Monthly Archives: September 2019

RIA PRO: The Moment You Know You Know, You Know!


  • Market Review & Update
  • The Moment You Know
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Review & Update

Last week, we started our discussion by itemizing the list of all the things going “right” for the bullish narrative. 

  • Trump easing up on tariffs and trade negotiations
  • The ECB (European Central Bank) went “all-in” on cutting rates and launching more Q.E.
  • The economy is showing some signs of life as data is “less bad” than it was previously, and as we concluded:

“All the bulls need now is the Fed to ‘cut’ rates at the meeting next week.” 

On Wednesday, the Fed did just that by cutting rates the expected 0.25% which aligned with our previous analysis:

“With markets hovering at all-time highs, the unemployment rate near record lows, and inflationary pressures near their target levels, there is little reason to be cutting rates now. 

For the bulls, the good news is, they will cut rates anyway.”

What the markets focused on, however, was The Fed suggesting they are open to “allowing the balance sheet to grow.” While this isn’t anything more than just stopping Q.T. entirely, the markets took this as a sign that Q.E. is just around the corner.

This is probably a mistaken conclusion.

As Mish Shedlock quoted:

To illustrate this point, the chart below shows excess reserves, required deposits, and currency in circulation. As you can see, everything went “pear-shaped” in 2008.

However, let’s zoom in a bit and add the Federal Reserves balance sheet. Prior to 2008, notice the Fed’s balance sheet was growing directly proportionate to the growth rate of the currency in circulation (which follows the growth rate of the economy.)

Therefore, what the Fed is suggesting is NOT more Q.E. but rather, just the normal “organic” expansion of the balance sheet in relation to the growth of the economy and the currency in circulation. 

It was this realization that ultimately disappointed the bulls late last week. 

Bulls Remain In Charge

However, despite the short-term disappointment, the bulls remain in charge for the time being as markets cling near all-time highs. The question we posed last week was:

“Is it all priced in?”

The risk/reward does not favor the bulls short term. The market is back to very overbought conditions, the upside to the top of the bullish trend channel is about 1.9%. The downside risk is about 5.5%.

(Chart updated through Friday. Shows the overbought condition as been slightly reduced.)

However, on an intermediate-term basis, all of our primary indicators are beginning to reach levels which have typically denoted short-term market peaks. 

This analysis keeps our portfolios weightings on the long-side, but we remain hedged currently which we slightly increased last week, along with additions to our intermediate-term bond holdings and gold. Cash also remains a slight overweight in model allocations and equities slightly underweight.. 

We discussed the reasoning for an additional hedge with our RIAPRO subscribers this week:

  • We added a starter position of VXX to portfolios yesterday to hedge against a pickup in volatility. We are likely a bit early, and volatility will likely drift lower in the days ahead, but as noted by the red box, volatility is extremely suppressed.

While our portfolios remain bullishly biased for the time being, that will NOT always be the case.

As discussed many times in the past, the point of risk management is NOT trying to win “short-term battles” by chasing asset prices, but the winning of the “war” by not losing a large chunk of investment capital during a market decline.

The Moment You Know

David Bowie once said:

“The moment you know you know, you know.” 

Unfortunately, for the vast majority of investors, they often come to this realization far too late to do anything about it. 

Of course, it is these drawdowns which destroy the time value of money. Such was the message in the “Stability/Instability Paradox:”

“The point here is that ‘all things do come to an end.’ The further from the ‘mean’ something has gotten, the greater the reversion is going to be. The two charts below illustrate this point clearly.”

Bull markets, with regularity, are almost entirely wiped out by the subsequent bear market.

Despite the best of intentions, market participants never act rationally.

There is an important distinction between investing success and failure as it relates to the destruction of capital during drawdowns. Last week, Ben Carlson had an important tweet:

The point he was making is by investing money in markets, and not worrying about drawdowns, it will grow over time. The math certainly supports his argument. 

Why hire a “financial adviser?” Just buy a cheap index fund, sit on it, and you will be fine. It is a great concept for the purveyors of ETF and index-based products, just not necessarily good for you. 

Let me explain.

Ben, who graduated from college in 2005, didn’t have money invested, or manage assets for others, during the 2008 financial crisis. (That’s not a criticism, I wish I were that young.)

The reality is that experience is a hard teacher. 

The concepts of “buy and hold” investing, “dollar-cost averaging,” etc. become mainstream commentary at the end of bull market cycles. It was the same in 1999, and in 2007, when I was managing money for clients.

I can tell you this with absolute certainty.

“When the bear market sets in, all the investing complacency goes flying out the window. Clients no longer care about low cost, indexing, or ‘time in’ the market, as their losses mount. Conversations are no longer about buying dips, but rather ‘get me the f*** out.'”

Everyone sells.

It is just a function of where your pain point is as losses mount. While investors may stay the course during a 10-20% decline, it is an entirely different matter when personal wealth is dropping 30, 40, or 50%. 

If you were invested in 2008, you know what I mean.

It is just human nature. 

However, what Ben’s analysis misses is the “time value” of money during those periods. Yes, a “buy and hold” portfolio will grow in the financial markets over time, but it DOES  NOT compound.

Read this carefully: “Compound returns assume no principal loss, ever.”

To visualize the importance of this statement, look at the chart below of $100,000, adjusted for inflation, invested in 1990 versus a 6% annual compound rate of return. The shaded areas show whether the portfolio value exceeds the required rate of return to reach retirement goals. 

If your financial plan required 6% “compounded” annually to meet your retirement goals; you didn’t make it. 

This is the single most important thing to understand about investing. 

“Investing is not about just growing capital. The actual GOAL is growing SAVINGS to a future target which will provide a required livable income in retirement adjusted for inflation.” 

If you f*** that up by not saving enough, taking on too much risk, and losing a chunk of your capital by speculating in the financial markets, you are going to have a tough time when you retire.

Two bear markets should have taught “financial advisers” this by now.

It is why 80% of Americans are almost entirely dependent on social security for retirement needs despite the longest bull market run in history.  ($100,000 in savings, or less, isn’t going to cut it)

Time is the most valuable commodity there is. It is also the one commodity you can not get more of.

You Don’t Want To Hear That

I know, I know. That’s being “bearish,” and that is “no fun.” 

As Bob Farrell once quipped: “Bull markets are more fun than bear markets.” 

Here is what you really want to me to write:

“If you just put all your money into this ETF portfolio, it will compound at 8-10% a year, and you can spend all your time at the beach.” 

Or,

“Here are the six stocks you can buy today, and retire on tomorrow.”

Or, just in case you haven’t started investing yet:

“If you can just save $100 a month, buy an S&P index fund, and dollar cost average into it every month in a Roth, it will grow at 12% a year and you will have $1 million in 30-years.” 

These types of articles sell products, get advisers clients who lure them in with promises of above-average returns for a small annual fee, and attract advertisers. This is why the media is full of “optimistic” articles touting exactly those issues.

The problem is they are all mathematically wrong. 

The truth is…you don’t want to hear to truth. 

Like the fact, that $1 million today is NOT $1 million in 30-years.

Or that you don’t actually get “average” returns from portfolios.

(We wrote a complete series on the many investing myths of the market and how to do better.)

The Definitive Guide To Investing For The Long Run

Think about it this way.

“IF investing actually worked as advertised, wouldn’t “everyone” be rich?” 

But they aren’t, because two major bear markets either wiped them out financially, or destroyed their confidence in investing in the markets. 

Most of the people in the mainstream media, and most people writing articles on investing, like Ben, have never actually been through a “bear market.” They may have witnessed it, but watching the “war” from the safety of your living room is very different than dodging bullets on the front line.

Of course, after a decade long bull market, it is certainly understandable that many investors, advisers, and planners have been lured into the belief that a “financial crisis” can never happen again.

Another crisis will happen. They have happened all throughout financial history going back to the 1600s, and Central Banks won’t be able to bail the markets out next time.

There is simply TOO. MUCH. DEBT.

However, it is these “beliefs,” “investment strategies,” and “complacency” which tend to mark the peaks of market cycles.

“The golden rule of investing is to buy low, and sell high.” – said every great investor in history

Here is what you DON’T SEE at market bottoms. (The point when you should be mortgaging the house to buy stocks.)

  • Companies like $TSLA and #WeWork which are cash burning machines, and potentially fraudulent companies, going public.
  • Investors chasing the highest risk assets like junk bonds, levered loans, and structured products.
  • People buying into silly and potentially extremely dangerous programs like the “F.I.R.E.” movement.
  • Advisors who promote “Buy and Hold” and “Dollar Cost Averaging” investment programs. (More than likely they have never seen a bear market.)
  • Wall Street hitting the markets with investment products which carry increasingly higher levels of risk to meet investor appetites. (Wall Street is a sales organization that creates products for consumers)
  • Untried and unproven products and investment programs like “Robo-Advisors”

And….Bowie Bonds, are back! 

A good example by my colleague Michael Lebowitz:

“In 1997 musician David Bowie, and in particular his revenues, supported an asset-backed security. In a first of its kind, Ziggy Stardust, Starman, and many other popular songs were securitized, raising $55 million for the artist. Investors received a stream of cash flows based on the sales of his 25 albums. In return for the lump sum of cash, Bowie forfeited any revenue from those albums until the bonds matured.

