally declined. While transportation, housing, and health care costs have increased.  The rate of new car annual inflation was as low as 1 percent in 2018.  Yet, according to Kelly Blue Book, the market shift to SUVs, full-sized trucks, and increasing Tesla sales have caused average U.S. yearly vehicle prices to zoom 4.2% in 2019. The soaring price of vehicles has caused auto loans to be extended out to 7 or 8 years, in some cases beyond the useful life of the car. 

Dealers are financing 25% of new car purchases with ‘negative equity deals’ where the debt from a previous vehicle purchase is rolled into the new loan.  The October consumer spending report shows consumer spending up by .3% yet durable goods purchases falling by .7% primarily due to a decline in vehicle purchases.  A 4.2% increase in vehicle prices year over year is unsustainable for most buyers and indicates likely buyer price resistance resulting in falling sales. The October durables sales decline could have been anticipated if inflation reporting was based on actual consumer purchasing experiences.

The trade wars with China, Europe, and other countries are contributing to significant price increases for consumer goods.  Tariffs have driven consumer prices higher for a variety of product groups, including: appliances, furniture, bedding, floor coverings, auto parts, motorcycles, sports vehicles, housekeeping supplies, and sewing equipment.

Sources: Department of Commerce, Goldman Sachs, The Wall Street Journal, The Daily Shot – 5/13/19

In the chart above, prices increased by about 3.5% over 16 months before mid-May 2019. As uncertainty in the trade wars grows and earlier cheaper supplies are sold, prices will likely continue to rise. The President has announced new tariffs of 15% on $160 billion of Chinese consumer goods for December 15th if a Phase One deal is not signed. On December 2nd, he announced resuming tariffs on steel and aluminum imports from Argentina and Brazil and 100 % tariffs on $2.4 billion of French goods. The implementation of all these tariffs on top of existing tariffs will only make consumer inflation worse. Tariffs are driving an underlying inflationary trend that is being under-reported by government agencies.

Evidently, the prices for goods and services that consumers experience are vastly different from what the federal government reports and uses to establish cost of living increases for programs like Social Security. So, why is there a disconnect between the government CPI rate of 2.2% and consumer reality of inflation at approximately 5%?  The raw data that the Bureau of Labor Statistics (BLS) uses to calculate the CPI rate is not available to the public.  When a Forbes reporter asked the BLS why the data was not available to the public the BLS response was companies could ‘compare prices’. This assumption does not make sense as companies can compare prices on the Internet, in stores, or find out from suppliers. The ‘basket of consumer items’ approach was discontinued in the 1980s for a ‘cost of living’ index based on consumer buying behaviors. There was political pressure to keep the inflation rate low. If real inflation figures were reported the government would have to increase payments to Social Security beneficiaries, food stamp recipients, military and Federal Civil Service retirees and survivors, and children on school lunch programs.  Over the past 30 years the BLS has changed the calculation at least 20 times, but due to data secrecy there is no way to audit the results. The BLS tracks prices on 80,000 goods and services based on consumer spending patterns, not price changes on goods and services per se.  For example, if consumers substitute another item for a higher-priced one it is discontinued in the calculation. 

Economist John Williams has calculated inflation rates based upon the pre-1980s basket approach versus the cost of living formula used by BLS today.  His findings show a dramatically higher rate of inflation using the 1980s formula.

Source: Shadow Government – 10/2019

His calculation using the earlier basket formula sets the present inflation rate at nearly 10%.  Based on our research on various price reporting services, we think the real consumer inflation rate is probably about 5 to 6%.

The implications of this gap between real inflation and reported inflation rates are profound and far-reaching.  Federal Reserve complacency about a low inflation rate to justify a low Fed Funds rates is called into question. In fact the economic reality of today is we are living in a 3.25%  ‘de facto’ negative interest rate environment where the ten year Treasury bond rate is 1.75%, and inflation is 5%. The liquidity pumping into the economy, based in part on low inflation, is overheating risk assets while providing support for corporate executives to take on debt at decade record levels.

Building the economic framework on erroneous inflation data versus the reality for consumers and businesses lead to massive financial dislocations. This economic bubble is unsustainable and will require a brutal recession to rebalance the economy.  As part of a possible soft ‘landing’ policy, the BLS could make price data available to all economists. Full data access will provide an opportunity for objective comments and feedback based on other consumer price research.

The Fed actually focuses on the even lower Personal Consumption Expenditure rate of 1.6% reported by the Bureau of Economic Analysis for October. The Fed prefers the PCE rate because a consumer survey technique is used, while economists prefer the CPI, which is more granular so it is easier to identify goods and services categories that are driving inflation. Using unrealistically low inflation assumptions leads to misguided policy decisions and perpetuation of the myth that inflation is under control. Yet, in fact inflation it is out of control due to extremely low Fed interest rates, liquidity injections, and trade war tariffs.

Patrick Hill is the Editor of The Progressive Ensignhttps://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.

Mauldin: The Dirty Secret Behind America’s “Full Employment”

Should just being “employed” make people/workers happy?

On one level, any job is better than no job. But we also derive much of our identities and self-esteem from our work.

If you aren’t happy with it, you’re probably not happy generally.

Unhappy people can still vote and are often easy marks for shameless politicians to manipulate. Their spending patterns change, too.

So it ends up affecting everyone and everything.

Unhappy Employment

There’s this plight of people who, while not necessarily poor, aren’t where they think they should be—and perhaps once were.

This disappointment isn’t just in their minds; the economy really has changed. Yes, you can probably get a job if you are physically able, but the odds it will support you and a family, if you have one, are lower than they once were.

The US Private Sector Job Quality Index aims to give data on this… distinguishing between low-wage, often part-time service jobs and higher-wage career positions.

What they have found so far isn’t encouraging.

Looking at “Production & Non-Supervisory” positions (essentially middle-class jobs), the inflation-adjusted wage gap between low-wage/low-hours jobs and high-wage/high-hours jobs widened almost fourfold between 1990 and 2018.

Worse, the good jobs are shrinking in number. In 1990, almost half (47%) were in the “high-wage” category. In 2018, it was only 37%.

Work More, Earn Less

Much of the wage gap came not from the hourly rates, but from the number of hours worked.

The labor market has basically split in two categories with little in between.

There are low-wage service jobs in which you get paid only when the employer really needs you, and higher-wage jobs that pay steady wages.

The number of young people working in the so-called gig economy, working multiple part-time jobs, is growing. And part-time jobs generally are not high-paying jobs.

This also helps explain why so many relatively well-off people feel like they are always working and ahave no free time. They aren’t imagining it. Their employers really do keep them busy.

So we really have two generally unhappy groups: people who want to work more and raise their income, and people who want to work less but keep their income.

What’s the answer? We need to find one, and to do so we must talk about it. And that is possibly an even bigger problem.

Broken Politics

The national anxiety level got where it is for many different reasons. Some are largely outside our control, like the technological advances that have replaced some human jobs.

Hence political decisions need to be made.

The problem is that the ideological gap between the median Democrat and the median Republican has widened into a huge chasm in this century.

What as recently as 2004 was a mountain-shaped distribution with a small dip in between now looks more like a volcanic crater.

The simple fact is that the “center” is shrinking. It is hard to consider compromises when positions are so hardened that no compromise is allowable.

Whatever the reason for this (which is another debate), it prevents our political system from addressing important issues. This leaves an anxious population to feel either completely abandoned, or thinking it must align with one side or the other just to survive.


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.

Why Every Investor Should Be Politically Flexible

Things used to be so simple.

You buy a stock, the government cuts taxes, the stock goes up.

Actually, things still are that simple.

And yet vastly more complex. We cut taxes in 2017, but future tax increases—large ones—are likely.

The Federal Reserve is lowering interest rates because it is told to by the president.

There are tariffs, things we haven’t seen in a while. Deficits are rising with zero collective will to contain them.

And we’ve seen a sharp rise in authoritarian behavior from elected leaders of all stripes, globally, which is a source of consternation.

There have been many articles written about how you should not mix your politics with your investing. Many. Except… occasionally, you should.

From 2009 to 2011, it paid to be a far-right gold bug. The liberals were left in the dust.

Since 2011, it has paid to be a liberal growth stock indexer.

Maybe going forward, it will pay to be an MMT-er. Who knows.

My point here is that the stock market goes through political regimes, much like it goes through volatility regimes.

It took me years to understand this. My early investing years were spent thinking that center-right policies were good for the stock market. In general, that is true.

And it is always and everywhere true that cutting taxes, especially corporate taxes and investment taxes, results in higher stock prices.

Aside from that, things get a little hazy. Tariffs are supposed to be bad for stocks, but on a long-term basis, they haven’t been.

As for deficits, the record is a bit mixed. Stocks have gone up when debt is both rising and falling.

Now that the debt issue is becoming a bit hard to handle, you might think that stocks would begin to care. Clearly, they don’t.

Crazy Town

You can’t say anything for certain anymore.

There are some folks out there—like Leon Cooperman—who say the stock market might not even open if Elizabeth Warren is elected president.

I tend to agree. But maybe not!

Maybe Elizabeth Warren gets elected—and stocks go up!

Sometimes stock markets go up when bad things are happening. This was true in Weimar Germany, Zimbabwe, and Venezuela.

There isn’t a person alive who can say with 100% certainty what stocks are going to do. After all, the conventional wisdom was wrong about Trump. The only thing you can say with 100% certainty is that it is going to be a surprise.

I try not to make normative statements about the stock market anymore.

I try not to say what the stock market should do.

I try to predict what the stock market will do.

One of the things I have been writing about is that supply and demand ultimately drives stock prices, and right now stock supply is down because of all the buybacks.

I’m not saying the market can’t go down, I’m saying it’s hard for it to go down.

Basically, nothing would surprise me about 2020. Nothing at all.

Political Investing

One of the hardest things about investing is to be intellectually malleable. To think one thing one day, and then think another thing the next.

Even harder is to be politically malleable. To have one political belief one day, and the opposite belief the next. Impossible.

I do not know one person who got it right from 2009 to 2011 and also got it right from 2011 to today. People take sides, they put on a jersey, and they play for that team. Which means you get to be right every so often, but not all the time.

I can sort of switch sides, but not really.

If it isn’t obvious by now, I am a libertarian-slash-classical liberal. Which means I have missed out on the stock market rally from about 2015 onwards.

I have run into a few people in my career who have actually told me that they would rather lose money than buy a stock like Alphabet. Or whatever. That gets into a central thesis of mine—the vast majority of people would rather be right than make money.

Ideally, you get to do both. But that is pretty rare. I remember buying fluffy tech stocks in 2013. It felt terrible, but I did it because it was the right trade. The trade worked. I was never comfortable with it. It was an unnatural act.

If you want to be right, put it on your tombstone. In this life, we make money.

Market Internals Review 12-05-19

A review of important measures of market breadth and participation.

Advance-Decline Line

  • Currently, the cumulative advance-decline line confirms the bull market recent new highs.
  • With no sign of weakness at the moment, the indicator suggests the bullish trend will likely continue for now. (That doesn’t mean we won’t have short-term corrections.)
  • One note is the A-D line does not distinguish between a 20% decline and a full-blown mean reverting event.
  • Also, the MACD of the indicator is close to triggering a SELL SIGNAL. The 4-previous events have led to decent corrections, so this is worth paying attention to.
  • The A-D Line is also a very COINCIDENT indicator. It is pretty useless other than letting you know the overall participation in the market.
  • Reading: Bullish

Bullish Percent

  • The S&P Bullish Percent index shows the percentage of stocks on bullish “buy” signals.
  • Despite the markets reaching all-time highs, the number of stocks on bullish “buy” signals remains in a negative trend.
  • This negative divergence tends to suggest latter stages of bull market advances as money flows into fewer stocks.
  • The current buy signal of the indicator suggests market support, but these signals have been fleeting in the past.
  • Reading: Neutral / Cautious

Percent Of Stocks Above Moving Averages

  • The number of stocks in the S&P 500 which are currently trading above their respective 50, 150, and 200 day moving averages remains weak despite new highs.
  • Again, this is consistent with latter stage markets as money flows into few stocks as momentum overtakes the investing mentality.
  • The negative divergence is a warning, but is not always an immediate indicator. So this is worth watching but NOT making immediate portfolio changes.
  • Reading: Neutral / Cautious

McClellan Oscillator

  • You are probably noticing a lot of similarities in these indicators.
  • As markets are hitting all-time highs, there are negative divergences across a multitude of indicators.
  • As noted, these negative trends occur leading into bear markets, and can persist for a very long time before the bear market sets in.
  • However, the important takeaway is that the bull market is still largely intact but there is some deterioration around the edges. This suggests that investors should remain invested for now, but maintain risk controls accordingly.
  • All good things do eventually come to an end.
  • Reading: Neutral

NYSE New Highs – New Lows

  • Again, we see another negative divergence of the new high-low index not reaching new highs even as the overall market does.
  • If the high-low index can reverse and make new highs, then that will confirm the new highs of the market and be supportive of further gains.
  • Keep a watch on this index and look for confirmation before becoming overly aggressive on risk exposure.
  • Reading: Cautious

Overbought / Oversold Conditions

  • On a technical basis the market are correcting an extremely overbought condition. This suggests the current correction may have a bit more to go over the next week or so.
  • The other measures also confirm the same, and when all of them are aligned, they have a decent record of predicting the markets next move.
  • The one important note is the market is trading below its previous broken bullish trend which makes the most recent lows critical support for this advance.
  • Given the short-term overbought condition of the market, use pull backs in the market to add exposure accordingly.
  • Reading: Bullish

Dimon’s View Of Economic Reality Is Still Delusional

“This is the most prosperous economy the world has ever seen and it’s going to be a very prosperous economy for the next 100 years.” – Jamie Dimon

That’s what the head of JP Morgan Chase told viewers in a recent “60-Minutes” interview.