Bowie bonds attracted investors for several reasons. Some investors found value in the bonds, thinking music sales would skyrocket. Clearly these investors did not see the coming digitization of music and the revenue implications. Other investors were simply fans and wanted to own a piece of the rock legend. The bonds also attracted speculators. Risk-taking was in vogue in the later ’90s.  It seemed like the object of many investors was to find the latest and greatest investment with the possibility to make them rich. Unlike Pets.com and e Toys, Bowie bonds did not default and in 2007 paid off its investors.”

Note: note the year the bonds were issued – 1997. So, here we are nearly two decades after the dot com crash and a decade after the financial crisis, and risk-taking and speculation are back in style. Mike continues:

“From negative interest rates to excessive valuations along with a rash of non-profitable IPOS, signs of risk fever surround us. Like Bowie bonds signaled in the late ‘90s, another omen is warning that a top is near.

Spencer Dinwiddie, a guard for the NBA’s Brooklyn Nets, recently announced that he would follow in Bowie’s shoes and issue a security backed by his basketball contract. Like Bowie, Dinwiddie will receive a lump sum cash payment today instead of income spread out over the life of his contract. Dinwiddie’s wants the cash today so he can invest and assumingly earn more than investors in his bonds. His basketball bonds will be issued in digital tokens.

 It seems like Dinwiddie is not only trying to take advantage of liquidity chasing digital assets as well as the demands of investors seeking investments with extra yield but he, in turn, wants to speculate with the money as well. Said differently, speculators are feeding the behavior of speculators.

In the late 1990s, investors chased any company that was thought to have been in involved in the World Wide Web. Bowie bonds made more sense than many dot com companies but nonetheless revealed the rampant speculation of the day. In the mid-2000s, investors were enamored with mortgage debt backed by subprime debt that could “never default.” Today speculators are chasing traditional and digital assets in what may be the broadest instance of overvaluations in at least 75 years.”

It is from this point, given valuations are once again pushing 30x earnings, that we review the expectations that individuals facing retirement should consider.

  • Expectations for future returns and withdrawal rates should be downwardly adjusted due to current valuation levels.
  • The potential for front-loaded returns going forward is unlikely.
  • Your personal life expectancy plays a huge role in future outcomes. 
  • The impact of taxation must be considered.
  • Future inflation expectations must be carefully considered.
  • Drawdowns from portfolios during declining market environments accelerates the principal bleed. Plans should be made during up years to harbor capital for reduced portfolio withdrawals during adverse market conditions.
  • The yield chase over the last 10-years, and low interest rate environment, has created an extremely risky environment for investors. Caution is advised.
  • Expectations for compounded annual rates of returns should be dismissed in lieu of variable rates of return based on current valuation levels.

Importantly, chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk that you most likely realize.

For the majority of individuals today facing, or in, retirement the two previous bear markets have left many further away from retirement than they ever imagined.

The next one will destroy those goals entirely.

Investing for retirement, should be done conservatively, and cautiously, with the goal of outpacing inflation, not the market, over time. Trying to beat some random, arbitrary index that has nothing in common with your financial goals, objectives, and most importantly, your life span, has tended to end badly for individuals.

As Michael concludes:

“We do not know, but we do know what we know, and we know that current investor behavior is unsustainable.”

You can do better.

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet  

  


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 has continued to improve as a defensive tilt has returned to the market. The sector not only held previous support but broke above the 50-dma and puts previous highs into focus. After taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

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

As noted, our more defensive positioning continues to outperform relative to the broader market. After taking some profits and re-positioning the portfolio, we will remain patient and wait for the market to tell us what it wants to do next. Real Estate, Staples and Utilities all continue to make new highs but are GROSSLY extended. We added to our position in XLC bringing it to full weight previously, but that position is now extended and overbought as well and testing previous highs.

Current Positions: Target weight XLP, XLU, XLRE, and XLC

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

While Technology, and Discretionary did turn higher and are looking to set new highs, they have continued to struggle at resistance. Relative performance is beginning to improve but the sectors need to see improvement soon. We previously added to our position in Discretionary and continue to hold Technology. 

Current Position: Target weight XLY, XLK

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF), Materials (XLB)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. While Energy did rally last week on news of Saudi production outage, XLE failed to clear above important downtrend resistance and is back to extreme overbought. The rally is likely a good opportunity to reduce exposure to the energy sector if you are holding much exposure. 

Current Position: 1/2 weight XLI, XLB

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps popped sharply last week on a rotation from large-cap stocks. However, as noted last week, we have seen these pops before which have quickly failed so we will need to give these markets some room to consolidate and prove up performance. With economic data weakening, which significantly impacts small-cap stocks, the risk of failure remains pretty high for now. Be patient.

Current Position: No position

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

The same advice goes for Emerging and International Markets which we have been out of for several weeks due to lack of performance. These markets rallied recently on hopes of a “trade resolution,” and the ECB going all in on rates and QE. The spike was good but the markets remain unconvincing as we have seen the rallies before that failed. We will watch and wait for a better 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.

Current Position: RSP, VYM, IVV

Gold (GLD) – The previous correction in Gold, which we have been looking for, we used to add to our positions. Gold is testing critical support and is working off its overbought condition and looks to be setting up for a rally higher. You can add to holdings if you have not done so. 

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

Bonds (TLT) – 

Like Gold, bonds also finally corrected to work off some of the EXTREMELY overbought condition. Like gold, we used the pullback to lengthen the duration in our bond portfolios by swapping GSY (short-duration) for IEF (longer-duration.) We will continue to add to IEF as the reversal in rates continues. 

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:

This past week, the market rallied on the Fed rate cut and hopes of “QE” in the future. The only thing that derailed the action were headlines which suggest “trade wars” may be continuing for a while longer. 

Nonetheless, the market did break above the consolidation to the upside and is now testing all-time highs. However, the market is extremely overbought currently which provides short-term risk to add positions into models.

Moreover, October tends to a fairly volatile month to begin with, but add to that the potential for trade disruption around mid-month and there is simply too much uncertainty to take on an increased level of equity risk currently.

We continue to maintain a defensive bias to portfolios, and have increased our hedges as of late, which has work to reduce volatility. After adding and rebalance positions in portfolios, we remain fully weighted in Technology, Discretionary, Communications, Healthcare, Staples and Utilities, we are content to wait for now to see what the market tells us to do next. We still remain underweight in Materials and Industrials (after taking profits previously) due to the ongoing “trade war.” 

We will continue to “rent” this rally, and will take profits, as needed. 

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

  • New clients: We have been onboarding slowly. Please contact your advisor with any questions. 
  • Equity Model: Added a position in VXX to hedge for a pickup in volatility.
  • ETF Model:  Added a position in VXX to hedge for a pickup in volatility.

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

401k-PlanManager-AllocationShift

The Narrative Is Getting Thin

As noted last week, the “narrative” that has been driving the market higher has been one of hopes for further “Fed easing” and a resolution to the “trade war.” With the Fed not easing, and looking like they are going to be more hawkish in the future, the risk falls on Trump for the “trade war.” 

While he should “do a deal, any deal,” to get it off the table, it looks like he is going to maintain a tough stance with China and try and win a “battle,” but potentially wind up “losing the war,” economically speaking. 

In the short-term, as shown in the 401k plan chart above, both of our signals are triggering a “sell signal” with the markets extremely extended above their long-term bullish trend line. Previous episodes have resulted in a short-term correction. 

Therefore, for now, we continue to remain underweight equities as the markets remain trapped within a fairly broad range. This makes it difficult to do anything other than just wait things out.

It will be important the market continues to rally next week. However, the overall action this past week was not great. Despite the rally this week, the downside risk is elevated, so we are maintaining underweight holdings for now. If you haven’t taken any actions as of late, it is not a bad time to do so. 

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

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

401k Plan Manager Beta Is Live

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

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

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

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

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

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

Current 401-k Allocation Model

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


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

 

#WhatYouMissed On RIA: Week Of 09-20-19

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

The Week In Blogs


The Best Of “The Lance Roberts Show”

Video Of The Week

Our Best Tweets Of The Week

Our Latest Newsletter


What You Missed At RIA Pro

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

See you next week!

Since 2000 Wage Growth Has Barely Grown, If You Even Got That Much

Women are slowly catching up to men in median wages but growth has been pathetic across the board.

BLS data on real wages shows women are slowly catching up to men.

That’s the good news.

The bad news is real wages for women have only risen at slightly over 1/2 of 1 percent per year for 19.5 years.

Men performed even worse. Real wages for men have risen at a pathetic rate of about 1/4 of 1 percent per year in the same period.

The featured images is from a set of Interactive BLS Graphs on Fred.

The anecdotes and calculations are mine.

I used an Annual Rate of Return Calculator to determine the percentages.

Major Assumption

The numbers assume you believe the BLS’ questionable rates of inflation.

I don’t because the BLS excludes housing prices and ignores asset bubbles. The BLS also dramatically understates health care costs.

Questioning the BLS Medical Care Index

I discuss health care and incorrect BLS methodology in Another Surge in CPI Medical Care Costs.

One person commented “I bought my own insurance and it went up about 180% in the first three years of Obamacare.”

Unfortunately, that’s typical. Anyone buying their own insurance will not believe the purported 4.3% rise in the past year.

I discuss other problems with the BLS’ medical calculations.

Annualized Home Price Increases

Housing Bubble Reblown

Last Chance for a Good Price

The Last Chance for a Good Price Was 7 Years Ago.

Home prices are not in the CPI.

Those who want to buy a home quickly discover wage growth has not kept up with home price growth.

Since 2000, assuming you believe the CPI, wages are going up 0.27% per year for men and 0.56% per year for men. Add them together to get a household and the combined increase is well under a full percent.

Home prices are dramatically outstripping median wage increases.

For those looking to buy a home and for those who do buy their own medical insurance, real wage growth is negative.

American Dream

In case you missed it, 68% of Millennial Homeowners Regret Buying a Home

The top regret “too costly to maintain”.

So congratulations American Dreamers on your 0.34% annualized wage growth since January, 2000, assuming you believe you actually got that.

Long-Short Idea List: 09-19-19

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

LONG CANDIDATES

AMZN – Amazon.com

  • If the market is going to move higher into year-end, the AMZN should lead the way particularly as we head into holiday shopping season.
  • The trade setup is pretty clean, with AMZN’s sell signal pretty deeply oversold.
  • Buy at current levels.
  • Stop is $1750

Broadcom, Inc.

  • This is a “pair trade” in the semi-conductor space.
  • Buy a position on a breakout of the consolidation at $295.
  • The short side of the pair is AMD discussed below.
  • Stop is $280

AVY – Avery Dennison Corp.

  • AVY has been in a pretty tight consolidation for a while. If AVY can breakout above $117.50 we will likely see a move higher.
  • AVY is close to a “sell signal” so don’t buy until there is confirmation of a move higher.
  • Stop-loss is $112.50

CGC – Canopy Growth Corp.

  • I have been getting lot’s of request for a “cannabis” play.
  • These stocks are all terrible fundamentally and most of them will likely go away through merger, acquisition, bankruptcy, etc.
  • However, from a trading perspective, CGC is very oversold and sitting on support.
  • From a trading perspective only, you can buy at current levels with a stop at the recent lows.
  • Short-term upside is $32.50 but a move above that level will likely get buyers excited.
  • Stop-loss is set at $23.

CHRW – C.H. Robison Worldwide

  • Trucking data has been horrendous for so long now that it is likely to improve simply on year-over-year comparisons.
  • Buy a position in CHRW at current levels.
  • Target for trade is $96
  • Stop loss is set at $82.

SHORT CANDIDATES

AMD – Advanced Micro Devices

  • AMD is the short-side of the “pair trade” with AVGO above.
  • AMD has triggered a “sell signal” and is close to breaking down out of its consolidation.
  • Trading parameters are very tight.
  • Sell short the position on break of $30.
  • Target for trade is $20-22
  • Stop-loss is at $32

DEO – Diego, Plc

  • DEO just broke its long-term uptrend and is on a sell-signal currently.
  • Sell short 1/2 position in DEO on any rally that fails to move above $165.
  • Sell short second 1/2 position on a break below $162.50
  • Target for trade is $145
  • Stop-loss is $167.50

FB – Facebook, Inc.

  • FB has been consolidating is a tightening pattern over the last couple of months.
  • With a “sell signal” now triggered at a fairly high level, downside risk is fairly decent.
  • Sell short FB on a break below $185
  • Target for trade is $160
  • Stop-loss is set to $190

GE – General Electric Co.

  • GE has rallied back to resistance and its “buy signal” is VERY extended and has recently reversed to a “sell signal.”
  • Short GE at current levels.
  • Stop loss is $10
  • Target for trade is $7

HLT – Hilton Worldwide Holdings.

  • HLT has also recently registered a “sell signal” and is trading at fairly overbought levels.
  • Sell Short HLT on a break below $90
  • Target for trade is $70
  • Stop-loss after shorting the position is set at $92.50

The Fed & The Stability/Instability Paradox

“Only those that risk going too far can possibly find out how far one can go.” – T.S. Eliot

Well, this certainly seems to be the path that the Federal Reserve, and global Central Banks, have decided take.

Yesterday, the Fed lowered interest rates by a quarter-point and maintained their “dovish” stance but suggested they are open to “allowing the balance sheet to grow.” While this isn’t anything more than just stopping Q.T. entirely, the markets took this as a sign that Q.E. is just around the corner.

That expectation is likely misguided as the Fed seems completely unconcerned of any recessionary impact in the near-term. However, such has always been the case, historically speaking, just before the onset of a recession. This is because the Fed, and economists in general, make predictions based on lagging data which is subject to large future revisions. Regardless, the outcome of the Fed’s monetary policies has always been, without exception, either poor, or disastrous.

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s. As shown in the chart below, when the Fed has lifted the short-term lending rates to a level higher than the 2-year rate, bad ‘stuff’ has historically followed.”

The idea of pushing limits to extremes also applies to stock market investors. As we pointed out on Tuesday, the risks of a liquidity-driven event have increased markedly in recent months. Yet, despite the apparent risk, investors have virtually “no fear.” (Bullish advances are supported by extremely low levels of volatility below the long-term average of 19.)

First, “record levels” of anything are records for a reason. It is where the point where previous limits were reached. Therefore, when a ‘record level’ is reached, it is NOT THE BEGINNING, but rather an indication of the MATURITY of a cycle. While the media has focused on employment, record stock market levels, etc. as a sign of an ongoing economic recovery, history suggests caution.”

In the “rush to be bullish” this a point often missed. When markets are hitting “record levels,” it is when investors get “the most bullish.” That is the case currently with retail investors “all in.”

Conversely, they are the most “bearish” at the lows.

It is just human nature.

“What we call the beginning is often the end. And to make an end is to make a beginning. The end is where we start from.” – T.S. Eliot

The point here is that “all things do come to an end.” The further from the “mean” something has gotten, the greater the reversion is going to be. The two charts below illustrate this point clearly.

Bull markets, with regularity, are almost entirely wiped out by the subsequent bear market.

Despite the best of intentions, market participants never act rationally.

Neither do consumers.

The Instability Of Stability

This is the problem facing the Fed.

Currently, investors have been led to believe that no matter what happens, the Fed can bail out the markets and keep the bull market going for a while longer. Or rather, as Dr. Irving Fisher once uttered:

“Stocks have reached a permanently high plateau.”

Interestingly, the Fed is dependent on both market participants, and consumers, believing in this idea. As we have noted previously, with the entirety of the financial ecosystem now more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” is now the most significant risk.

The “stability/instability paradox” assumes that all players are rational and such rationality implies an avoidance of complete destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption as it provides the “room” needed, after more than 10-years of the most unprecedented monetary policy program in U.S. history, to try and navigate the risks that have built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

Unfortunately, that has never been the case.

The behavioral biases of individuals is one of the most serious risks facing the Fed. Throughout history, as noted above, the Fed’s actions have repeatedly led to negative outcomes despite the best of intentions.

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2006 was a doozy
  • Today, it’s ETF’s and “Passive Investing,” and levered credit.

As noted Tuesday, the risk to this entire house of cards is a credit-related event.

Anyone wonder what might happen should passive funds become large net sellers of credit risk? In that event, these indiscriminate sellers will have to find highly discriminating buyers who–you guessed it–will be asking lots of questions. Liquidity for the passive universe–and thus the credit markets generally–may become very problematic indeed.

The recent actions by Central Banks certainly suggest risk has risen. Whether this was just an anomalous event, or an early warning, it is too soon to know for sure. However, if there is a liquidity issue, the risk to ‘uniformed investors’ is substantially higher than most realize. 

Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing. That is, until suddenly, and often without warning, it all goes “pear\-shaped.”

In November and December of last year, it was the uniformity of the price moves which revealed the fallacy “passive investing” as investors headed for the door all at the same time. While, that rout was quickly forgotten as markets stormed back to all-time highs, on “hopes” of Central Bank liquidity and “trade deals.”

The difference today, versus then, are the warning signs of deterioration in areas which pose a direct threat to everyone “acting rationally.” 

“While yields going to zero] certainly sounds implausible at the moment, just remember that all yields globally are relative. If global sovereign rates are zero or less, it is only a function of time until the U.S. follows suit. This is particularly the case if there is a liquidity crisis at some point.

It is worth noting that whenever Eurodollar positioning has become this extended previously, the equity markets have declined along with yields. Given the exceedingly rapid rise in the Eurodollar positioning, it certainly suggests that ‘something has broken in the system.’” 

Risk is clearly elevated as the Fed is cutting rates despite the “economic data” not supporting it. This is clearly meant to keep everyone acting rationally for now.

The problem comes when they don’t.

The Single Biggest Risk To Your Money

All of this underscores the single biggest risk to your investment portfolio.

In extremely long bull market cycles, investors become “willfully blind,” to the underlying inherent risks. Or rather, it is the “hubris” of investors they are now “smarter than the market.”