“The consumer, which is 70% of the U.S. economy, is quite strong. Confidence is very high. Their balance sheets are in great shape. And you see that the strength of the American consumer is driving the American economy and the global economy. And while business slowed down, my current view is that, no, it just was a slowdown, not a petering out.” – Jamie Dimon

If you’re in the top 1-2% of income earners, like Jamie, I am sure it feels that way.

For everyone else, not so much.

This isn’t the first time that I have discussed Dimon’s distorted views, and just as we discussed then, even just marginally scratching the surface on the economy and the “household balance sheet,” reveals an uglier truth.

The Most Prosperous Economy

Let’s start with the “most prosperous economy in the world” claim.

As we recently discussed in “Socialism Rises,” 

“How did a country which was once the shining beacon of ‘capitalism’ become a country on the brink of ‘socialism?’

Changes like these don’t happen in a vacuum. It is the result of years of a burgeoning divide between the wealthy and everyone else. It is also a function of a 40-year process of capitalism morphing an entire population into ‘debt slaves’ to sustain economic prosperity. 

It is a myth that the economy has grown by roughly 5% since 1980. In reality, economic growth rates have been on a steady decline over the past 40 years, which has been supported by a massive push into deficit spending by consumers.”

With the slowest average annual growth rate in history, it is hard to suggest the economy has been the best it has ever been.

However, if an economy is truly prosperous it should benefit the majority of economic participants, which brings us to claim about “household balance sheet” health.

For Billionaires, The Grass Is Always Green

If you are in the upper 20% of income earners, not to mention the top .01% like Mr. Dimon, I am quite sure the “economic grass is very green.”  If you are in the bottom 80%, the “view” is more akin to a “dirt lot.” Since 1980, as noted by a recent study from Chicago Booth Review, the wealth gap has progressively gotten worse.

“The data set reveals since 1980 a ‘sharp divergence in the growth experienced by the bottom 50 percent versus the rest of the economy,’ the researchers write. The average pretax income of the bottom 50 percent of US adults has stagnated since 1980, while the share of income of US adults in the bottom half of the distribution collapsed from 20 percent in 1980 to 12 percent in 2014. In a mirror-image move, the top 1 percent commanded 12 percent of income in 1980 but 20 percent in 2014. The top 1 percent of US adults now earns on average 81 times more than the bottom 50 percent of adults; in 1981, they earned 27 times what the lower half earned.

The issue is the other 80% are just struggling to get by as recently discussed in the Wall Street Journal:

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. Mortgage debt slid after the financial crisis a decade ago but is rebounding.”WSJ

The ability to simply “maintain a certain standard of living” has become problematic for many, which forces them further into debt.

“The debt surge is partly by design, a byproduct of low borrowing costs the Federal Reserve engineered after the financial crisis to get the economy moving. It has reshaped both borrowers and lenders. Consumers increasingly need it, companies increasingly can’t sell their goods without it, and the economy, which counts on consumer spending for more than two-thirds of GDP, would struggle without a plentiful supply of credit.” – WSJ

I show the “gap” between the “standard of living” and real disposable incomes 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 $2600 annual deficit that cannot be filled. (Note: this deficit accrues every year which is why consumer credit keeps hitting new records.)

But this is where it gets interesting.

Mr. Dimon claims the “household balance sheet” is in great shape. However, this suggestion, which has been repeated by much of the mainstream media, is based on the following chart.

The problem with the chart is that it is an illusion created by the skew in disposable incomes by the top 20% of income earners, needless to say, the top 5%. The Wall Street Journal exposed this issue in their recent analysis.

“Median household income in the U.S. was $61,372 at the end of 2017, according to the Census Bureau. When inflation is taken into account, that is just above the 1999 level. Without adjusting for inflation, over the three decades through 2017, incomes are up 135%.” – WSJ

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

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

‘On the surface things look pretty good, but if you dig a little deeper you see different subpopulations are not performing as well,’ said Cris deRitis, deputy chief economist at Moody’s Analytics.” – WSJ


With this understanding, we need to recalibrate the “debt to income” chart above to adjust for the bottom 80% of income earnings versus those in the top 20%. Clearly, the “household balance sheet” is not nearly as healthy as Mr. Dimon suggests.

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

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

With respect to those who say “the debt doesn’t matter,” I respectfully argue that you looking at a very skewed view of the world driven by those at the top.

Mr. Dimon’s Last Call

What Mr. Dimon tends to forget is that it was the U.S. taxpayer who bailed out the financial system, him included, following the financial crisis. Despite massive fraud in the major banks related to the mortgage crisis, only small penalties were paid for their criminal acts, and no one went to jail. The top 5-banks which were 40% of the banking system prior to the financial crisis, became 60% afterwards. Through it all, Mr. Dimon became substantially wealthier, while the American population suffered the consequences.

Yes, “this is the greatest economy ever” if you are at the top of heap.

With household debt, corporate debt, and government debt now at records, the next crisis will once again require taxpayers to bail it out. Since it was Mr. Dimon’s bank that lent the money to zombie companies, households again which can’t afford it, and took on excessive risks in financial assets, he will gladly accept the next bailout while taxpayers suffer the fallout. 

For the top 20% of the population that have money actually invested, or directly benefit from surging asset prices, like Mr. Dimon, life is great. However, for the vast majority of American’s, the job competition is high, wages growth is stagnant, and making “ends meet” is a daily challenge.

While Mr. Dimon’s view of America is certainly uplifting, it is delusional. But of course, give any person a billion dollars and they will likely become just as detached from economic realities.

Does America have “greatest hand ever dealt.”

The data certainly doesn’t suggest such. However, that can change.

We just have to stop hoping that we can magically cure a debt problem by adding more debt, and then shuffling it between Central Banks. 

But then again, such a statement is also delusional.

Selected Portfolio Position Review: 12-04-19

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.

This week we are reviewing positions which may require some additional attention soon, either trimming, adding, or removing, plus recent additions.

SDS – Proshares Ultra-Short S&P 500

  • In recent postings, we discussed all the various measures of “overbought and extended” conditions which currently exist in the market.
  • Finally, the markets cracked as the “trade deal” rhetoric fell apart.
  • As noted previously, we have taken profits and rebalanced risks in portfolios over the course of the last several months, we have a lot of equity exposure vulnerable to a short-term correction.
  • We previously added 5% of a 2x leveraged S&P 500 index which gives us an effective 10% equity hedge in portfolios against a short-term decline.
  • While we are currently down about 0.5% in the position, that is okay because our defensive and bond positioning have been offsetting the drag. As an example: yesterday the equity portfolio was off by .24% while the S&P 500 was down -.66%
  • Given the market has worked off a good bit of the previous short-term overbought condition we will be looking to exit the position over the next couple of days.
  • Stop is set at $26ish

BA – Boeing Co.

  • We bought BA following the 737MAX crash and have been patiently holding the position and collecting the dividend. The basing and consolidation has continued for months with brief spurts of activity,.
  • Currently, BA is about to trigger a short-term buy signal, but remains trapped within the long-term consolidation range.
  • Which ever way the stock eventually breaks out will be a big move. So we are maintaining our stop at the bottom of the range.
  • Stop set at $320

CHCT – Community Healthcare

  • CHCT has been one our better performers this year as interest rates have declined.
  • Currently, CHCT continues to try and work off some of the more extreme overbought conditions while continuing to hold its bullish trend.
  • We are moving our stop up to the 200-dma for now.
  • Stop loss is set at $40

ABBV – AbbVie, Inc.

  • We had been watching ABBV for a while before adding it to the portfolio. We love the healthcare space because of the aging demographic.
  • Since adding it to the portfolio, it has surged sharply and ran into resistance.
  • We need a pullback to add to our holdings and while ABBV is on a buy signal it is extremely overbought.
  • We are looking for a pullback to the 50-dma which has now crossed above the 200-dma.
  • Stop loss is set at $72.50

NSC – Norfolk Southern

  • We have previously taken profits in NSC but have been looking for an entry point to add back to the position. We may be getting close to that point.
  • NSC held important support at $170 and turned up with the onset of QE-4.
  • With a buy signal now triggered, we are watching to see if NSC can hold support at the 200-dma. If it does we will add to our position.
  • With the market overbought in total, if the market pulls back, so to will NSC. We would like to use a temporary respite to add to our holdings.
  • For now we are holding our current position and moving the stop up.
  • Stop has been moved up to $180

DOV – Dover Corp.

  • We bought DOV earlier this year and it turned into one of best performers. Despite trade rhetoric, the company continues to make gains.
  • DOV is EXTREMELY overbought so a correction is needed to consider adding to the position. We took profits previously.
  • With the buy signal extremely extended some consolidation or correction is highly likely.
  • Stop is currently set at $95

GDX – VanEck Vectors Gold Miners

  • GDX broke out strongly earlier this year and after a strong run we sold 1/2 of our position to take profits.
  • Currently, GDX is on a “sell signal” and is oversold. Importantly, it has continued to hold support at $26 and looks to be turning up.
  • It is too soon to add to our position, but if volatility begins to increase and “trade issues” return, Gold will likely start making gains again.
  • For now we will move our stop up on the position as a whole.
  • Stop loss has been adjusted to $25

MU – Micron Technology

  • MU had a nice rally following our initial purchase and got extremely overbought very quickly.
  • We are not consolidating that advance and potentially setting up support at the 200-dma which could provide an additional entry point to increase holdings.
  • MU is very subject to the “trade deal,” so we are keeping our stops tight on the position for now.
  • Stop loss set at $40

PG – Procter & Gamble

  • PG had gotten EXTREMELY overbought with the advance from the May lows in 2018.
  • However, that overbought condition has been reversed and even with a “sell signal” in place, PG has held its bullish trend.
  • We will look to add to our holdings if PG continues to hold up and triggers a “buy signal.”
  • We are moving our stop up on the whole position.
  • Stop-loss moved up to $110

WELL – WellTower, Inc.

  • WELL has pulled back to the 200-dma and is deeply oversold.
  • We are looking to add to our position but would like to see some stabilization and see the “sell signal” turn up first.
  • Be patient for now, but an entry point is approaching.
  • Stop loss remains at $80

Beware Of Those Selling “Technology”

“3. And they said to one another, ‘Come, let us make bricks, and burn them thoroughly.’ And they had brick for stone, and bitumen for mortar. 4. Then they said, ‘Come, let us build ourselves a city, and a tower with its top in the heavens, and let us make a name for ourselves; otherwise we shall be scattered abroad upon the face of the whole earth.’” Genesis 11:3-4 (NRSV)

Technology

Technology can be thought of as the development of new tools. New tools enhance productivity and profits, and productivity improvements afford a rising standard of living for the people of a nation. Put to proper uses, technological advancement is a good thing; indeed, it is a necessary thing. Like the invention of bricks and mortar as documented in the book of Genesis, the term technology has historically been applied to advancements in tangible instruments and machinery like those used in manufacturing. Additional examples include the printing press, the cotton gin, and the internal combustion engine. These were truly remarkable technological achievements that changed the world.

Although the identity of a technology company began to emerge in the late 1930s as IBM developed tabulation equipment capable of processing large amounts of data, the modern-day distinction did not take shape until 1956 when IBM developed the first example of artificial intelligence and machine learning. At that time, a computer was programmed to play checkers and learn from its experience. About one year later, IBM developed the FORTRAN computer programming language. Until the early 1980s, IBM was the dominant tech company in the world and largely stood as the singular representative of the burgeoning technology investment sector.

The springboard for the modern tech era came in 1980 when the U.S. Congress expanded the definition list of copyright law to include the term “computer program.” With that change, software developers and companies like IBM involved in programming computers (mostly mainframes at that time) had a legal means of preventing unauthorized copying of their software. This development led to the proliferation of software licensing.

As further described by Ben Thompson of stratechery.com –

This highlighted another critical factor that makes tech companies unique: the zero marginal cost nature of software. To be sure, this wasn’t a new concept: Silicon Valley received its name because silicon-based chips have similar characteristics; there are massive up-front costs to develop and build a working chip, but once built additional chips can be manufactured for basically nothing. It was this economic reality that gave rise to venture capital, which is about providing money ahead of a viable product for the chance at effectively infinite returns should the product and associated company be successful.

To summarize: venture capitalists fund tech companies, which are characterized by a zero marginal cost component that allows for uncapped returns on investment.

Everybody is a Tech Company

Today, every company employs some form of software to run their organization, but that does not make every company a tech company. As such, it is important to differentiate real tech companies from those that wish to pose as one. If a publicly traded company can convince the investing public that they are a legitimate tech company with scalability at zero marginal cost, it could be worth a large increase in their price-to-earnings multiple. Investors should be discerning in evaluating this claim. Getting caught with a pretender almost certainly means you will have bought high and will be forced to sell low.

Pretenders in Detail

Ride share company Uber (Tkr: UBER) went public in May 2019 at a market capitalization of over $75 billion. Their formal name is Uber Technologies, but in reality, they are a cab company with a useful app and a business producing negative income.