Yet, the list of concerns remains despite being completely ignored by investors and the mainstream media.

  • Growing economic ambiguities in the U.S. and abroad: peak autos, peak housing, peak GDP.
  • Political instability and a crucial election.
  • The failure of fiscal policy to ‘trickle down.’
  • An important pivot towards easing in global monetary policy.
  • Geopolitical risks from Trade Wars to Iran 
  • Inversions of yield curves
  • Deteriorating earnings and corporate profit margins.
  • Record levels of private and public debt.
  •  More than $3 trillion of covenant light and/or sub-prime corporate debt. (now larger and more pervasive than the size of the subprime mortgages outstanding in 2007)

For now, none of that matters as the Fed seems to have everything under control.

The more the market rises, the more reinforced the belief “this time is different” becomes.

Yes, our investment portfolios remain invested on the long-side for now. (Although we continue to carry slightly higher levels of cash and hedges.)

However, that will change, and rapidly so, at the first sign of the “instability of stability.” 

Unfortunately, by the time the Fed realizes what they have done, it has always been too late.

QE Debate: Powell’s Comment On “Resuming Balance Sheet Growth”

Some interpreted Powell’s statement to mean more QE. There’s a strong clue Powell meant something else. OK, but ….

What did Powell Mean?

I confess, I thought Powell was talking about QE, but I did not see the exact quote. Powell said “organic growth”.

I believe Coppola has the correct intent.

Intention vs Reality

However, Coppola’s point is mostly moot.

What the Fed thinks it will do and intends to do, typically miss the mark badly on what it actually does.

The Fed “intended” to dramatically shrink its balance sheet. Look what happened.

Look at a Dot Plot of interest rate expectations from 2017.

Dot Plot December 13, 2017

Fade This Consensus

That was my precise comment at the time.

Some FOMC participants actually believed the Fed would hike to over 4.0% by 2020 (next year!). The majority believed rates would be over 3.0%.

Fed’s Intended Meaning

So what?!

The Fed may do a brief period of “organic” expansion (which by the way can mean anything the Fed wants), but I propose more QE is coming whether the Fed “intends” to do so or not.

By the way, we really do not know what the Fed “intended”. Perhaps the the Fed wanted to open the door for more QE later but without alarming the market of that.

Caution: Mean Reversion Ahead

If you watch CNBC long enough, you are bound to hear an investment professional urging viewers to buy stocks simply because of low yields in the bond markets. While the advice may seem logical given historically low yields in the U.S. and negative yields abroad, most of these professionals fail to provide viewers with a mathematically grounded analysis of their expected returns for the equity markets.

Mean reversion is an extremely important financial concept and it is the “reversion” part that is so powerful.  The simple logic behind mean reversion is that market returns over long periods will fluctuate around their historical average. If you accept that a security or market tends to revolve around its mean or a trend line over time, then periods of above normal returns must be met with periods of below normal returns.

If the professionals on CNBC understood the power of mean reversion, they would likely be more enthusiastic about locking in a 2% bond yield for the next decade. 

Expected Bond Returns

Expected return analysis is easy to calculate for bonds if one assumes a bond stays outstanding till its maturity (in other words it has no early redemption features such as a call option) and that the issuer can pay off the bond at maturity.

Let’s walk thought a simple example. Investor A and B each buy a two-year bond today priced at par with a 3% coupon and a yield to maturity of 3%. Investor A intends to hold the bond to maturity and is therefore guaranteed a 3% return. Investor B holds the bond for one year and decides to sell it because the bond’s yield fell and thus the bond’s price rose. In this case, investor B sold the bond to investor C at a price of 101. In doing so he earned a one year total return of 4%, consisting of a 3% coupon and 1% price return. Investor B’s outperformance versus the yield to maturity must be offset with investor C’s underperformance versus the yield to maturity of an equal amount. This is because investor C paid a 1% premium for the bond which must be deducted from his or her total return. In total, the aggregate performance of B and C must equal the original yield to maturity that investor A earned.

This example shows that periodic returns can exceed or fall short of the yield to maturity expected based on the price paid by each investor, but in sum all of the periodic returns will match the original yield to maturity to the penny. Replace the term yield to maturity with expected returns and you have a better understanding of mean reversion.   

Equity Expected Returns

Stocks, unlike bonds, do not feature a set of contractual cash flows, defined maturity, or a perfect method of calculating expected returns. However, the same logic that dictates varying periodic returns versus forecasted returns described above for bonds influences the return profile for equities as well.

The price of a stock is, in theory, based on a series of expected cash flows. These cash flows do not accrue directly to the shareholder, with the sole exception of dividends. Regardless, valuations for equities are based on determining the appropriate premium or discount that investors are willing to pay for a company’s theoretical future cash flows, which ultimately hinge on net earnings growth.

The earnings trend growth rate for U.S. equities has been remarkably consistent over time and well correlated to GDP growth. Because the basis for pricing stocks, earnings, is a relatively fixed constant, we can use trend analysis to understand when market returns have been over and under the long-term expected return rate.

The graph below does this for the S&P 500. The orange line is the real price (inflation adjusted) of the S&P 500, the dotted line is the polynomial trend line for the index, and the green and red bars show the difference between the index and the trend.

Data Courtesy Shiller/Bloomberg

The green and red bars point to a definitive pattern of over and under performance. Periods of outperformance in green are met with periods of underperformance in red in a highly cyclical pattern. Further, the red and green periods tend to mirror each other in terms of duration and performance. We use black arrows to compare how the duration of such periods and the amount of over/under performance are similar.  

If the current period of outperformance is once again offset with a period of underperformance, as we have seen over the last 80 years, than we should expect a ten year period of underperformance. If this mean reversion were to begin shortly, then expect the inflation adjusted S&P 500 to fall 600-700 points below the trend over the next ten years, meaning the real price of the S&P index could be anywhere from 1500-2300 depending on when the reversion occurs. 

We now do similar mean reversion analysis based on valuations. The graph below compares monthly periods of Cyclically Adjusted Price to Earnings (CAPE) versus the following ten-year real returns. The yellow bar represents where valuations have been over the last year.

Data Courtesy Shiller/Bloomberg

Currently CAPE is near 30, or close to double the average of the last 100 years. If returns over the next ten years revert back to historic norms, than based on the green dotted regression trend line, we should expect annual returns of -2% for each of the next ten years. In other words, the analysis suggests the S&P 500 could be around 2300 in 2029. We caution however, valuations can slip well below historical means, thus producing further losses.

John Hussman, of Hussman Funds, takes a similar but more analytically rigorous approach. Instead of using a scatter plot as we did above, he plots his profit margin adjusted CAPE alongside the following twelve-year returns. In the chart below, note how closely forward twelve-year returns track his adjusted CAPE. The red circle highlights Hussman’s expected twelve-year annualized return.

If we expect this strong correlation to continue, his analysis suggests that annual returns of about negative 2% should be expected for the next twelve years. Again, if you discount the index by 2% a year for twelve years, you produce an estimate similar to the prior two estimates formed by our own analysis.  

None of these methods are perfect, but the story they tell is eerily similar. If mean reversion occurs in price and valuations, our expectations should be for losses over the coming ten years.

Summary

As the saying goes, you can’t predict the future, but you can prepare for it. As investors, we can form expectations based on a number of factors and adjust our risk and investment thesis as we learn more.

Mean reversion promises a period of below average returns. Whether such an adjustment happens over a few months as occurred in 1987 or takes years, is debatable. It is also uncertain when that adjustment process will occur. What is not debatable is that those aware of this inevitability can be on the lookout for signs mean reversion is upon us and take appropriate action. The analysis above offers some substantial clues, as does the recent equity market return profile. In the 20 months from May 2016 to January 2018, the S&P 500 delivered annualized total returns of 21.9%. In the 20 months since January 2018, it has delivered annualized total returns of 5.5% with significantly higher volatility. That certainly does not inspire confidence in the outlook for equity market returns.

We remind you that a bond yielding 2% for the next ten years will produce a 40%+ outperformance versus a stock losing 2% for the next ten years. Low yields may be off-putting, but our expectations for returns should be greatly tempered given the outperformance of both bonds and stocks over the years past. Said differently, expect some lean years ahead.

Selected Portfolio Position Review: 09-18-19

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.

VXX – IPath Series VIX Short-Term Futures

  • We added a starter position of VXX to portfolios yesterday to hedge against a pickup in volatility. We are likely a bit early, and volatility will likely drift lower in the days ahead, but as noted by the red box, volatility is extremely suppressed.
  • We have a stop set at $22 where we will re-evaluate our holding relative to market action and overall overbought conditions.
  • We will update our position as we continue to build into it.

CHCT – Community Healthcare Trust

  • We added CHCT earlier this year and it has turned into one of our best performers.
  • It is so overbought we can not conceivably add to the position currently, however, we have taken profits previously.
  • It is close to a “sell signal” so we are hopeful we will get a pullback to support between $38 and $40 to add to the position.
  • Stop is moved up to $37.

CMCSA – Comcast Corp.