Arlo Technologies (Tkr: ARLO) develops high-tech home security cameras and uses a cloud-based platform to “provide software solutions.” ARLO IPO’ed at $16 per share in August 2018. After trading as high as $23 per share within a couple of weeks of the initial offering, they currently trade at less than $4. Although the Arlo app is available to anyone, use of it requires an investment in the Arlo security equipment. Unlike a pure tech company, that is not a zero marginal cost platform.

Peloton (Tkr: PTON) makes exercise bikes with an interactive computer screen affording the rider the ability to tap in to live sessions with professional exercise instructors and exercise groups from around the world. Like Arlo, the Peloton app is available to anyone, but the experience requires an investment of over $2,000 for the stationary bike. PTON went public in September 2019 at the IPO price of $29 per share. It currently trades at roughly $23.

Recent Universe

From 2010 to the end of the third quarter of 2019, there have been 1,192 initial public offerings or IPOs. Of those, 19% or 226 have been labeled technology companies. Over the past two years, many of the companies brought to the IPO market have, for reasons discussed above, desperately tried to label themselves as a tech company. Using analysis from Michael Cembalest, Chief Strategist for JP Morgan Asset Management, we considered 32 “tech” stocks that have gone public over the past two years under that guise. We decided to look at how they have performed.

In an effort to capture the reality that most investors are not able to get in on an IPO before they are priced, the assumption for return calculations is that a normal investor may buy on the day after the IPO. We acknowledge that the one-day change radically alters the total return data, but we stand by it as an accurate reflection of reality for most non-institutional investors.

As shown in the table below, 23 of the 32 IPOs we analyzed, or 72%, have produced a negative total return through October 31, 2019. Additionally, those stocks as a group underperformed the S&P 500 from the day after their IPO date through October 31, 2019 by an average of over 35%.

Data Courtesy Bloomberg

Summary

Over the past several years, we have seen an unprecedented move among companies to characterize themselves as technology companies. The reason is that the “tech” label carries with it a hefty premium in valuation on a presumption of a steeper growth trajectory and the zero marginal cost benefit. A standard consumer lending company may employ technology to convince investors they are actually a new-age lender on a sophisticated and proprietary technology platform. If done convincingly, this serves to garner a large price-to-earnings multiple boost thereby significantly (and artificially) increasing the value of the company.

A new automaker that can convince investors they are more of a technology company than other automobile companies’ trades at many multiples above that of the traditional yet profitable car companies. Still, the core of the business is making cars and trying to sell them to a populace that already has three in the driveway.

Using the technology label falsely is a deceptive scheme. Those who fall for the artificial marketing jargon are doomed to sacrifice hard-earned wealth as has been the case with Lyft and Fiverr among many others. For those who are not discerning, the lessons learned will ultimately be harsh as were those described in the story of the tower of Babel.

It is not in the long-term best interest of the economic system or its stewards to chase high-flying pseudo-technology stocks. Frequently they are old school companies using software like every other company. Enron and Theranos offer stark lessons. Those were total loss outcomes, yet the allure of jumping aboard a speculative circus is as irresistible as ever, especially with interest rates at near-record lows. The investing herd continues to follow the celebrity of popular “momentum” investing, thereby they ignore the analytical rigor aimed at discovering what is reasonable and what allows one to, as Warren Buffett says, “avoid big mistakes.”

Never Forget These 10 Investment Rules.

“Psychology is probably the most important factor in the markets, and one that is least understood.”

– David Dreman

A motive of the financial industry  is to blur the lines between investor and trader. I’m convinced it’s to make investors feel guilty for taking control of their portfolios. After all, Wall Street firms ares the experts with YOUR money.

How dare you question them?

Sell to take profits, sell to minimize losses, purchase an investment that fits into your risk parameters and asset allocations; it’s all enough to brand one as ‘trader’ in the buy & forget circles  that are paid to push the narrative that markets are on a permanent trek higher and bears are mere speed bumps. Wall Street has forgotten the financial crisis. You can’t afford such a luxury.

And, if you’re a reader of RIA, you’re astute enough to know better.

“You’re a trader now?”

Broker at a  big box financial shop.

A planning client called his financial partner to complete two trades. Mind you, the only trades he’s made this year. His request was to sell an investment that hit his loss rule and purchase a stock (after homework completed on riapro.net). His broker was dismayed and asked the question outlined above. 

Investors are advised – Be like Warren Buffett and his crew: You know, he’s buy and hold, he never sells! Oh, please. 

From The Motley Fool:

Here’s what Berkshire sold in the third quarter:

During the third quarter, Berkshire sold some or all of five stock positions in its portfolio:

  • 750,650 shares of Apple. 
  • 31,434,755 shares of Wells Fargo. 
  • 1,640,000 shares of Sirius XM. 
  • 370,078 shares of Phillips 66. 
  • 5,171,890 shares of Red Hat.

What Do Paul Tudor Jones, Ray Dalio, Ben Graham, and even Warren Buffett have in common?

  • A strict investment discipline.
  • Despite mainstream media to the contrary, all great investors have a process to “buy” and “sell” investments.

Investment rules keep “emotions” from ruling investment decisions:

Rule #1:

Cut Losers Short & Let Winners Run.

While this seems logical,  it is one of the toughest tenets to follow.

“I’ll wait until it comes back, then I’ll sell.”

“If you liked it at price X, you have to love it at Y.”

It takes tremendous humility to successfully navigate markets. There can be no such thing as hubris when investments go the way you want them; there’s absolutely no room in your brain or portfolio for denial when they don’t. Investors who are plagued with big egos cannot admit mistakes; or they believe they’re the greatest stock pickers who ever lived. To survive markets, one must avoid overconfidence.

 Many investors tend to sell their winners too soon and let losers hemorrhage. Selling is a dilemma. First, because as humans we despise losses twice as much as we relish gains. Second, years of financial dogma have taken a toll on consumer psyche where those who sell are made to feel guilty for doing so. 

It’s acceptable to limit losses. Just because you sell an investment that isn’t working doesn’t mean you can’t purchase it again. That’s the danger and beauty of markets. In other words, a stock sold today may be a jewel years from now.  I find that once an investor sells an investment, it’s rarely considered again.  Remember, it’s not an item sold on eBay. The beauty of market cycles is the multiple chances investors receive to examine prior holdings with fresh perspective.

Rule #2:

Investing Without Specific End Goals Is A Big Mistake.

I understand the Wall Street mantra is “never sell,” and as an individual investor  you’re a pariah if you do. However, investments are supposed to  be harvested to fund specific goals. Perhaps it’s a college goal, or retirement. To purchase a stock because a friend shares a tip on a ‘sure winner,’ (right), or on a belief that an investment is going to make you wealthy  in a short period of time, will only set you up for disappointment. 

Also,  before investing, you should already know the answer to the following two questions:

 At what price will I sell or take profits if I’m correct?

Where will I sell it if I am wrong?

 Hope and greed are not  investment processes.

Rule #3:

Emotional & Cognitive Biases Are Not Part Of The Process.

If your investment  (and financial) decisions start with:

–I feel that…

–I was told…

–I heard…

–My buddy says…

You are setting yourself up for a bad experience.

In his latest tome, Narrative Economics,  Yale Professor Robert J. Shiller makes a formidable case for how specific points of view which go viral have the power to affect or create economic conditions as well as generate tailwinds or headwinds to the values of risk assets like stocks and speculative ventures such as Bitcoin.  Simply put: We are suckers for narratives.  They possess the power to fuel fear, greed and our overall emotional state.  Unfortunately, stories or the seductive elements of them that spread throughout society can lead to disastrous conclusions. 

Rule #4:

Follow The Trend.

80% of portfolio performance is determined by the underlying trend

Astute investors peruse the 52-week high list for ideas. Novices tend to consider stocks that make 52-week highs the ones that need to be avoided or sold. Per a white paper by Justin Birru at The Ohio State University titled “Psychological Barriers, Expectational Errors and Underreaction to News,” he posits how investors are overly pessimistic for stocks near 52-week highs although stocks which hit 52-week highs tend to go higher.

Thomas J. George and Chuan-Yang Hwang penned “The 52-Week High and Momentum Investing,” for  The Journal of Finance. The authors discovered  purchasing stocks near 52-week highs coupled with a short position in stocks far from a 52-week high, generated abnormal future returns. Now, I don’t expect anyone to invest solely based on studies such as these. However, investors should understand how important an underlying trend is to the generation of returns.

Rule #5:

Don’t Turn A Profit Into A Loss.

I don’t want to pay taxes is the worst excuse ever to not fully liquidate or trim an investment.

If you don’t sell at a gain – you don’t make any money. Simpler said than done. Investors usually suffer from an ailment hardcore traders usually don’t – “Can’t-sell-taxes-due” itis

An investor which allows a gain to deteriorate to loss has now begun a long-term financial rinse cycle.  In other words, the emotional whipsaw that comes from watching a profit turn to loss and then hoping for profit again, isn’t for the weak of mind.  I’ve witnessed investors who suffer with this affliction for years, sometimes decades. 

Rule #6:

Odds Of Success Improve Greatly When Fundamental Analysis is Supported By Technical Analysis. 

Fundamentals can be ignored by the market for a long-time.  

After all,  the markets can remain irrational longer than you can remain solvent. 

The RIA Investment Team monitors investments for future portfolio inclusion. The ones that meet our fundamental criteria – cash flows, growth of organic earnings (excluding buybacks), and other metrics, are sometimes not ready to be free of “incubation,” which I call it; where from a technical perspective, these  prospective holdings are not in a favorable trend for purchase. 

It’s a challenge for investors to wait. It’s a discipline that comes with experience and a commitment to be patient or allocate capital over time. 

Rule #7:

Try To Avoid Adding To Losing Positions.

Paul Tudor Jones once said “only losers add to losers.”

The dilemma with ‘averaging down’ is that it reduces the return on invested capital trying to recover a loss than redeploying capital to more profitable investments.

Cutting losers short, like pruning a tree, allows for greater growth and production over time. 

Years ago, close to 30, when I was starting out at a brokerage firm, we were instructed to use ‘averaging down’ as a sales tactic. First it was an emotional salve for investors who felt regret over a loss. It inspired false confidence backed up by additional dollars as it manipulated or lowered the cost basis; adding to a loser made the financial injury appear healthier than it actually was. Second, it was an easy way for novice investors to generate more commissions for the broker and feel better at the same time.

My rule was to have clients average in to investments that were going up, reaching new highs. Needless to say, I wasn’t very popular with the bosses. It’s a trait, good or bad, I carry today. Not being popular with the cool admin kids by doing what’s right for clients has always been my path.

Rule #8:

In Bull Markets You Should be “Long.” In Bear Markets – “Neutral” or “Short.”

Whew. A lot there to ponder.

To invest against the major “trend” of the market is generally a fruitless and frustrating effort. 

I know ‘going the grain’ sounds like a great contrarian move. However, retail investors do not have unlimited capital to invest in counter-trends. For example, there are institutional short investors who will  continue to commit jaw-dropping capital to fund their beliefs and not blink an eye. We unfortunately, cannot afford such a luxury.

So, during secular bull markets – remain invested in risk assets like stocks, or initiate an ongoing process of trimming winners.

During strong-trending bears – investors can look to reduce risk asset holdings overall back to their target asset allocations and build cash. An attempt to buy dips believing you’ve discovered the bottom or “stocks can’t go any lower,” is overconfidence bias and potentially dangerous to long-term financial goals.

I’ve learned that when it comes to markets, fighting the overall tide is a fruitless endeavor. It smacks of overconfidence. And overconfidence and finances are a lethal mix.

We can agree on extended valuations; or how future returns on risk assets may be lower because of them. However, valuation metrics alone are not catalysts for turning points in markets. With global central banks including the Federal Reserve  hesitant to increase rates and clear about their intentions not to do so anytime in the near future, expect further ‘head scratching’ and  astonishment by how long the current bullish trend may continue. 

Rule #9:

Invest First with Risk in Mind, Not Returns.

Investors who focus on risk first are less likely to fall prey to greed. We tend to focus on the potential return of an investment and treat the risk taken to achieve it as an afterthought.

Years ago, an investor friend was excited to share with me how he made over 100% return on his portfolio and asked me to examine his investments. I indeed validated his assessment. When I went on to explain how he should be disappointed, my friend was clearly puzzled.

I went on to explain how based on the risk, his returns should have been closer to 200%! In other words,  my friend was so taken with the achievement of big returns that he went on to take dangerous speculation with his money and frankly, just got lucky. It was a good lesson about the danger of hubris. He now has an established rule which specifies how much speculation he’s willing to accept within the context of his overall portfolio. 

The objective of  responsible portfolio management is to grow money over the long-term to reach specific financial milestones and to consider the risk taken to achieve those goals. Managing to prevent major draw downs in portfolios means giving up SOME upside to prevent capture of MOST of the downside. As many readers of RIA know  from their own experiences, while portfolios may return to even after a catastrophic loss, the precious TIME lost while “getting back to even” can never be regained.

To understand how much risk to consider to achieve returns, it’s best to begin your investor journey with a holistic financial plan.  A plan should help formulate a specific risk-adjusted rate of return or hurdle rate required to reach the needs, wants and wishes that are important to you. and your family. 

Rule #10:

The Goal Of Portfolio Management Is A 70% Success Rate.

Think about it – Major League batters go to the “Hall Of Fame” with a 40% success rate at the plate.

Portfolio management is not about ALWAYS being right. It is about consistently getting “on base” that wins the long game. There isn’t a strategy, discipline or style that will work 100% of the time. 

As an example, the value style of investing has been out of favor for a decade. Value investors have found themselves frustrated. That doesn’t mean they should  have decided to alter their philosophy, methods of analysis or throw in the towel about what they believe. It does showcase however, that even the most thorough of research isn’t always going to be successful.