  • CMCSA recently broke out to a new high and continues to perform well since adding it to the portfolio.
  • It has reversed its previous “sell signal” and the new highs are unconstrained at this point.
  • We will look to see where the next pullback builds a base which is where we will look to add to our holding and move stop levels up to.
  • Stop loss is at $42

DOV – Dover Corp.

  • As noted last week, after almost getting stopped out, DOV has turned up from support. DOV is currently on a sell signal, but we are now looking for an entry point to add to our existing holdings after taking profits previously.
  • The stock is back to overbought currently as industrials have surged on hopes of a trade deal with China in October.
  • We are looking for the sell-signal to reverse to set up a move to new highs.
  • Stop loss is moved up to support at $87.50

COST – Costco Wholesale

  • COST has had a big run in recent months and is extremely overbought.
  • Currently the position is pulling back from a rather extreme extension so support needs to hold around $280.
  • If support holds we can look to add to our current holding after taking profits previously.
  • Stop-loss moved up to $250

MDLZ – Mondelez International

  • MDLZ after a huge run has been building a base around support.
  • With a “sell signal” in place we are reluctant to add to our holdings currently. But given the current support of prices, we are reluctant to sell now as well.
  • We have taken profits previously, so we are simply moving our stop levels up for now and watching support.
  • Stop loss is moved up to $53

PEP – Pepsico Inc.

  • PEP recently broke out to all-time highs as the bid for Staples has continued unabated.
  • PEP is very overbought and flirting with a “sell signal,” so there is currently no rush to add exposure at the moment.
  • A pullback that works off the overbought condition and holds support will provide a better entry point to add to our holdings.
  • Stop-loss is set at $125

UNH – UnitedHealth Group

  • UNH has continued to struggle in downtrend as of late but has failed to violate our stop levels.
  • Given the position is extremely oversold we are being patient to allow our thesis of sector rotation to come to favor.
  • We are looking to add to these positions opportunistically as performance improves.
  • Stop-loss is set at $220

UTX – United Technologies

  • UTX, along with BA, have had very nice rallies over the last couple of weeks.
  • With UTX triggering a “buy signal” we are bullish on the position for now but need a breakout to new highs to confirm our thesis.
  • If that occurs we will look to add opportunistically to our position.
  • Stop loss remains at $122.50

XOM – Exxon Mobil

  • Interestingly, XOM was moving higher ahead of the Saudi oil production strikes.
  • However, yesterday, the gains were reversed as it is realized the disruption will likely not last long.
  • XOM is extremely oversold and the pickup in performance is encouraging.
  • I had noted a couple of weeks ago that XOM was deeply oversold and we were looking to add to the position. A pullback that establishes a higher low will provide that opportunity to add back to our position.
  • We are looking for our “buy signal” to turn higher and some further price action which gives us more confidence in adding back to our holding after selling 1/2 the position earlier this year.
  • Stop loss remains at $67

Today’s Melt Up Triggers Tomorrow’s Melt Down

Since November of 2016, the NDX has soared by 72% and is poised to break the recent all-time high of 8027. Today, it seems that sentiment is shifting back to selling bonds and buying riskier equities with hyped estimates. FAANG stocks have fueled an ongoing rally, via stock buybacks, non – GAAP financial gimmicky, and promises of eventual profitability for many unicorn startups.

Source: Stockcharts.com – 9/12/19

Sentiment has moved prices up as the market has suspended its disbelief of key fundamentals like future earnings, declining sales, job layoffs, contracting world trade, and negative cash flow.

First, let’s look at downward revised earnings forecasts for the rest of the year indicating a decline almost to a contraction level in the U.S.:

Sources: Bloomberg, IIF – 9/10/19

Analysts expect lower earnings and profitability due to declining sales. The pivotal function of any business is sales. The inventory to sales ratio is now at 2008 levels indicating that sales are declining while production is continuing, which is typical of the later stages in the business cycle:

Sources: The Wall Street Journal, The Daily Shot – 9/12/19

Continuing present production levels with flat to declining sales is unsustainable.  Executives are faced with declining sales overseas in part due to tariffs. As such, the number of production shifts must be reduced, as the highest cost for most businesses is payroll.  A key indicator of executives beginning to reduce staff is indicated by an increase in jobless claims in five key manufacturing states starting about when tariffs were first enacted in November of 2018:

Sources: B of A Merrill, Haver, The Wall Street Journal, The Daily Shot – 8/30/19

Markets are underestimating the devasting impact that broad tariffs are having on U.S. corporate sales.  S & P 100 corporations generally recognize from 50 – 60 % of total sales from overseas, and profits of 15 – 25 % or more from emerging markets like China and India.  When tariffs hit U.S. products, there is a cascading effect on small businesses, and throughout the worldwide supply chain. Even if a product is produced domestically, many of the sourced parts come from several emerging markets which now face tariffs. China’s tariffs on U.S. farm products like soybeans have reduced sales by 90 %.  Soybean farmers are looking for new markets, but are having a difficult time replacing the massive purchases that China makes each year.  Tariffs are culminating sales headwinds and investment uncertainty at the fastest rate since 2008.

Sources: CPB World Monitor, The Wall Street Journal, The Daily Shot – 9/11/19

In the midst of all these economic and business headwinds, executives should be running tight finances, right?  Well, not exactly. Due to a surge in debt issuance, corporations now have the highest debt to GDP ratio in history.  However, they may not have learned about how to keep out of financial trouble.  S & P 500 corporations are paying out more cash than they are taking in, creating a cash flow crunch at a – 15 % rate (that’s right they are burning cash) to maintain stock buyback and dividend levels:

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

Source: RIA PRO (www.riapro.net) Chart of the Day -9/10/2019

Unicorn IPO valuations are off the chart, many with unproven business models and large losses. 2019 has seen the highest value of IPOs since 2000, an indicator of high interest in risky investments and soaring investor sentiment. Not surprising, 2019 has the highest number of negative earnings per share IPO companies since 2000 as well.

Sources: Dealogic, The Wall Street Journal, The Daily Shot – 6/18/19

Sources: Jay Ritter, University of Florida, The Wall Street Journal – 3/16/18

The lack of profitability and the number of IPOs ‘to cash out before it’s too late’ evokes memories of the 2000 Dotcom Crash.  Then, investors were looking for ‘high tech growth’ stocks, and as it was assumed that companies would figure out their business model later. 

When?  As an example, Uber just recorded a $5.24 billion loss for the 2nd quarter of 2019.  Lyft lost $644 million in the same quarter.  Despite the popularity of their services, the business models for both ride-sharing companies has yet to be proven. Making profitability even harder for these companies, the State of California legislature just passed a bill recognizing ride-sharing drivers as employees and not contractors. Gov. Gavin Newsom is expected to sign the legislation.  If Uber and Lyft have to pay salaries, benefits and other costs for full-time employees they will incur staggering costs, and may likely never be profitable.  Uber says it is building a ‘transportation platform’ where drivers are delivering food and packages not transporting passengers so they can avoid being labeled a passenger transportation company.  Both firms are planning to put an initiative on the ballot to declare their drivers as contractors to save their business models.  It is still unclear, even with drivers being recognized as contractors, that they have viable business models. Yet investors just didn’t care at IPO time, though both stocks have since dropped in price dramatically since their IPO dates. Ride sharing is just one small industry and one example. There are many other unicorns with questionable businesses that are flourishing in the markets.

The suspended disbelief we see today is similar to the sentiment that sent the NDX up nearly 400% just before the Y2K crash.   We can learn from what happened beginning 20 months before the Y2K crash.  The NDX started in October of 1998 at 1063 and peaked at 4816 in May of 2000:

That astounding move up was followed by a roller coaster ride down to 2897 for a 38 % decline by May of 2000, followed further by a two year decline to 795, or 84 % decline from the 2000 peak.  The NDX would not reach the 4816 level again for another 16 years!  Investors had to wait a long time just to break even.

One similarity to the Y2K related drop in sales we see today is from tariffs. Companies have pulled purchases forward to avoid tariffs. Similar activity occurred in 1999 as IT departments bought new software and hardware to solve a possible year 2000 (Y2K) software bug. Software and hardware purchases were pulled forward into 1999, then as one IT manufacturer CEO put it ‘the lights went out on sales.’  The hard dates for tariff increases a year ago forced corporations to pull up purchases that would otherwise be made later in the year, resulting in an unnatural boost followed by a contraction of business activity.

Consumer products will be hit with 15 % tariffs in October and 25 % in December, so consumer, like businesses, are likely moving up their purchases. We expect consumer spending to show increases in August, and September, and decline after that.  A contraction in consumer business operations is likely to follow pulled up consumer purchases.

Plus, investors need to be cognizant of the huge transformation of the world trade infrastructure into two competing trade blocks triggered by the trade war by the U.S. and China as discussed in my post: Navigating A Two Block Trading World. The forming of two trade blocks will change the character of world trade, and therefore create uncertainty in international sales for all businesses dependent on overseas customers to maintain growth and profitability.

Today, sentiment is set in suspended disbelief that ‘the Fed will cut rates’ and make the economy grow.  Corporations are swimming in low-cost debt, with negative cash flows and flat to falling sales.  If the Fed governors pick up an attaché case with a sales pitch and get sales going again then the Fed might have an impact on corporate profitability. Yes, cheap money may help stave off layoffs or cost reductions, but in the end businesses will have to cut costs to match new lower sales levels.

The market ‘hopes’ that a trade deal will revive the economy as well.  An ‘interim’ trade deal where China gives up very little except a commitment to purchase agriculture and livestock products in return for a suspension of increased tariffs won’t change the broad-based tariff damage to the economy.  Unless broad-based tariffs are ended, as 1,100 economists recommended in a letter to the Trump administration 18 months ago, the hemorrhaging of sales will continue.

So what can we learn from today’s investor sentiment compared to sentiment observed during the Dotcom crash?  When the market finally ends its disbelief and is hit with the reality of business fundamentals, the decline will be fast and deep. The melt up, or whatever is left of it, will trigger a melt down.  The 4:1 return difference in the 2000 melt up versus today’s melt up today is likely due to the 4.7 % GDP rate in 1999 versus the forecasted 1.7 % GDP forecasted for 2nd quarter this year.  In 2000, the economy was simply growing a lot faster than today, and productivity was rapidly growly. This helped sentiment and provided some basis for the melt up.  Further the melt up in 1999 was fueled by the Fed providing excessive liquidity to help ensure that Y2K did not shut down the economy.

The current melt up is occurring at a much lower level of economic activity. Yet, both instances are based on a disconnect between what is happening in the economy and the valuations of stocks. The longer the disconnect with fundamentals, the longer it will take for the reversion to the mean to rebalance the economy. Plus, the further the disconnect the larger reversion to the mean or even an overshoot and it will take longer to get back to ‘even’ – maybe 16 years from the peak as we saw in Dotcom Crash in 2000.

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.

5-Things Your Broker Wont Tell You – Part 4

Social Security is America’s pension.

Without Social Security included as part of a retirement income plan, even disciplined savers may experience financial vulnerability in retirement.

With the inclusion of Social Security or an inflation-adjusted income annuity that lasts a lifetime, a retiree may depend less on variable assets like stocks to create a predictable retirement income, especially during market cycles characterized by poor sequence of returns risk. Investors in distribution mode must now pay attention to the imminent headwind in stock market returns.

When investment assets perform poorly over a series of years perhaps decades, guaranteed income sources like Social Security can decrease the burden on a portfolio alone to shoulder the distribution burden. In other words, there’s less pressure to withdraw from variable assets that may require time to appreciate or recover if there are guaranteed income options considered.

We witness the fortunate few who have pensions AND  are smart with Social Security decisions, retire earlier than 65 and comfortably compared to their non-pension brethren. According to Willis Towers Watson, only 16% of Fortune 500 companies offer defined benefits plans (pensions) to new hires (2017), compared to 59% in 1998.

According to surveys conducted by the Social Security Administration, roughly half the aged population live in households that receive at least 50% of total family income from Social Security. About a quarter of senior households receive at least 90% of household income from Social Security; a bad benefits enrollment  decision can result in thousands of lost lifetime income for recipients, spouses and possibly survivors.

Many brokers are replete with incorrect information about Social Security. Their organon is based on political affiliation, anecdotal headline fodder and perhaps something perused on the internet. After all, Social Security analysis takes time and there are big sales quotas to meet! You as a future retiree, cannot afford to be so casual about the decision – A wrong move can lead to a diminished quality of life throughout retirement.

At our Retirement Right Lane Classes and Wednesday Lunch & Learn events, Social Security is a hot topic.

Here are several Social Security concepts your broker will ignore. Oh, we know they ignore them.

We listen to the stories from attendees.

Social Security ‘blanket information’ can be dangerous.

Blanket information about Social Security is pervasive which makes the topic treacherous to navigate. Take benefits early at 62 because it’s going away; wait until full retirement age or postpone benefits until age 70 to capture delayed retirement credits.

What to do?

The proper advice depends on several personal factors including overall health of the recipient and a spouse,  additional household retirement income resources including pensions and investments, and the intent to preserve investment assets for heirs or spend them down. At RIA, we also incorporate our firm’s expected future returns on variable investments like stocks and the probability of sequence of returns risk to determine whether a future Social Security recipient should enroll for benefits at full retirement age (full retirement age is older than age 66 if born after 1954) or postpone until age 70.

Social Security is a family decision.

The ripple effect of a poor Social Security claiming decision can affect a family for decades. Non-working spouses, women in particular, can suffer from poor decisions made by husbands who claim Social Security early at age 62, thus permanently cutting spousal and survivor benefits by  roughly 25%.

Given the fact that women live longer and second marriages may result in additional children, claiming Social Security before full retirement age can be a narrow-minded decision when spouses and families are involved. Often, the decision is driven by emotion and false narratives such as – “I need to live long enough to breakeven,” or the ever-popular “I want to take it early when I can spend it, not when I’m 80 and don’t need it.” I can’t even wrap my head around rationale for the latter.

Unfortunately, we hear of brokers who support or communicate similar bonehead (thank you for the word, President Trump!) commentary. I understand why people aspire to breakeven or get out of the system what they put in however, this is flawed logic.

There is much more to a claiming decision, as I mentioned previously. For the most part, Social security is ‘actuarial agnostic,’ which means most recipients receive their entitled benefits in full. Retirees who maintain healthy lifestyle habits and have loved ones to consider have better reasons to wait until age 70.

There are people who express how upset they are with Social Security. They believe in their own investment acumen over the U.S. government guarantee to provide lifetime income. It doesn’t appear that individual investors are as good as they believe they are. It’s called overconfidence bias and it’s an emotional plague.

Based on Dalbar’s annual Quantitative Analysis of Investor Behavior study, investors consistently do poorly relative to market benchmarks.

The key findings of the 2017 Dalbar study include:

  • In 2016, the average equity mutual fund investor underperformed the S&P 500 by a margin of -4.70%. While the broader market made gains of 11.96%, the average equity investor earned only 7.26%.
  • In 2016, the average fixed income mutual fund investor underperformed the Bloomberg Barclays Aggregate Bond Index by a margin of -1.42%. The broader bond market realized a return of 2.65% while the average fixed income fund investor earned 1.23%.
  • Equity fund retention rates decreased materially in 2016 from 4.10 years to 3.80 years. (This is directly related to psychology and behavior.)
  • In 2016, the 20-year annualized S&P return was 7.68% while the 20-year annualized return for the Average Equity Fund Investor was only 4.79%, a gap of -2.89% annualized.

In 2018, Dalbar discovered that most investors lost 9.42%; the S&P 500 was down 4.38%.

To compare Social Security benefits to returns from stocks is like looking for similarities between apples and squirrels. A suitable evaluation would have one researching returns for guaranteed investments such as long-term U.S. Treasury bonds.

Also, if retail investors were so disciplined, the median 401(k) balance for those 65 and older would be a heck of a lot greater than $58,035. Yes, you read that correctly.  Yet, roughly one-third of Americans claim Social Security at 62 and cut by 25% quite possibly, the only  guaranteed lifetime income they’re going to receive.

Claiming a Social Security widow’s benefit early is almost always a mistake.

A Retirement Right Lane Class attendee explained how a financial professional advised her to take her Social Security widow’s benefit at age 60 even though she didn’t need the money, is gainfully employed full time and not planning to retire until age 65.  

Her husband enrolled in Social Security early at age 62 which ultimately reduced the survivor benefit to 82.5% of the amount his widow would have received had he waited to claim benefits at full retirement age.

If our attendee had listened to the professional advice and claimed her survivor benefit at age 60, she would have received 71.5% of an already reduced benefit. Based on our Social Security maximization analysis using a life expectancy of 88 years old (from www.livingto100.com), we counseled this widow to wait until full retirement age to claim her survivor benefit, postpone her benefit and claim on her own record at age 70. This strategy will result in an increase of $288,284 in lifetime benefits if she lives to age 88.

Social Security planning should be included in your holistic financial planning process. To ignore or minimize its positive financial impact to a retiree or survivor’s bottom line is shortsighted.

Part 5 – Your pending tax bombshell in retirement – Courtesy of your broker and the financial services industry.

Surging Repo Rates- Why Should I Care?

A subscriber emailed us regarding our repurchase agreement (repo) analysis from Tuesday’s Daily Commentary. Her question is, “why should I care about a surge in repo rates?” The commentary she refers to is at the end of this article.

Before answering her question, it is worth emphasizing that it is rare for overnight Fed Funds or Repo rates to spike, as happened this week, other than at quarter and year ends when bank balance sheets have little flexibility. Clearly, balance sheet constraints due to the end of a quarter or year are not causing the current situation.  Some say the current situation may be due to a lack of bank reserves which are used to make loans, but banks have almost $2 trillion in excess cash reserves. Although there may likely be an explanation related to general bank liquidity, there is also a chance the surge in funding costs is due to a credit or geopolitical event with a bank or other entity that has yet to be disclosed to the public.

Before moving ahead, let us take a moment to clarify our definitional terms.