Those investors who strayed from the momentum stocks such as Facebook, Amazon, Netflix and Google have  paid the price. Although there’s been a resurgence in value investing since October, it’s too early to determine whether the trend is sustainable. Early signs are encouraging. 

Chart: BofA Merrill Lynch US Equity & Quant Strategy, FactSet.

A trusted financial professional doesn’t push a “one-size-fits-all,” product, but offers a process and philosophy. An ongoing method to manage risk, monitor trends and discover opportunities.

Even then, even with the best of intentions, a financial expert isn’t going to get it right every time as I outlined previously. The key is the consistency  to meet or exceed your personalized rate of return.

And that return is only discovered through holistic financial planning.

Fundamentally Speaking: Earning Season’s Good, Bad & Ugly

With the third quarter of 2019 reporting season mostly behind us, we can take a look at what happened with earnings to see what’s real, what’s not, and what it will mean for the markets going forward.

The Good

As always is the case, the majority of companies beat their quarterly estimates, as noted by Bespoke Investment Group.

With 73% of companies beating estimates, it certainly suggests that companies in the S&P 500 are firing on all cylinders, which should support higher asset prices.

However, as they say, the “Devil is in the details.” 

The Bad

As I noted previously:

One of the reasons given for the push to new highs was the ‘better than expected’ earnings reports coming in. As noted by FactSet: 

73% have reported actual EPS above the mean EPS estimate…The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (76%) average and above the 5-year (72%) average.”

The problem is the ‘beat rate’ was simply due to the consistent ‘lowering of the bar’ as shown in the chart below:

Beginning in mid-October last year, estimates for both 2019 and 2020 crashed. 

This is why I call it ‘Millennial Soccer.’ 

Earnings season is now a ‘game’ where scores aren’t kept, the media cheers, and everyone gets a ‘participation trophy’ just for showing up.

Let’s take a look at what really happened with earnings.

During Q3-2019, quarterly operating earnings declined from $40.14 to $40.05 or -0.25%. While operating earnings are completely useless for analysis, as they exclude all the “bad stuff” and mostly fudge the rest, reported earnings declined by from $34.93 to $34.33 or -1.75%.

While those seem like very small declines in actual numbers, context becomes very important. In Q3-2018, quarterly operating earnings were $41.38 and reported earnings were $36.36. In other words, over the last year operating earnings have declined by -3.21% and reported earnings fell by -5.58%. At the same time the S&P 500 index has advanced by 7.08%.

It’s actually worse.

Despite the rise in the S&P 500 index, both Operating and Reported earnings have fallen despite the effect of substantially lower tax rates and massive corporate share repurchases, which reduce the denominator of the EPS calculation.

Steve Goldstein recently penned for MarketWatch

“Research published by the French bank Societe Generale shows that S&P 500 companies have bought back the equivalent of 22% of the index’s market capitalization since 2010, with more than 80% of the companies having a program in place.

The low cost of debt is one reason for the surge, with interest rates not that far above zero, and President Trump’s package of tax cuts in 2017 further triggered a big repatriation of cash held abroad. Since the passage of the Tax Cuts and Jobs Act, non-financial U.S. companies have reduced their foreign earnings held abroad by $601 billion.

This repatriation may have run its course, and stock buybacks should decline from here, but they will still be substantial.

This is no small thing.

As noted in “4-Risks To The Bullish View,”  previously, share repurchases have made up roughly 100% of the net purchases of stocks over the last year.

We have discussed the issue of “share buybacks” numerous times and the distortion caused by the use of corporate cash to lower shares outstanding to increase earnings per share.

“The reason companies spend billions on buybacks is to increase bottom-line earnings per share, which provides the ‘illusion’ of increasing profitability to support higher share prices. Since revenue growth has remained extremely weak since the financial crisis, companies have become dependent on inflating earnings on a ‘per share’ basis by reducing the denominator. As the chart below shows, while earnings per share have risen by over 360% since the beginning of 2009; revenue growth has barely eclipsed 50%.”

Chart updated through Q3-2019

The problem with this, of course, is that stock buybacks create an illusion of profitability. However, for investors, the real issue is that almost 100% of the net purchases of equities has come from corporations.

The issue is two-fold:

  1. That corporate spending binge is slowing down, as noted by Mr. Goldstein; and,
  2. If a recession sets in, share repurchases could easily cease altogether. 

If you don’t think that’s important, the charts above and below should at least make you reconsider.

Of course, such should not be a surprise.

Since the recessionary lows, much of the rise in “profitability” have come from a variety of cost-cutting measures and accounting gimmicks rather than actual increases in top-line revenue. While tax cuts certainly provided the capital for a surge in buybacks, revenue growth, which is directly connected to a consumption-based economy, has remained muted.

Since 2009, the operating earnings per share of corporations has risen 296%. However, the increase in earnings did not come from a commensurate increase in actual revenue which has only grown by a marginal 62% during the same period. At the same time, investors have bid up the market more than 300% from the financial crisis lows of 666.

Needless to say, investors are once again extremely optimistic they haven’t overpaid for assets once again.

Always Optimistic

But optimism is certainly one commodity that Wall Street always has in abundance. When it comes to earnings expectations, estimates are always higher regardless of the trends of economic data. As shown, Wall Street is optimistic the current earnings decline is just a blip on the way to higher-highs.

As of April 2019, when Wall Street first published their estimates for 2020, the expectations were that earnings would grow to $174.29 by the end of next year.

The difference between Wall Street’s expectations and reality tends to be quite dramatic.

You can see the over-optimism collided with reality in just a few short months. Since April, forward expectations have fallen by more than $11/share as economic realities continue to impale overly optimistic projections.

Unfortunately, estimates are still too high and have further to fall. It is very likely, particularly if “tariffs” remain in place into 2020, that the majority of expected earnings growth will be reversed.

(This shouldn’t surprise you. We previously warned that by the end of 2018, the entirely of the “Trump Tax Cut” benefit would be erased.)

The Ugly

This divergence in stock prices not only shows up in operating earnings but also in reported corporate profits. As noted previously, the deviation between prices and profits is at historically high levels which cannot be sustained indefinitely.

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

While the market has rallied sharply in 2019 on continued “hopes” for a “trade deal,” and more accommodative actions from the Federal Reserve, the deviations from fundamentals have reached extremes only seen at peaks of previous market cycles.

The chart below shows the real, inflation-adjusted, profits after-tax versus the cumulative change to the S&P 500. Here is the important point – when markets grow faster than profitability, which it can do for a while; eventually a reversion occurs. This is simply the case that all excesses must eventually be cleared before the next growth cycle can occur. Currently, we are once again trading a fairly substantial premium to corporate profit growth.

Since corporate profit growth is a function of economic growth longer term, we can also see how “expensive” the market is relative to corporate profit growth as a percentage of economic growth. Once again, we find that when the price to profits ratio is trading ABOVE the long-term linear trend, markets have struggled, and ultimately experienced a more severe mean-reverting event. With the price to profits ratio once again elevated above the long-term trend, there is little to suggest that markets haven’t already priced in a good bit of future economic and profits growth.

While none of this suggests the market will “crash” tomorrow, it is supportive of the idea that future returns will be substantially weaker in the future.

Currently, there are few, if any, Wall Street analysts expecting a recession currently, and many are certain of a forthcoming economic growth cycle. Yet, at this time, there are few catalysts supportive of such a resurgence.

  • Economic growth outside of China remains weak
  • Employment growth is going to slow.
  • There is no massive disaster currently to spur a surge in government spending and reconstruction.
  • There isn’t another stimulus package like tax cuts to fuel a boost in corporate earnings
  • With the deficit already pushing $1 Trillion, there will only be an incremental boost from additional deficit spending this year. 
  • Unfortunately, it is also just a function of time until a recession occurs.

Wall Street is notorious for missing the major turning of the markets and leaving investors scrambling for the exits.

While no one on Wall Street told you to be wary of the markets in 2018, we did, but it largely fell on deaf ears as “F.O.M.O.” clouded basic investment logic.

The next time won’t be any different.

Sector Buy/Sell Review: 12-03-19

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.

NOTE – We have been talking about the market needing a correction for the last couple of weeks. As we approach mutual fund distributions, this week and next, and with the “trade war” likely to reignite, risk is to the downside currently. Most of the analysis reflects both of these points.

Basic Materials

  • XLB has started to reverse the overbought condition, and is set to test support at the recent breakout level. It needs to hold.
  • With the trade war likely to reignite in response to Trump signing the Pro-HongKong support bill and implementing tariffs on Brazil and Agentina, there is risk to the downside currently.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with a tighter stop-loss.
    • Stop-loss adjusted to $57
  • Long-Term Positioning: Bearish

Communications

  • XLC finally broke out to new highs and joined its brethren technology sector as $AMZN finally mustered a rally.
  • With the reversal of the “sell signal” it should lift the sector higher, but in the short-term XLC is extremely overbought.
  • 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 failed at downtrend resistance which is disappointing. As noted in the market report yesterday, oil prices also broke support to the downside.
  • With relative performance weakening again, we will remain out of the position for now.
  • 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.
  • Short-Term Positioning: Bearish
    • Last week: No Position – looking to add
    • This week: No Position – looking to add
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF finally broke out to new highs which makes it much more interesting to add to the portfolio. The recent bounce off of the uptrend line is also bullish.
  • However, the sector is extremely overbought, and the buy signal is extremely extended as well. A pull back or consolidation is required to add holdings into the portfolio.
  • We will see if a break above resistance can hold before adding exposure back into portfolios for a “trading basis” only. We need a decent correction to work off the extreme overbought.
  • Short-Term Positioning: Neutral
    • Last week: Hold Positions
    • This week: Hold Positions
    • Stop-loss adjusted to $28
  • Long-Term Positioning: Bearish

Industrials

  • Like XLB, XLI broke out to new highs, but the trade war now threatens the sector.
  • A correction is needed to correct the extreme overbought condition, but support needs to hold at the breakout level.
  • We are looking for a bit of consolidation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • 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 $78
  • Long-Term Positioning: Neutral

Technology

  • XLK is extremely overbought on both a price and momentum basis.
  • We are currently target weight on Technology, but may increase exposure on a pullback to support within the overall uptrend. (A retest of the breakout that holds) The upper rising trendline is also providing resistance so look to add on a pullback that holds the lower trendline support.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $77.50
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform better as money is just chasing markets now.
  • XLP continues to hold its very strong uptrend as has now broken out to new highs. However, XLP is back to more extreme overbought.
  • If the short-term “sell signal” is reversed, it could provide additional lift to the sector.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • 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 but broke to the downside. The subsequent rally failed to move back above previous support so the risk is to the downside currently. The rally in XLRE failed on Monday.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected which has now been completed.
  • XLRE Registered a deep “sell signal” and is oversold. A trading opportunity is approaching but be cautious currently.
  • You can add to positions if you are underweight but maintain a stop at recent lows for new purchases.
  • 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 with XLU rallying to test previous support. Unfortunately, the test of support failed which now turns it into future resistance.
  • After taking profits, we have time to be patient and wait for the right setup. We may be getting an opportunity here soon if support can hold as the overbought condition is reversed.
  • Long-term trend line remains intact but XLU and the sell signal is now triggered. A reversal of the sell signal will provide more lift.
  • Hold off adding new positions currently.
  • 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 remained intact and broke out to new highs and has accelerated that advance.
  • However, the rapid acceleration of the sector has taken XLV to extreme overbought conditions which will give way sooner than later. Take profits and rebalance holdings.
  • We noted previously, healthcare would begin to perform better soon as money looked for “value” in the market. That has been the case as of late, but has gone too far, too quickly.
  • We are looking for entry points to add to current holdings, but it is too overbought currently.
  • We are moving our stop up for now, but look for a reduction of the overbought condition to add weight to the sector.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $90
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY has not participated as much as other sectors like Financials, Industrials and Materials, and has failed to break above resistance.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is struggling to reverse back to a buy signal, and overhead resistance is going to problematic short-term.
  • Hold current positions for now, as the Christmas Shopping Season is approaching, which should help push the sector higher. However, the dismal performance relative to other sectors of the markets suggests not adding new/additional exposure currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has broken out of consolidation but quickly ran into resistance.
  • XTN is now testing breakout support and needs to hold. But the trade war may well put a damper on the sector. A break below $63 won’t be a good sign.
  • With a “buy” signal in place, combined with the fact XTN is not overbought, a better setup is forming to add holdings. Take profits if long, and wait for a pullback to add to holdings.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Cartography Corner – December 2019

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

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

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

GTA Users Guide


A Review of November

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESZ9) during November 2019. In our November 2019 edition of The Cartography Corner, we wrote the following:

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

  • M4                 3221.00
  • M3                 3093.00
  • M1                 3084.25
  • PMH              3055.00
  • Close             3035.75     
  • MTrend         2950.42
  • PML               2855.00     
  • M2                 2821.00    
  • M5                2684.25

Active traders can use 3055.00 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 2950.42 as the downside pivot, whereby they maintain a flat or short position below that level.

Figure 1 below displays the daily price action for November 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first trading session of November saw the market price settle above our isolated upside pivot level at PMH: 3055.00.  The market price never looked back. 