Fed Funds are daily overnight loans between banks that are unsecured, or not collateralized. Overnight Repo funding are also daily overnight loans but unlike Fed Funds, are backed with assets, typically U.S. Treasuries or mortgage-backed securities. The Federal Reserve has the authority to conduct financing transactions to add or subtract liquidity to ensure overnight markets trade close to the Fed Funds target. These transactions are referred to as open market operations which involve the buying or selling of Treasury bonds to increase or decrease the amount of reserves (money) in the system. Reserves regulate how much money a bank can lend. When reserves are limited, short-term interest rates among and between banks rise and conversely when reserves are abundant, funding costs fall. QE, for instance, boosted reserves by nearly $3.5 trillion which enabled banks to provide liquidity to markets and make loans at low interest rates.

Our financial system and economy are highly leveraged. Currently, in the U.S., there is over $60 trillion in debt versus a monetary base of $3.3 trillion. Further, there is at least another $10-15 trillion of dollar-based debt owed outside of the U.S. 

Banks frequently have daily liquidity shortfalls or overages as they facilitate the massive amount of cash moving through the banking system. To balance their books daily, they borrow from or lend to other banks in the overnight markets to satisfy these daily imbalances. When there is more demand than supply or vice versa for overnight funds, the Fed intervenes to ensure that the overnight markets trade at, or close to, the current Fed Funds rate.

If overnight funding remains volatile and costly, banks will increase the amount of cash on hand (liquidity) to avoid higher daily costs. To facilitate more short term cash on their books, funds must be conjured by liquidating other assets they hold. The easiest assets to sell are those in the financial markets such as U.S. Treasuries, investment-grade corporate bonds, stocks, currencies, and commodities.  We may be seeing this already. To wit the following is from Bloomberg:  

“What started out as a funding shortage in a key U.S. money market is now making it more costly to get hold of dollars globally. After a sudden surge in the overnight rate on Treasury repurchase agreements, demand for the dollar is showing up in swap rates from euros, pounds, yen and even Australia’s currency. As an example, the cost to borrow dollars for one week in FX markets while lending euros almost doubled.”

A day or two of unruly behavior in the overnight markets is not likely to meaningfully affect banks’ behaviors. However, if the banks think this will continue, they will take more aggressive actions to bolster their liquidity.

To directly answer our reader’s question and reiterating an important point made, if banks bolster liquidity, the financial markets will probably be the first place from which banks draw funds. In turn, this means that banks and their counterparties will be forced to reduce leverage used in the financial markets. Stocks, bonds, currencies, and commodities are all highly leveraged by banks and their clientele. As such, all of these markets are susceptible to selling pressure if this occurs.

We leave you with a couple of thoughts-

  • If the repo rate is 3-4% above the Fed Funds rate, the borrower must either not be a bank or one that is seriously distressed. As such, is this repo event related to a hedge fund, bank or other entity that blew up when oil surged over 10% on Monday? Could it be a geopolitical related issue given events in the Middle East? 
  • The common explanation seems to blame the massive funding outlays due to the combination of Treasury debt funding and corporate tax remittances. While plausible, these cash flow were easy to predict and plan for weeks in advance. This does not seem like a valid excuse.

In case you missed it, here is Tuesday’s RIA repo commentary:  Yesterday afternoon, overnight borrowing costs for banks surged to 7%, well above the 2.25% Fed Funds rate. Typically the rate stays within 5-10 basis points of the Fed Funds rate. Larger variations are usually reserved for quarter and year ends when banks face balance sheet constraints. It is believed the settlement of new issue Treasury securities and the corporate tax date caused a funding shortage for banks. If that is the case, the situation should clear up in a day or two. Regardless of the cause, the condition points to a lack of liquidity in the banking sector. We will follow the situation closely as it may impact markets if it continues.

Technically Speaking: The Risk Of A Liquidity Driven Event

Over the last few days, the internet has been abuzz with commentary about the spike in interest rates. Of course, the belief is that the spike in rates is “okay” because the market are still rising. 

“The yield on the benchmark 10-year Treasury note was poised for its largest weekly rally since November 2016 as investors checked prior concerns that the U.S. was careening toward an economic downturn.” – CNBC

See, one good economic data point and apparently everything is “A-okay.” 

Be careful with that assumption as the backdrop, both economically and fundamentally, does not support that conclusion. 

While the 10-year Treasury rate did pop up last week, it did little to reverse the majority of “inversions” which currently exist on the yield curve. While we did hit the 90% mark on August 28th, the spike in rates only reversed 2 of the 10 indicators we track. 

Nor did it reverse the most important inversion which is the 10-year yield relative to the Federal Reserve rate. 

However, it isn’t the “inversion” you worry about. 

Take a look at both charts carefully above. It is when these curves “un-invert” which becomes the important recessionary indicator. When the curves reverse, the Fed is aggressively cutting rates, the short-end of the yield curve is falling faster than the long-end as money seeks the safety of “cash,” and a recession is emerging.

As I noted in yesterday’s missive on the NFIB survey, there are certainly plenty of warning signs the economy is slowing down. 

 In turn, business owners remain on the defensive, reacting to increases in demand caused by population growth rather than building in anticipation of stronger economic activity. 

What this suggests is an inability for the current economy to gain traction as it takes increasing levels of debt just to sustain current levels of economic growth. However, that rate of growth is on the decline which we can see clearly in the RIA Economic Output Composite Index (EOCI). 

All of these surveys (both soft and hard data) are blended into one composite index which, when compared to GDP and LEI, has provided strong indications of turning points in economic activity. (See construction here)”

“When you compare this data with last week’s employment data report, it is clear that recession” risks are rising. One of the best leading indicators of a recession are “labor costs,” which as discussed in the report on “Cost & Consequences Of $15/hr Wages” is the highest cost to any business.

When those costs become onerous, businesses raise prices, consumers stop buying, and a recession sets in. So, what does this chart tell you?”

There is a finite ability for either consumers or businesses to substantially sustain higher input costs in a slowing economic environment. While debt can fill an immediate spending need, debt does not lead to economic growth. It is actually quite the opposite, debt is a detractor of growth over the long-term as it diverts productive capital from investment to debt service. Higher interest rates equals higher debt servicing requirements which in turns leads to lower economic growth.

The Risk Of Liquidity

In the U.S., we have dismissed higher rates because of a seemingly strong economy. However, that “strength” has been a mirage. As I previously wrote:

“The IIF pointed out the obvious, namely that lower borrowing costs thanks to central banks’ monetary easing had encouraged countries to take on new debt. Amusingly, by doing so, this makes rising rates even more impossible as the world’s can barely support 100% debt of GDP, let alone 3x that.”

That illusion of economic growth has kept investors blind to the economic slowdown which is already occurring globally. However, with global bond yields negative, the US Treasury is the defacto world’s risk-free rate. 

If global bond yields rise, by any significant degree, there is a liquidity funding risk for global markets. This is why, as I noted this past week, the ECB acted in the manner it did to increase liquidity to an already illiquid market. The reason, to bail out a systemically important bank. To wit:

We had previously stated the Central Banks are going to act to bail out systemically important banks which are on the brink of failure – namely, Deutsche Bank ($DB) Not surprisingly, this was the same conclusion Bloomberg finally arrived at:

“Deutsche Bank AG will benefit the most by far from the European Central Bank’s new tiered deposit rate. Germany’s largest lender stands to save roughly 200 million euros ($222 million) in annual interest paymentsthanks to a new rule that exempts a big chunk of the money it holds at the ECB from the negative rate the central bank charges on deposits. That’s equivalent to 10% of the pretax profit the analysts expect the bank to report in 2020, compared with an average of just 2.5% for the EU banks included in the analysis.”

When you combine rising yields with a stronger U.S. dollar it becomes a toxic brew for struggling banks and economies as the global cost of capital rising is the perfect cocktail for a liquidity crunch.

Liquidity crunches generally occur when yield curves flatten or invert. Currently, as noted above, the use dollar has been rising, as the majority of yield curves remain inverted. This is a strong impediment for economic growth as funding costs are distorted and the price of exports are elevated. This issue is further compounded when you consider the impact of tariffs on the cost of imports which impacts an already weak consumer. 

Yes, for now the US economy seems to be robust, and defying the odds of a slowdown. However, such always seems to be the case just before the slowdown begins. It is likely a US downturn is closer than most market participants are predicting.

If we are right, this is going to leave the Federal Reserve in a tough position trying to reverse rates with inflation showing signs of picking up, unemployment low, and stocks near record highs.

Concurrently, bond traders are still carrying one of the largest short positions on record, leaving plenty of fuel to drive rates lower as the realization of weaker economic growth and deteriorating earnings collide with rather excessive stock market valuations. 

How low could yields go. In a word, ZERO.

While that certainly sounds implausible at the moment, just remember that all yields globally are relative. If global sovereign rates are zero or less, it is only a function of time until the U.S. follows suit. This is particularly the case if there is a liquidity crisis at some point.

It is worth noting that whenever Eurodollar positioning has become this extended previously, the equity markets have declined along with yields. Given the exceedingly rapid rise in the Eurodollar positioning, it certainly suggests that “something has broken in the system.” 

You can see this correlation to equities more clearly in the chart below. 

Did Something Break?