Over the following eight trading sessions, the market price ascended, and settled, above our next isolated resistance levels at M1: 3084.25 and M3: 3093.00.  It is worth noting the long lower shadows on the six candlesticks of November 8th through November 14th (highlighted in the chart).  These lower shadows demonstrate the battle between longs and shorts, through increased intra-session volatility, as these isolated resistance levels were reached.  Once the market price settled above these levels, despite the volatility, it never rotated back below them on a settlement basisThese candlesticks provide a good example of why we choose to emphasize settlements in our decision-making framework.

The remainder of November was spent with the market price continuing its ascent towards our isolated Monthly Upside Exhaustion level at M4: 3221.00, stopping short by 2.05%.

Active traders following our analysis had the opportunity to capture a 2.63% profit.   

Figure 1:

New Zealand Dollar Futures

We continue with a review of New Zealand Dollar Futures (“Kiwi”, 6NZ9) during November 2019.  In our November 2019 edition of The Cartography Corner, we wrote the following:

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

  • M4         0.6627
  • M3         0.6558
  • PMH       0.6444
  • M1         0.6426
  • Close       0.6416
  • MTrend   0.6361
  • PML        0.6215             
  • M2         0.6169                         
  • M5           0.5968

Active traders can use 0.6361 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for November 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first eight trading sessions were primarily spent with the market price descending to, and settling below, our isolated pivot level at MTrend: 0.6361.  The low settlement price for the month of November was realized on November 8th at 0.6330, 0.48% below the Monthly Trend.  Three trading sessions later, on November 13th, Kiwi traded a big-figure higher, testing our isolated resistance level at M1: 0.6426.  In the November 14th session, Kiwi reversed course again, testing Monthly Trend at MTrend: 0.6361.  Volatility anyone?

The remainder of November was spent with Kiwi ascending back to, and essentially straddling, our isolated resistance level at M1: 0.6426.  After much volatility, Kiwi settled the month of November at 0.6423, basically unchanged from October.  We retain a positive intermediate outlook, for a sustained Trend Reversal, since November’s settlement price remained above Monthly Trend.

Active traders following our work most likely were victims of the intra-month volatility, in the worst-case capturing an approximate 2.00% loss.

Figure 2:

December 2019 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESZ9).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Daily Trend             3145.06       
  • Current Settle         3143.75
  • Weekly Trend         3118.03       
  • Monthly Trend        3018.97       
  • Quarterly Trend      2840.92

In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures have been “Trend Up” for three quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures have been “Trend Up” for six months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures have been “Trend Up” for eight weeks.  The relative positioning of the Trend Levels is bullishly aligned.  The market price is above all of them (with exception of Daily Trend) which is bullish as well.

Support/Resistance:

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

  • M4                 3455.00
  • M1                 3255.00
  • M3                 3251.75
  • M2                 3211.00
  • PMH              3155.00     
  • Close              3143.75
  • PML               3033.00     
  • MTrend         3018.97     
  • M5                3011.00

Active traders can use 3155.00 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

U.S. Ten-Year Note Futures

For the month of December, we focus on U.S. Ten-Year Note Futures (“Tens”).  We provide a monthly time-period analysis of TYH0.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Monthly Trend      130-02           
  • Daily Trend           129-17
  • Current Settle       129-12           
  • Weekly Trend       129-10           
  • Quarterly Trend    126-16

As can be seen in the quarterly chart below, Tens have been “Trend Up” for four quarters.  Stepping down one time-period, the monthly chart shows that Tens are in “Consolidation”, after having been “Trend Up” for twelve months.  Stepping down to the weekly time-period, the chart shows that Tens are in “Consolidation”, after having been “Trend Down” for six weeks.  The Trend Levels are beginning to rotate above the market price.

In the monthly time-period, the “signal” was given in August 2019 to anticipate a two-month low within the following four to six months.  That two-month low was realized in November 2019 with the trade below 128-16.

As we stated in our November edition, “Our first priority in performing technical analysis is to identify the beginning of a new trend, the reversal of an existing trend, or a consolidation area.”  The twelve-month uptrend that began in November 2018 has ended.  Only time will tell if this weakness is consolidation or if a new downtrend develops.  

 

Support/Resistance:

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

  • M4         131-30
  • PMH       130-16
  • MTrend  130-02
  • Close      129-12
  • M1           128-30
  • M3           128-14
  • PML        128-00             
  • M2         126-30                         
  • M5           123-30

Active traders can use 130-16 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Summary

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

Major Market Buy/Sell Review: 12-02-19

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.

S&P 500 Index

  • With a “buy signal” triggered, there is a positive bias, however with both the price and “buy signal” very extended we expect a short-term correction for a better entry point to add exposure.
  • As noted previously, we did add a “short S&P 500” index hedge to both the Equity and ETF portfolios. We are okay with the little bit of performance drag it provides relative to the risk reduction we get in the portfolio.
  • Given the deviation from the mean, and the more extreme overbought condition, it is advisable to wait for some consolidation/correction before increasing equity allocations.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position with a bias to add to holdings.
    • Stop-loss moved up to $290
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • DIA broke out to new highs with the reversal of the “buy” signal to the positive. However, that buy signal is pushing some of the higher levels seen historically so a correction is likely.
  • Hold current positions, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $265.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Like SPY and DIA, the technology heavy Nasdaq has broken out to new highs but is pushing very extended levels.
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a consolidation or correction to add exposure.
  • However, as with SPY, QQQ is EXTREMELY overbought short-term, so remain cautious adding exposure. A slight correction that alleviates some of the extension will provide a much better entry point.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $185
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • As noted previously, small-caps broke out above previous resistance but have been struggling.
  • Last week, small-caps successfully tested the breakout level, there is now a bias to add exposure.
  • However, as suggested, be patient as these historical deviations tend not to last long. SLY is extremely overbought and deviated from its longer-term signals.
  • We will wait to see where the next oversold trading opportunity sets up.
  • 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 is holding up better than SLY and has not broken back down into its previous consolidation range.
  • MDY has now registered a short-term “buy” signal, but needs a slight correction/consolidation to reduce the extreme overbought and extended condition. The buy signal is very extended as well.
  • Look to add exposure to the market on a pullback that doesn’t violate support.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform and failed to hold its breakout.
  • With the “buy signal” extremely extended, the set up to add exposure here is not warranted. Watch the US Dollar for clues to EEM’s direction.
  • As we noted last week, PAY ATTENTION to the Dollar (Last chart). If the dollar is beginning a new leg higher, EEM and EFA will fail.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like MDY, EFA rallied out of its consolidation channel and is holding that level but is struggling with previous resistance.
  • Like EEM, it and the market are both EXTREMELY overbought.
  • Be patient for now and wait for a confirmed breakout before adding exposure, and again, watch the U.S. Dollar for important clues.
  • 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)

  • While commodities tend to perform well under liquidity programs due to their inherent leverage. Oil has continued to languish under the problems of over-supply and weak sector dynamics.
  • There is a short-term buy signal for oil, but the price failed at the downtrend and has now broken back down below the 200-dma.
  • We are starting to dig around the sector for some trading opportunities, but setups look terrible. We will keep you appraised in our weekly position report.
  • 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 got back to oversold and broke support at the 200-dma previously.
  • We are sitting on our stop-loss for the position currently, and had previously sold half our position.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. So, if we get stopped out of our holdings, we will look to buy them back at lower levels.
  • Short-Term Positioning: Neutral
    • Last week: Hold remaining position.
    • This week: Hold remaining position.
    • Stop-loss for whole position adjusted to $132.50
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices also broke support and triggered a sell-signal.
  • However, this past week, as “trade deal turbulence” returned, bonds rallied back to the top of its current downtrend channel.
  • Watch your exposure and either take profits or shorten your duration in your portfolio for now.
  • As noted last week, with the oversold condition in place, the bounce we were looking for arrived. Given bonds are still oversold, an equity correction will like move bond prices higher short-term. Use any bounce to rebalance holdings.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Despite much of the rhetoric 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.
  • Furthermore, the dollar bounced off support of the 200-dma and the bottom of the uptrend. If the dollar rallies back to the top of its trend, which is likely, this will take the wind out of the emerging market, international, and oil plays.
  • The “sell” signal is also turning up. If it triggers a “buy” the dollar will likely accelerate pretty quickly.

The Most Important & Overlooked Economic Number

Every month, and quarter, economists, analysts, the media, and investors pour over a variety of mainstream economic indicators from GDP, to employment, to inflation to determine what the markets are likely to do next.

While economic numbers like GDP, or the monthly non-farm payroll report, typically garner the headlines, the most useful statistic, in my opinion, is the Chicago Fed National Activity Index (CFNAI). It often goes ignored by investors and the press, but the CFNAI is a composite index made up of 85 sub-components, which gives a broad overview of overall economic activity in the U.S.

The markets have run up sharply over the last couple of months due to the Federal Reserve once again intervening into the markets. However, the hopes are that U.S. economic growth is going to accelerate going into 2020, which should translate into a resurgence of corporate earnings. However,  if recent CFNAI readings are any indication, investors may want to alter their growth assumptions heading into next year.

While most economic data points are backward-looking statistics, like GDP, the CFNAI is a forward-looking metric that gives some indication of how the economy is likely to look in the coming months.

Importantly, understanding the message that the index is designed to deliver is critical. From the Chicago Fed website:

“The Chicago Fed National Activity Index (CFNAI) is a monthly index designed to gauge overall economic activity and related inflationary pressure. A zero value for the index indicates that the national economy is expanding at its historical trend rate of growth; negative values indicate below-average growth; and positive values indicate above-average growth.

The overall index is broken down into four major sub-categories which cover:

  • Production & Income
  • Employment, Unemployment & Hours
  • Personal Consumption & Housing
  • Sales, Orders & Inventories

To get a better grasp of these four major sub-components, and their predictive capability, I have constructed a 4-panel chart showing each of the four CFNAI sub-components compared to the four most common economic reports of Industrial Production, Employment, Housing Starts and Personal Consumption Expenditures. To provide a more comparative base to the construction of the CFNAI, I have used an annual percentage change for these four components.

The correlation between the CFNAI sub-components and the underlying major economic reports do show some very high correlations. This is why, even though this indicator gets very little attention, it is very representative of the broader economy. Currently, the CFNAI is not confirming the mainstream view of an “economic soft patch” that will give way to a stronger recovery by next year.

The CFNAI is also a component of our RIA Economic Output Composite Index (EOCI). The EOCI is even a broader composition of data points including Federal Reserve regional activity indices, the Chicago PMI, ISM, National Federation of Independent Business Surveys, and the Leading Economic Index. Currently, the EOCI further confirms that “hopes” of an immediate rebound in economic activity is unlikely. To wit:

“The problem is there is not a ‘major shift’ coming for the economy, at least not yet, as shown by the readings from our Economic Output Composite Index (EOCI).”

“There are a couple of important points to note in this very long-term chart.

  1. Economic contractions tend to reverse fairly frequently from high peaks and those contractions tend to revert towards the 30-reading on the chart. Recessions are always present with sustained readings below the 30-level.
  2. The financial markets generally correct in price as weaker economic data weighs on market outlooks. 

Currently, the EOCI index suggests there is more contraction to come in the coming months, which will likely weigh on asset prices as earnings estimates and outlooks are ratcheted down heading into 2020.”

It’s In The Diffusion

The Chicago Fed also provides a breakdown of the change in the underlying 85-components in a “diffusion” index. As opposed to just the index itself, the “diffusion” of the components give us a better understanding of the broader changes inside the index itself.

There two important points of consideration:

  1. When the diffusion index dips below zero have coincided with weak economic growth and outright recessions. 
  2. The S&P 500 has a history of corrections, and outright bear markets, which correspond with negative reading in the diffusion index.

The second point should not be surprising since the stock market is ultimately a reflection of economic growth. The chart below simply compares the annual rate of change in the S&P 500 and the CFNAI index. Again, the correlation should not be surprising.

Investors should also be concerned about the high level of consumer confidence readings. There have been numerous headlines touting the “strength of consumer” as support for the ongoing “bull market.”

Overly Confident In Confidence

As we discussed just recently. 

“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.”

The issue is the divergence between “consumer” confidence and that of “CEO’s.” 

“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?”

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.” 

The CFNAI also tells the same story with large divergences in consumer confidence eventually “catching down” to the underlying index.

This chart suggests that we will begin seeing weaker employment numbers and rising layoffs in the months ahead, if history is any guide to the future.

This last statement is key to our ongoing premise of weaker than anticipated economic growth despite the Federal Reserve’s ongoing liquidity operations. The current trend of the various economic data points on a broad scale are not showing indications of stronger economic growth but rather a continuation of a sub-par “muddle through” scenario of the last decade.

While this is not the end of the world, economically speaking, such weak levels of economic growth do not support stronger employment, higher wages, or justify the markets rapidly rising valuations. The weaker level of economic growth will continue to weigh on corporate earnings, which like the economic data, appears to have reached their peak for this current cycle.

The CFNAI, if it is indeed predicting weaker economic growth over the next couple of quarters, also doesn’t support the recent rotation out of defensive positions into cyclical stocks that are more closely tied to the economic cycle. The current rotation is based on the premise that economic recovery is here, however, the data hasn’t confirmed it as of yet.

Either the economic data is about to take a sharp turn higher, or the market is set up for a rather large disappointment when the expected earnings growth in the coming quarters doesn’t appear. From all of the research we have done lately, the latter point seems most likely as a driver for the former seems lacking.

Maybe the real question is why we aren’t paying closer attention to what this indicator has to tell us?

S&P 500 Monthly Valuation & Analysis Review – 12-1-19

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


Michael Markowski: Market Ripens For Correction…Or Crash

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


Based on my analysis of the S&P 500 technical chart patterns after new all-time highs were set in 1999, 2000, 2007, 2018 and 2019, the index is ripening for a significant correction or a crash.  The volatility increasing for a market that is making new all-time highs near the end of a secular bull market and economic expansion is quite logical.  

Each of the four new all-time highs in the chart below were followed by corrections of 5.9% to 17.5% which began within 8 to 38 days after the new high was established.  As of the 29th of November, 23 days have passed since the most recent new all-time high was made on October 28, 2019. 

The table below depicts the days to a correction after a new all-time high was established and the percentage decline from the peak after the new high was made to the trough of the correction.  For a new all-time high to qualify as a correction to begin or start the S&P 500 had to decline by at least 2% from where the index closed on the date of the new all-time high.

During the adolescent stages of a secular bull market post all-time new high volatility is low as the market steadily climbs to newer all-time highs.  The chart below for 2017 is a perfect example since there were dozens of new all-time highs. Yet for 2017, unlike 2018 and 2019, the S&P 500 did not experience any 2% post new all-time high corrections.

A two-year period which had similar post-new all-time high volatility as 2018 and 2019 was the 24 months August 2006 through July 2008 period.

The chart below depicts that from August of 2006 to January of 2007, the S&P 500 advanced steadily to new all-time highs without a major correction.  The volatility increased after the S&P 500 made a new all-time high in January 2007. After recovering from a 5.9% correction the index established a newer all-time high in July 2007, which was followed by a 9.4% correction.   In October of 2007, the S&P 500 made its final all-time high prior to the crash of 2008. The index declined by 56.8% and October 2007’s new all-time high was not exceeded until March of 2013.  

The corrections from the three 2007 all-time highs are similar to the all-time highs for the 2018/2019 period.  The declines for both periods were above 5%. The 2018/2019 period’s longest number of days before a correction began was 38.   This compared to the highest being 31 days for 2007. Both 2018/2019 and 2007 also experienced at least one double digit decline after the new all-time high occurred.

The 1995 to 2002 and the 1999 to 2000 charts below confirm that post new all-time high volatility increases in the late stages of a secular bull market and economic expansion.  All-time new high volatility increasing for 1999 and 2000 prior to the steep decline to the 2002 low is very similar to what happened in 2007, before the 2008 market crash.

The probability is high that the S&P 500 will soon correct by a minimum of 5% from its peak.  The secular bull is now a full-grown adult. The current US economic expansion is the longest on record.  For these reasons the S&P 500 is also ripe for the much greater minimum peak to trough decline of 50% which normally occurs at the end of a secular bull market and economic expansion.   

To profit from market corrections and crashes click below to subscribe to the Bull & Bear Tracker which publishes text alerts to purchase ETFs including inverse ETFs which increase in value when the market declines.     

#WhatYouMissed On RIA: Week Of 11-25-19

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

Economist Daniel LeCalle’s new book, “Freedom or Equality,” will be released in March 2020, and we get a preview of his thoughts on the difference between equality and equal opportunity, whitewashing interventionism; capitalism isn’t broken, but it’s been warped by corporate stock buy-backs; four reasons US Healthcare is the way it is; why our challenges cannot by solved by destroying the greatness of the US; why you cannot equalize-up, only equalize-down to the lowest-common denominator.

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)

The QE-4 Report below was released to our subscribers 3-weeks ago. Subscribe today for a FREE trial and get the UPDATED version of this report.

See you next week!

Mauldin: We Are On The Brink Of The Second “Great Depression.”

You really need to watch this video of a recent conversation between Ray Dalio and Paul Tudor Jones. Their part is about the first 40 minutes.

In this video, Ray highlights some problematic similarities between our times and the 1930s. Both feature:

  1. a large wealth gap
  1. the absence of effective monetary policy
  1. a change in the world order, in this case the rise of China and the potential for trade wars/technology wars/capital wars.

He threw in a few quick comments as their time was running out, alluding to the potential for the end of the world reserve system and the collapse of fiat monetary regimes.

Maybe it was in his rush to finish as their time is drawing to a close, but it certainly sounded a more challenging tone than I have seen in his writings.

Currency Wars

It brought to mind an essay I read last week from my favorite central banker, former BIS Chief Economist William White.

He was warning about potential currency wars, aiming particularly at the US Treasury’s seeming desire for a weaker dollar. Ditto for other governments around the world. He believes this is a prescription for disaster.

One possibility is that it might lead to a disorderly end to the current dollar based regime, which is already under strain for a variety of both economic and geopolitical reasons. To destroy an old, admittedly suboptimal, regime without having prepared a replacement could prove very costly to trade and economic growth.

Perhaps even worse, conducting a currency war implies directing monetary policy to something other than domestic price stability. There ceases to be a domestic anchor to constrain the expansion of central bank balance sheets.

Should this lead to growing suspicion of all fiat currencies, especially those issued by governments with large sovereign debts, a sharp increase in inflationary expectations and interest rates might follow. How this might interact with the record high debt ratios, both public and private, that we see in the world today, is not hard to imagine.

I called Bill to ask if he thought this was going to happen. Basically, he said no, but it shouldn’t even be considered. It was his gentlemanly way of issuing a warning.

Currency devaluations against gold were part of the root cause of the Great Depression. Coupled with protectionism and tariffs, they devastated global economic growth and trade.

The Repeat of the 1930s?

Do I think it will happen in any significant way in the next few years?

It is not my highest probability scenario. But imagine a recession that brings the US deficit to $2 trillion, possibly followed by a governmental change that raises taxes and spending.

This could bring about a second “echo” recession with even higher deficits. This would force the Federal Reserve to monetize debt in order to keep interest rates from skyrocketing, thereby weakening the dollar.

Couple this with a concurrent crisis in Europe, potentially even a eurozone breakup, resulting in countries all over the world trying to weaken their currencies with the potential for higher inflation in many places.

In such a scenario, is it hard to imagine a desperate president and Congress, toward the latter part of the next decade, regardless of which party is in control, instructing the US Treasury to use its tools to weaken the dollar?

Can you say beggar thy neighbor? Can you see other countries following that path? All as debt is increasing with no realistic exit strategy except to monetize it?


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.

Need A Break From The Inlaws? Your “Turkey Day” Reading List

It’s “Thanksgiving Day,” and after the annual indulging into too much Turkey and dressing, cranberry sauce, and pecan pie, you might just need a break from the family to “do some research.”

We are happy to oblige with a few of our most important articles over the last few months as they relate to where we are in the current economic and market cycle.


Consumers Are Keeping The U.S. Out Of Recession? Don’t Count On It.

“[Who is a better measure of economic strength?] 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? A quick look at history shows this level of disparity (between consumer and CEO confidence) is not unusual. It happens every time prior to the onset of a recession.

The Corporate Maginot Line

“We believe investors are being presented with a window to sidestep risk while giving up little to do so. If a great number of BBB-rated corporate bonds are downgraded, it is highly likely the prices of junk debt will plummet as supply will initially dwarf demand. It is in these types of events, as we saw in the sub-prime mortgage market ten years ago, that investors who wisely step aside can both protect themselves against losses and set themselves up to invest in generational value opportunities.”

Corporate Profits Are Worse Than You Think

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

Who Is Funding Uncle Sam

“Unfortunately, two of the largest buyers/holders of U.S. Treasury debt (China and the Federal Reserve) are no longer pulling their weight. More concerning, this is occurring as the amount of Treasury debt required to fund government spending is growing rapidly. The consequences of this drastic change in the supply and demand picture for U.S. Treasury debt are largely being ignored.”

The Disconnect Between The Markets & Economy Has Grown

“The stock market has returned almost 103.6% since the 2007 peak, which is more than 4-times the growth in GDP and nearly 3-times the increase in corporate revenue. (I have used SALES growth in the chart below as it is what happens at the top line of income statements and is not AS subject to manipulation.)

The all-time highs in the stock market have been driven by the $4 trillion increase in the Fed’s balance sheet, hundreds of billions in stock buybacks, and valuation (PE) expansion. With Price-To-Sales ratios and median stock valuations near the highest in history, one should question the ability to continue borrowing from the future?”

Investors Are Grossly Underestimating The Fed – RIA PRO UNLOCKED

“The market has a long history of grossly underestimating, in both directions, what the Fed will do. The implications to stocks and bonds can be meaningful. To the extent one is inclined and so moved to exercise prudence, now seems to be a unique opportunity to have a plan and take action when necessary.”

Happy Thanksgiving!

Your Appreciative & Thankful Team At RIA Advisors

Selected Portfolio Position Review: 11-27-19

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.

This week we are reviewing a couple of our current positions as well as 4-positions we are analyzing for a potential portfolio addition.

CMCSA – Comcast Corp.

  • After taking profits in CMCSA there hasn’t been much for us to do but wait, and watch.
  • Currently, CMCSA is on a “sell signal” and back to more extreme oversold levels.
  • If you are looking for an entry point, this might be as good of an opportunity as you get for a while with a very tight stop-loss at the 200-dma.
  • We are long our position currently and are holding with the same stop-loss levels
  • Stop is set at $42

AAPL – Apple, Inc.

  • We bought AAPL in January of this year and now have a 40% gain in the position. We took profits in May before the decline, but the breakout to new highs has been exaggerated.
  • AAPL and MSFT have made up 38% of the entire S&P 500 gain this year. The top 15 largest S&P 500 companies have also made up 38% of the advance leaving just 24% of the lift to the remain 485 stocks. This is a very narrow advance and is symptomatic of a late stage bull market cycle.
  • We are probably going to take profits again by the end of the year but for now we will just keep raising our stop level.
  • Stop set at $220

DUK – Duke Energy Corp.

  • DUK has not been that great of a performer since we added the position earlier this year. The breakout of the consolidation failed, but we have clipped a decent coupon so far.
  • DUK is currently very oversold but is wrestling with the 200-dma resistance.
  • Hold off on adding a position until it clears the 200-dma.
  • We are also moving our stop-loss up.
  • Stop loss is set at $86

ABBV – AbbVie, Inc.

  • We had been watching ABBV for a while before adding it to the portfolio. We love the healthcare space because of the aging demographic.
  • Since adding it to the portfolio, it has surged 12%. We have been watching for a pullback to add to our holdings and while ABBV is on a buy signal, that signal is extremely overbought.
  • We are looking for a pullback towards the 200-dma that reduces the overbought condition without triggering a “sell signal.”
  • Stop loss is raised to $72.50.

NSC – Norfolk Southern

  • We have previously taken profits in NSC but have been looking for an entry point to add back to the position. We may be getting close to that point.
  • NSC held important support at $170 and turned up with the onset of QE-4.
  • Now that the buy signal has been triggered positions can be added with a tight-stop at $185
  • With the market overbought in total, if the market pulls back, so to will NSC. We would like to use a temporary respite to add to our holdings.
  • For now we are holding our current position and moving the stop up.
  • Stop has been moved up to $185

AMZN – Amazon.com Inc.

  • AMZN has been working through a several month long “sell signal” which continues to resolve itself.
  • The good news is that AMZN continues to hold support but unfortunately has been unable to climb above the 200-dma.
  • We will add to our position on a confirmed break higher with the initiation of a “buy signal.”
  • Stop is currently set at $1700

AMLP – Alerian MLP ETF (Watchlist)

  • We are starting to dig around the energy sector for opportunities in a beaten up space.
  • There are lots of things going wrong in the sector, not to mention a lot of CCC rated debt on the verge of defaulting, but there will be companies that will survive.
  • We are specifically looking at the Midstream Energy and Pipeline space. It is TOO EARLY to take a position but the risk reward is moving into a positive position.
  • We are currently preparing a research report for subscribers we will have out soon.
  • Given we manage money for IRA’s and taxable accounts, and that our clients do NOT like dealing with K-1’s at tax time, we are looking to use an ETF that converts everything to 1099-income. Plus, with a 10% yield, gives us time and a cushion to wait for our thesis to play out.
  • Stop loss has not been set.

NTG – Tortoise Midstream Energy Fund (Watchlist)

  • The second part of our “pair trade” is a closed-end fund that will add a bit of leverage to our thesis once it begins to play out.
  • If our original idea with AMLP comes to fruition, then we will begin to layer a position in NTG which is trading at a slight discount to its NAV but has about 40% leverage which makes it too risky as an initial holding.
  • However, the leverage boosts the overall total return by pushing the yield to over 15%.
  • We are not implementing this strategy yet as we are still in our research process. We will keep you updated.
  • Stop loss not set yet.

CGC – Canopy Growth Corporation (Watchlist/Trade Only)

  • Another pair-trade we are looking at is with Canopy Growth Corporation.
  • “NO…we aren’t smoking anything.”
  • There are two things we see happening in this sector in 2020. The first will be a push to further legalize the use of marijuana in all 50-states. However, what we think will most likely be the case is a wave of mergers and acquisitions to bolster other brands that want to participate in the space.
  • CGC is a likely candidate for a merger or acquisition.
  • Risk / Reward set up is easy with a stop-loss at $14.
  • We aren’t entering the trade just yet, but we are watching.
  • Stop-loss would be set at $14.

STZ – Constellation Brands (Watchlist)

  • Since we don’t like buying fundamentally weak companies, we are looking to back any purchase of CGC above with a position in STZ.
  • STZ has already entered the CBD/marijuana space and is looking to produce and distribute cannabis infused drinks. STZ is also a likely candidate for further acquisitions if demand grows.
  • However, given STZ fundamentals are substantially stronger than CGC, we will back our trade in CGC with a equal position of STZ which also adds yield to our total holding.
  • We aren’t entering this trade just yet, as noted above, we are just watching and analyzing the opportunity.
  • Stop loss not set yet.

Mauldin: The Calm Before The Economic Storm

The global economy is slowing.

Germany, for instance, may already be in recession. GDP there dropped 0.1% in this year’s second quarter, with little reason to expect better from Q3 which we will learn soon.

Whatever you call it, Germany is certainly not in a good spot. It is highly dependent on exports which, for various reasons, are weakening, particularly in their auto industry.

Meanwhile, Brexit (depending on how it ends) could greatly reduce UK purchases of German goods.

On top of that, uncertainties induced by President Trump’s trade war are deterring businesses in Europe (as well as here) from investing in future growth projects.

And overarching all of it is the technology-driven decline in globalized manufacturing.

If Germany’s “technical recession” morphs into a real recession, the rest of Europe will certainly follow. And recession in Europe—and the measures its central banks will take to fight it—won’t leave the US economy unscathed.

The Rest of the World Is Not Well

Not coincidentally, commodity-producing emerging markets are also experiencing difficulty. Ditto for some more advanced commodity exporters like Australia and Canada.

Their problem springs from lower commodity prices, but more specifically from China. My friend Sam Rines (Director and Chief Economist at Avalon Advisors) explored this in a recent note.

Much of the commodity price pressure can be blamed on slowing Chinese growth, but that is not the entire story. China is roughly 20% of global GDP on a PPP basis, and constitutes much of the incremental growth in the global economy. When China’s growth slows, the ripples are felt in many places.

Commodity prices and China’s growth rate are understandably intertwined, and that may be a difficult correlation to break down. Why? It is difficult to pinpoint the next major tailwind. And—even when speculating on the next tailwind—timing is a further difficult hurdle to overcome.

But why not try. Of the three major headwinds to commodity pricing in the post-dual stimuli world (end of China’s building spree, US dollar following QE, and slower overall global growth), the US dollar is the most likely to abate as a headwind in the near-term. Global growth is dependent largely on US and China trade policy, but there could be a marginal shift higher in growth (the worst might be over). Replacing the rapid growth of China is not easy to see. India is gaining share of global GDP. But it is not easy to see the path to a full replacement of the China commodity cycle.

We may soon see the other side of China’s growth story. Just as it had an outsized effect on global GDP on the way up, it will likely be a major drag on the way down.

Note, when my young friend Sam says “the worst may be over,” he is talking in particular about the downturn from slower Chinese growth. If you read his daily missives, as I do, he is far from predicting a US recession.

Slower growth? Yes. It sounds like he thinks we are in a slower muddle-through world for the next few quarters at least. And maybe through the next elections…

The Signs of Looming Recession

While more goods are delivered electronically and supply chains are shrinking, the movement of physical goods is still the economy’s circulatory system.

The Cass Freight Index is the most comprehensive, high-frequency indicator of this. It tends to lead the economy by a few quarters but has signaled almost every economic turning point.

So the fact its year-over-year change has been negative every single month since December 2018 is more than a little concerning.

As you can see from the chart below, there have been periods of negative growth without a recession, but the latest drop’s sheer magnitude and rapidity is eye-opening.

Freight traffic is falling, and it looks even worse when Cass digs into the specifics.

Going deeper, Cass notes that “dry van” truck volume is a fairly reliable predictor for retail sales and is still relatively healthy.

That fits what we see elsewhere about consumer spending sustaining growth. But they also note that seasonally, dry van volume should be even stronger than it is. That suggests caution as the year winds down.

Other transport modes—rail, flatbed trucks, chemical tankers—indicate real problems in the industrial economy. Manufacturers seem to have little faith consumers will keep buying at the rates they are.

And, given how much consumer spending is debt-financed, they’re probably right to be cautious. Strong retail spending is not necessarily positive. Consider this Comscore holiday spending report from November 2007.

The Friday after Thanksgiving is known for heavy spending in retail stores, but it’s clear that consumers are increasingly turning to the Internet to make their holiday purchases,” said Comscore Chairman Gian Fulgoni. “Online spending on Black Friday has historically represented an early indicator of how the rest of the season will shake out. That the 22-percent growth rate versus last year is outpacing the overall growth rate for the first three weeks of the season should be seen as a sign of positive momentum.

The Great Recession began one month after this “sign of positive momentum.” A strong holiday shopping season won’t mean we are out of the woods and could mean we are just entering them.


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.

Can The Fed Fight Wealth Inequality

Minneapolis Fed President Neel Kashkari says the Fed Can Fight Inequality. Then in a move guaranteed to fail, Kashkari Hires an Obama Economic Advisior as His Guide.

Neel Kashkari, the outspoken dove at the Minneapolis Fed, says monetary policy can play the kind of redistributing role once thought to be the preserve of elected officials.

When Kashkari, a year into his job, launched an in-house effort in 2017 to examine widening disparities in the economy, he was expecting to generate research that might inform lawmakers’ decisions, rather than the Fed’s.

“We had historically said: distributional outcomes, monetary policy has no role to play,” he said in an October interview. “That was kind of the standard view at the Fed, and I came in assuming that. I now think that’s wrong.”

Kashkari’s project has taken an unexpected turn over the last two years, morphing into something more ambitious. It has the potential to transform an intensely political debate about inequality into a scientific endeavor that the Fed’s 21st-century technocrats could take up.

This year, he finally found someone to lead it: Abigail Wozniak, a Notre Dame economics professor, became the first head of the Minneapolis Fed’s Opportunity and Inclusive Growth Institute. Wozniak was a member of President Barack Obama’s Council of Economic Advisers.

One of its priorities has been to build a network of experts on income and wealth distribution, the same way the Fed brings in specialists in financial markets or growth.


Fed a Key Driver of Income Inequality

Kashkari is correct in a perverse sort of way given that Fed is a key driver of income inequality:

  1. By bailing out banks and financial institutions when they get in trouble
  2. By keeping interest rates too low too long
  3. By promoting economic bubbles
  4. By promoting inflation

So yes, the Fed could help if it simply stopped doing those things. It would be better still if there was no Fed at all, so the main thing the Fed could do would be to promote a sound currency then disband itself.

There is No Economic Benefit to Inflation

The BIS did a historical study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study*.*

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Challenge to Keynesians

And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.

Irony Abounds

Kashkari came to the right conclusion but instead of disbanding the Fed or changing any of the above four points, he hires and Obama economic clown as his guide.

Note that Kashkari is the biggest dove on the Fed. He would vote for 2, 3, and 4 at every chance.

Yet, inflation benefits those with first access to money (banks, wealthy, asset holders, and corrupt politicians). The poor only participate in bubbles after there is nothing left to gain.

Curiously, my answer is the same as Kashkari’s. Yes, the Fed can help. And the first thing Kashkari could do to help is simple enough, resign.

Addendum

A reader criticized the title “income inequality”. He thought distorted the picture.

He is correct but in the opposite sense as he intended. Wealth inequality (via asset bubbles) is imore of the issue.

I change the title to “wealth inequality”. The title of the linked-to article simply says “inequality”. It’s both income and wealth actually.

Income inequality is via stock options and pay bonuses for blowing bubbles. Wealth comes from cashing out stock options and holding assets accumulated during bubble phases.

Sector Buy/Sell Review: 11-26-19

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.

NOTE – Not much changed in the charts from last week. So recommendations remain primarily the same. With markets and sectors EXTREMELY overbought, it is likely best to wait for some corrective action before adding exposure. Hence the “short position” we added into portfolios to hedge risk. See portfolio commentary on home page.

Basic Materials

  • XLB is extremely overbought short-term, but the recent pullback to test breakout support is encouraging.
  • Given the pullback, add exposure if you have no exposure to materials currently.
  • With the market as a whole extremely overbought, we are likely to see a bit of correction over the next couple of weeks at which point we will bring our weighting up to target.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Add 1/2 position if no holdings currently.
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • XLC finally broke out to new highs and joined its brethren technology sector as $AMZN finally mustered a rally.
  • With the reversal of the “sell signal” it should lift the sector higher, but in the short-term XLC is extremely overbought.
  • 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 failed at downtrend resistance which is disappointing.
  • The “sell signal” has been reversed. With relative performance improving, we may see more gains but the failure to break above resistance keeps us out of the sector for now.
  • 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.
  • Short-Term Positioning: Bearish
    • Last week: No Position – looking to add
    • This week: No Position – looking to add
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF finally broke out to new highs which makes it much more interesting to add to the portfolio. The recent bounce off of the uptrend line is also bullish.
  • However, the sector is extremely overbought, and the buy signal is extremely extended as well. A pull back or consolidation is required to add holdings into the portfolio.
  • We will see if a break above resistance can hold before adding exposure back into portfolios for a “trading basis” only.
  • Short-Term Positioning: Neutral
    • Last week: Hold Positions
    • This week: Hold Positions
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • Like XLF, XLI broke out to new highs. After a long-consolidation, this is an important development.
  • As with Materials above, a rotation into cyclical exposures is likely to continue as QE and Trade Deals are hoped for.
  • We are looking for a bit of consolidation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • 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 $75
  • Long-Term Positioning: Neutral

Technology

  • XLK is back to a more extreme overbought condition, but has now broken out of the consolidation. Given technology makes up about 1/5th of the S&P 500 weighting, this sector is dragging the whole market higher.
  • We are currently target weight on Technology, but may increase exposure on a pullback to support within the overall uptrend. (A retest of the breakout that holds) The upper rising trendline is also providing resistance so look to add on a pullback that holds the lower trendline support.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $77.50
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform better as money is just chasing markets now.
  • XLP continues to hold its very strong uptrend as has now broken out to new highs. However, XLP is back to more extreme overbought.
  • If the short-term “sell signal” is reversed, it could provide additional lift to the sector.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • 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 but broke to the downside. The subsequne rally failed to move back above previous support so the risk is to the downside currently.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected which has now been completed.
  • XLRE Registered a deep “sell signal” and is oversold. A trading opportunity is approaching but be cautious currently.
  • You can add to positions if you are underweight but maintain a stop at recent lows for new purchases.
  • 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 with XLU rallying to test previous support. Unfortunately, the test of support failed which now turns it into future resistance.
  • After taking profits, we have time to be patient and wait for the right setup. We may be getting an opportunity here soon if support can hold as the overbought condition is reversed.
  • Long-term trend line remains intact but XLU and the sell signal is now triggered. A reversal of the sell signal will provide more lift.
  • Hold off adding new positions currently.
  • 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 remained intact and broke out to new highs.
  • However, the rapid acceleration of the sector has taken XLV to extreme overbought conditions.
  • We noted previously, healthcare would begin to perform better soon as money looked for “value” in the market. That has been the case as of late, but has gone too far, too quickly.
  • We are looking for entry points to add to current holdings, but it is too overbought currently.
  • We are moving our stop up for now, but look for a reduction of the overbought condition to add weight to the sector.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $90
  • Long-Term Positioning: Neutral

Discretionary

  • The rally in XLY has not participated as much as other sectors like Financials, Industrials and Materials, and has failed to break above resistance.
  • We added to our holdings previously to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is struggling to reverse back to a buy signal, and overhead resistance is going to problematic short-term.
  • Hold current positions for now, as the Christmas Shopping Season is approaching, which should help push the sector higher. However, the dismal performance relative to other sectors of the markets suggests not adding new/additional exposure currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has broken out of consolidation but will quickly run into previous highs. The chase into previously “out of favor” sectors is likely going to end as quickly as it began.
  • With a “buy” signal in place, combined with the fact XTN is not overbought, a better setup is forming to add holdings. Take profits if long, and wait for a pullback to add to holdings.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: Turkeys, Markets & A “Revision Of Belief”

On Monday, the markets jumped on more “trade news,” despite there being no real progress made. However, such wasn’t surprising as we discussed in this past weekend’s newsletter:

“Over the last few weeks, we have been discussing the ‘QE, Not QE’ rally. Regardless of what the Fed wishes to call their bond purchases, the market has interpreted the expansion of their balance sheet as a ‘QE’ program. Given that investors have been ‘trained’ by the Fed’s ‘ringing of the bell,’ the subsequent 6-week advance was not surprising.

(I might have missed a couple of ‘trade deal’ headlines but you get the drift.)”

If you aren’t subscribed, you are missing out. 

However, this “trade deal” rally was also something we suspected would happen.

“With QE-4 in play, the bias remains to the upside keeping our target of 3300 on the S&P 500 in place. This is particularly the case as we head further into the seasonally strong period combined with an election year cycle.

As shown in the chart below, the breakout to all-time highs was substantial, and regardless of your bias, this was a “bullish” advance and suggests higher prices in the short-term.”

“The correction this past week is likely not yet complete. Our short-term trading indicators are NOT oversold, but it is worth noting they are not as overbought as they were. This suggests the market could certainly muster a post-Thanksgiving rally.

Looking ahead, a subsequent pre-Christmas correction remains likely, particularly as the market drifts between one “trade deal” tweet, to the next. 

For now, we continue to maintain our hedges as all of our indicators are still suggestive of a short-term reversal.”

Yea…I know…“Don’t Fight The Fed.” 

I don’t disagree, and our portfolios remain primarily long exposed despite the short-term hedge we added to reduce the risk of a short-term “reversion.”

Risk Of Correction Remains

In a market that is excessively bullish, and overly complacent, investors are “willfully blind” to the relevant “risks” of excessive equity exposure. The level of bullishness, by many measures, is extremely optimistic. 

Not surprisingly, that extreme level of bullishness has led to some of the lowest levels of volatility and cash allocations in market history.

Of course, these actions must have a supporting narrative. 

Stocks To Be Propelled Higher In 2020: U.S. equity strategist, David Kostin said:

“We expect the current bull market in US equities will continue in 2020. The durable profit cycle and continued economic expansion will lift the S&P 500 index by 5% to 3250 in early 2020.”

The Great Rotation: JP Morgan analyst Nikolaos Panigirtzoglou said:

“Given this year proved to be a strong year for equity markets, helped by institutional investors, then we should see retail investors responding to this year’s equity market strength by turning [into] big buyers of equity funds in 2020. This suggests 2020 could be another strong year for equities driven by retail rather than institutional investors.”

This is an interesting turn of sentiment considering that just a month ago headlines were plastered with “recession” fears. 

Despite the “narrative,” and the “prima facie” evidence you shouldn’t “Fight The Fed,” the current detachment of prices from valuations, and the deviation of price from long-term norms, are concerning. 

CAPE-5 is a modified version of Dr. Robert Shiller’s smoothed 10-year average. By using a 5-year average of CAPE (Cyclically Adjusted Price Earnings) ratio, it becomes more sensitive to market movements. Historically, deviations above +40% have preceded secular bear markets, while deviations exceeding (-40%) preceded secular bull markets.

Also, as I noted in Monday’s missive on “Investing vs Speculation:”

“Regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.” – Jason Zweig

The chart below is the 3-year average of annual inflation-adjusted returns of the S&P 500 going back to 1900. The power of regression is clearly seen. Historically, when returns have exceeded 10% it was not long before returns fell to 10% below the long-term mean which devastated much of investor’s capital.

Not surprisingly, when the price of the index has deviated significantly from the underlying long-term moving averages, corrections and bear markets have not been too distant.

Combining the above measures (volatility, valuation, and deviation) together shows this a bit more clearly. The chart shows both 2 and 3-standard deviations above the 6-year moving average. The red circles denote periods where valuations, complacency, and 3-standard deviation moves have converged. 

While the media continues to suggest the markets are free from risk, and investors should go ahead and “stick-their-necks-out,” history shows that periods of low volatility, high valuations, and deviations from long-term means has resulted in very poor outcomes.

Lastly, there has been a lot of talk about how markets have entered into a new “secular bull market” period. As I discussed in “Which Secular Bull Market Is It,” I am not sure such is the case. Given the debt, demographic and deflationary backdrop, combined with the massive monetary interventions of global Central Banks, it is entirely conceivable this is more like the 1920-29 advance that led up to the “Great Depression.” 

Regardless, whenever the RSI (relative strength index) on a 3-year basis has risen above 70, it has usually marked the end of the current advance. Currently, at 75, there is little doubt the market has gotten ahead of itself.

No matter how you look at it, the risk to forward returns greatly outweighs the reward presently available.

Revision Of Belief

Importantly, this doesn’t mean that you should “sell everything” and go hide in cash, but it does mean that being aggressively exposed to the financial markets is likely not wise.

It reminds me much of what Nassim Taleb once penned in his 2007 book “The Black Swan.”

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,’ as a politician would say.

On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey.

It will incur a revision of belief.”

Such is the market we live in currently.

It has become a “Turkey” market. Unfortunately, like Turkeys, we really have no clue where we are on the current calendar. We only know that today is much like yesterday, and the “bliss” of calm and stable markets have lulled us into extreme complacency.

You can try and fool yourself that weak earnings growth, low interest rates, and high-valuations are somehow are justified. The reality is, like Turkeys, we will ultimately be sadly mistaken and learn a costly lesson.

“Price is what you pay, Value is what you get.” – Warren Buffett

Major Market Buy/Sell Review: 11-25-19

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.

S&P 500 Index

  • With a “buy signal” triggered, there is a positive bias, however with both the price and “buy signal” very extended we expect a short-term correction for a better entry point to add exposure.
  • As noted previously, we did add a “short S&P 500” index hedge to both the Equity and ETF portfolios. We are okay with the little bit of performance drag it provides relative to the risk reduction we get in the portfolio.
  • Given the deviation from the mean, and the more extreme overbought condition, it is advisable to wait for some consolidation/correction before increasing equity allocations.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position with a bias to add to holdings.
    • Stop-loss moved up to $290
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • DIA broke out to new highs with the reversal of the “buy” signal to the positive. However, that buy signal is no pushing some of the higher levels seen historically so a correction is likely.
  • Hold current positions, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $265.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Like SPY and DIA, the technology heavy Nasdaq has broken out to new highs but is pushing very extended levels.
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a consolidation or correction to add exposure.
  • However, as with SPY, QQQ is EXTREMELY overbought short-term, so remain cautious adding exposure. A slight correction that alleviates some of the extension will provide a much better entry point.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $185
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • As noted previously, small-caps broke out above previous resistance but have been struggling.
  • Last week, small-caps failed to hold the breakout which puts us back on cautionary footing for the market.
  • We suggested being patient on adding exposure as these historical deviations tend not to last long. SLY is extremely overbought and deviated from its longer-term signals. That turned out to be correct for now.
  • We will wait to see where the next oversold trading opportunity sets up.
  • 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 is holding up better than SLY and has not broken back down into its previous consolidation range.
  • MDY has now registered a short-term “buy” signal, but needs a slight correction/consolidation to reduce the extreme overbought and extended condition. The buy signal is very extended as well.
  • Look to add exposure to the market on a pullback that doesn’t violate support.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • Like SLY, EEM continues to underperform and failed to hold its breakout.
  • With the “buy signal” extremely extended, the set up to add exposure here is not warranted. Watch the US Dollar for clues to EEM’s direction.
  • As we noted last week, PAY ATTENTION to the Dollar (Last chart). If the dollar is beginning a new leg higher, EEM and EFA will fail.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like MDY, EFA rallied out of its consolidation channel and is holding that level but failed at previous resistance.
  • Like EEM, a the “buy signal” and market are both EXTREMELY overbought.
  • Be patient for now and wait for a confirmed breakout before adding exposure, and again, watch the U.S. Dollar for important clues.
  • 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. A nice bottom has been forming for oil prices between $51-52 so look for a move to the upper downtrend line at $59.
  • Commodities tend to perform well under liquidity programs due to their inherent leverage. So we are looking to add exposure to energy holdings.
  • 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.
  • We are starting to dig around the sector for some trading opportunities. We will keep you appraised in our weekly position report.
  • 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 got back to oversold and broke support at the 200-dma previously.
  • We are sitting on our stop-loss for the position currently, and had previously sold half our position.
  • With the “QE4” back in play, the “safety trade” may be off the table for a while. So, if we get stopped out of our holdings, we will look to buy them back at lower levels.
  • Short-Term Positioning: Neutral
    • Last week: Hold remaining 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 also broke support and triggered a sell-signal.
  • However, this past week, as “trade deal turbulence” returned, bonds rallied back to the top of its current downtrend channel.
  • Watch your exposure and either take profits or shorten your duration in your portfolio for now.
  • As noted last week, with the oversold condition in place, the bounce we were looking for arrived. Given bonds are still oversold, an equity correction will like move bond prices higher short-term. Use any bounce to rebalance holdings.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Despite much of the rhetoric 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.
  • Furthermore, the dollar bounced off support of the 200-dma and the bottom of the uptrend. If the dollar rallies back to the top of its trend, which is likely, this will take the wind out of the emerging market, international, and oil plays.
  • The “sell” signal is also turning up. If it triggers a “buy” the dollar will likely accelerate pretty quickly.

The Difference Between Investing & Speculation (10-Investing Rules)

Are you an “investor” or a “speculator?” 

In today’s market the majority of investors are simply chasing performance. However, why would you NOT expect this to be the case when financial advisers, the mainstream media, and WallStreet continually press the idea that investors “must beat” some random benchmark index from one year to the next.

But, is this “speculation” or “investing?” 

Think about it this way.

If you were playing a hand of poker, and were dealt a “pair of deuces,” would you push all your chips to the center of the table?

Of course, not.

The reason is you intuitively understand the other factors “at play.” Even a cursory understanding of the game of poker suggests other players at the table are probably holding better hands which will lead to a rapid reduction of your wealth.

Investing, ultimately, is about managing the risks which will substantially reduce your ability to “stay in the game long enough” to “win.”

Robert Hagstrom, CFA penned a piece discussing the differences between investing and speculation:

“Philip Carret, who wrote The Art of Speculation (1930), believed “motive” was the test for determining the difference between investment and speculation. Carret connected the investor to the economics of the business and the speculator to price. ‘Speculation,’ wrote Carret, ‘may be defined as the purchase or sale of securities or commodities in expectation of profiting by fluctuations in their prices.’”

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

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

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

There is also very important passage in Graham’s The Intelligent Investor:

“The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all its dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.”

Indeed, the meaning of investment has been lost on most individuals. However, the following 10-guidelines from legendary investors of our time will hopefully get you back on track.


10-Investing Guidelines From Legendary Investors

1) Jeffrey Gundlach, DoubleLine

“The trick is to take risks and be paid for taking those risks, but to take a diversified basket of risks in a portfolio.”

This is a common theme that you will see throughout this post. Great investors focus on “risk management” because “risk” is not a function of how much money you will make, but how much you will lose when you are wrong. In investing, or gambling, you can only play as long as you have capital. If you lose too much capital but taking on excessive risk, you can no longer play the game.

Be greedy when others are fearful and fearful when others are greedy. One of the best times to invest is when uncertainty is the greatest and fear is the highest.

2) Ray Dalio, Bridgewater Associates

“The biggest mistake investors make is to believe that what happened in the recent past is likely to persist. They assume that something that was a good investment in the recent past is still a good investment. Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.”

Nothing good, or bad, goes on forever. The mistake that investors repeatedly make is thinking “this time is different.” The reality is that despite Central Bank interventions, or other artificial inputs, business and economic cycles cannot be repealed. Ultimately, what goes up, must and will come down.

Wall Street wants you to be fully invested “all the time” because that is how they generate fees. However, as an investor, it is crucially important to remember that “price is what you pay and value is what you get.” Eventually, great companies will trade at an attractive price. Until then, wait.

3) Seth Klarman, Baupost

“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”

Investor behavior, driven by cognitive biases, is the biggest risk in investing. “Greed and fear” dominate the investment cycle of investors which leads ultimately to “buying high and selling low.”

4) Jeremy Grantham, GMO

“You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.”

Successful investors avoid “risk” at all costs, even it means under performing in the short-term. The reason is that while the media and Wall Street have you focused on chasing market returns in the short-term, ultimately the excess “risk” built into your portfolio will lead to extremely poor long-term returns. Like Wyle E. Coyote, chasing financial markets higher will eventually lead you over the edge of the cliff.

5) Jesse Livermore, Speculator

“The speculator’s deadly enemies are: ignorance, greed, fear and hope. All the statute books in the world and all the rule books on all the Exchanges of the earth cannot eliminate these from the human animal….”

Allowing emotions to rule your investment strategy is, and always has been, a recipe for disaster. All great investors follow a strict diet of discipline, strategy, and risk management. The emotional mistakes show up in the returns of individuals portfolios over every time period. (Source: Dalbar)

Dalbar-2015-QAIB-Performance-040815

6) Howard Marks, Oaktree Capital Management

“Rule No. 1: Most things will prove to be cyclical.

Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.”

As with Ray Dalio, the realization that nothing lasts forever is critically important to long term investing. In order to “buy low,” one must have first “sold high.” Understanding that all things are cyclical suggests that after long price increases, investments become more prone to declines than further advances.

7) James Montier, GMO

“There is a simple, although not easy alternative [to forecasting]… Buy when an asset is cheap, and sell when an asset gets expensive…. Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance.”

“Cheap” is when an asset is selling for less than its intrinsic value. “Cheap” is not a low price per share. Most of the time when a stock has a very low price, it is priced there for a reason. However, a very high priced stock CAN be cheap. Price per share is only part of the valuation determination, not the measure of value itself.

8) George Soros, Soros Capital Management

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

Back to risk management, being right and making money is great when markets are rising. However, rising markets tend to mask investment risk that is quickly revealed during market declines. If you fail to manage the risk in your portfolio, and give up all of your previous gains and then some, then you lose the investment game.

9) Jason Zweig, Wall Street Journal

“Regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.”

The chart below is the 3-year average of annual inflation-adjusted returns of the S&P 500 going back to 1900. The power of regression is clearly seen. Historically, when returns have exceeded 10% it was not long before returns fell to 10% below the long-term mean which devastated much of investor’s capital.

10) Howard Marks, Oaktree Capital Management

“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.”

The biggest driver of long-term investment returns is the minimization of psychological investment mistakes.

As Baron Rothschild once stated: “Buy when there is blood in the streets.” This simply means that when investors are “panic selling,” you want to be the one they are selling to at deeply discounted prices. Howard Marks opined much of the same sentiment: “The absolute best buying opportunities come when asset holders are forced to sell.”

As an investor, it is simply your job to step away from your “emotions” for a moment and look objectively at the market around you. Is it currently dominated by “greed” or “fear?” Your long-term returns will depend greatly not only on how you answer that question, but to manage the inherent risk.

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

As I stated at the beginning of this missive, “Market Timing” is not an effective method of managing your money. However, as you will note, every great investor through out history has had one core philosophy in common; the management of the inherent risk of investing to conserve and preserve investment capital.

“If you run out of chips, you are out of the game.”