The rush by the Central Banks globally to ease liquidity, the ECB restarting the QE, and the Federal Reserve cutting rates in the U.S. suggest there is a liquidity problem somewhere in the system. 

Ironically, as I was writing this report, something “broke.” 

“Rising recession concerns in August – manifesting in the form of an inverted yield curve, cash hiding in repo, and a slow build in UST supply – kept secured funding pressures at bay. However, the dollar funding storm we warned about has just made landfall as the overnight general collateral repo rate, an indicator of secured market stress and by extension, dollar funding shortages, soared from Friday’s close of 2.25% to a high of 4.750%, a spike of 250bps…” – Zerohedge

This is likely just a warning for now.

Given the disproportionate role of quant-driven strategies, leveraged traders, and the compounded risk of “passive strategies,” there is profound market risk when rates rise to quickly. If the correlations that underpin the multitude of algo-driven, levered, risk-parity portfolios begin to fail, there is more than a significant risk of a disorderly reversion in asset prices. 

The Central Banks are highly aware of the risks their policies have grown in the financial markets. Years of zero interest rates, massive liquidity injections, and easy financial standards have created the third asset bubble this century. The problem for Central Bankers is the bubble exists in a multitude of asset classes from stocks to bonds, and particularly in the sub-prime corporate debt market.

As Doug Kass noted on Monday, roughly 80% of loan issuers have no public securities (which serves to limit financial disclosure) and 62% of junk issuers have only 144A bonds.

Source: JPM, Bloomberg Barclays, Prequin

However, here is the key point:

“While a paucity of financial disclosure is not problematic during a bull market for credit, it is a defining feature of a liquidity crisis during a bear market. Human beings are naturally inclined towards fear–even panic–when they are unable to obtain the information they deem critical to their (financial) survival.” – Tad Rivelle, TCW

As noted, liquidity is the dominant risk in the multitude of “passive investing products” which are dependent upon the underlying securities that comprise them. As Tad notes:

“There is yet another feature of this cycle, that while not wholly unique will likely play a major supporting role in the next liquidity crisis: the passive fund. Passive funds are the epitome of the low information investor. 

Anyone wonder what might happen should passive funds become large net sellers of credit risk? In that event, these indiscriminate sellers will have to find highly discriminating buyers who–you guessed it–will be asking lots of questions. Liquidity for the passive universe–and thus the credit markets generally–may become very problematic indeed.”

The recent actions by Central Banks certainly suggests risk has risen. Whether this was just an anomalous event, or an early warning, it is too soon to know for sure. However, if there is a liquidity issue, the risk to “uniformed investors” is substantially higher than most realize. As Doug concludes:

“Never before in history have traders and investors been so uninformed. Indeed, some might (with some justification) say that never before in history have traders and investors been so stupid!

But, the conditions of fear and greed have not been repealed — and will contribute to bouts of liquidity changes that range from, and alternate between, where ‘anything goes’ and ‘nothing is believed.’

Arguably, stock and bond prices have veered from the real economy as the cocktail of easing central banks and passive investing strategies produce a constant bid for financial assets, suppresses volatility and, in the fullness of time, will likely cause a liquidity ‘event.’ 

While the absence of financial knowledge, disclosure and the general lack of skepticism are accepted in a bull market, sadly in a bear market (when everyone is “on the same side of the boat,”) it is a defining feature of a liquidity crisis.”

While those in the mainstream media only focus on the level of the S&P 500 index to make the determination that all is right with the world, a quick look from behind the “rose colored” glasses should at least give you a reason pause. 

Risk is clearly elevated, and investors are ignoring the warning signals as markets continue to bid higher.

We saw many of the same issues in 2008 when Bear Stearns collapsed. 

No one paid attention then either.

Sector Buy/Sell Review: 09-17-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • XLB remains confined to a very broad topping pattern currently BUT it continues to hold onto support at the 200-dma as rumors of a “trade deal” seem to always come just in the “nick of time.”
  • XLB rallied last week on hopes of upcoming trade talks and is reversing the oversold condition.
  • There are multiple tops just overhead which will provide significant resistance.
  • We are remaining underweight the sector for now.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • As noted last week, XLC held support and bounced back towards highs and is testing resistance.
  • With XLC not overbought yet, a further rally is possible if the market trades higher.
  • Support is held at $48.
  • XLC has a touch of defensive positioning from “trade wars” and given the recent pullback to oversold, a trading position was placed in portfolios.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $46
  • Long-Term Positioning: Bearish

Energy

  • What a difference a bit of bombing can make. Last week, we discussed that XLE continues to struggle with supply builds and a weakening economy.
  • In one session, XLE broke above the 200-dma and is trading towards previous target resistance levels.
  • The rally that occurred is a positive but its too soon to buy into until we see a bit of consolidation of this advance which is now extremely overbought. A pullback to the 200-dma that holds would be an ideal entry point to add weightings.
  • We were stopped out of our position previously.
  • Short-Term Positioning: Bearish
    • Last week: Stopped out.
    • This week: Stopped out.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF remains in a long consolidation range since the beginning of 2018.
  • XLF has reversed its “sell” signal but is back to very overbought. Look for a pullback that retest the breakout of the downtrend to add exposure to the sector.
  • We previously closed out of positioning as inverted yield curves and Fed rate cuts are not good for bank profitability. However, there is a trading opportunity present with the right setup.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • XLI bounced back over the last week on hopes of a trade war “resolution” and is trying to break above a series of previous tops. This is very bullish if it holds.
  • We need to wait through Friday to see if XLI can maintain the breakout of if it fails. If it is able to confirm the breakout we will add to our existing holdings.
  • XLI is back to overbought but the sell signal is reversing.
  • We reduced our risk to the sector after reaching our investment target. We are now adjusting our stop-loss for the remaining position.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $72
  • Long-Term Positioning: Neutral

Technology

  • XLK remains one of the “safety” trades against the “trade war.”
  • XLK has moved back to short-term overbought, and remains a fairly extended and crowded trade.
  • XLK held support at $75 and is breaking its short-term consolidation. Next target are old highs and the top of the uptrend line.
  • The buy signal is close to reversing to a “sell.”
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $75.00
  • Long-Term Positioning: Neutral

Staples

  • As noted previously, defensive positioning remains a VERY crowded trade.
  • The “buy” signal (lower panel) is still in place but has been worked off to a good degree. We continue to recommend taking some profits if you have not done so.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $58
    • Long-Term Positioning: Bullish

Real Estate

  • As with XLP above, XLRE was consolidating its advance and has now pushed to new highs and is extremely extended.
  • XLRE is also a VERY CROWDED defensive trade.
  • XLRE is correcting its previously overbought condition, so be careful adding new positions and keep a tight stop for now.
  • We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That occurred.
  • Buy signal has been reduced and has turned positive which is bullish for now.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLRE and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup.
  • Long-term trend line remains intact and the recent test of that trend line with a break to new highs confirms the continuation of the bullish trend.
  • Buy signal reversed and held and has now turned higher.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has triggered a sell signal but has remained intact and is trying to recover with the market.
  • While XLV continues to flirt with support levels. The current correction was expected, and a break above $92 will put old highs into focus.
  • We continue to maintain a fairly tight stop for now.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • Despite the fact the latest round of tariffs directly target discretionary items, XLY rallied anyway on hopes to a resolution of the “trade war” before the holiday shopping season.
  • We added to our holdings last week to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY is trying to reverse its “sell signal.”
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN spiked higher over the last couple of trading sessions on an “oversold” bounce and is now extremely overbought once again.
  • XTN remains is a very broad trading range, and this rally is most likely going to fail at the previous highs for the range. It is now make or break for the sector.
  • XTN has reversed its “sell” signal but is extremely overbought.
  • A break above resistance will set XTN up for a rally to old highs and will become a much more intresting trade.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Quick Take: Revising The Data

“The United States economy is an extremely complex and dynamic system. Trying to measure the level and pace of economic growth, employment, inflation, and productivity are very difficult, if not impossible tasks. The various government and private agencies bearing the responsibility for such measurement do their best in what must be acknowledged as a highly imperfect effort. Initial readings are always revised, sometimes heavily, especially at key turning points in the economy.”  –The Fed Body Count (LINK)

In the preliminary annual employment benchmark revision based on state unemployment insurance records, the Labor Department recently revised job gains recorded in the period from April 2018 through March 2019 down by 501,000. As shown below, that is the largest downward revision in the past ten years. The unusually large negative adjustment means that job growth averaged only 170,000 per month versus the previous estimate of 210,000 per month for the period.

Two of the biggest revisions came in the bellwether industries of leisure & hospitality and retail, down 175,000 and 146,000 respectively. Professional and business services employment was revised lower by 163,000. The economy needs to produce 150,000- 200,000 jobs per month in order to keep the unemployment rate from rising. What this report from the Bureau of Labor Services (BLS) suggests is that employment was significantly weaker than believed through March 2019 and the unemployment rate may not be as good as is generally believed.

That downward revision is surprising given the tax cuts, large boost to fiscal spending, and solid GDP growth throughout 2018. Unfortunately, it appears that while the tax cuts helped corporate bottom lines, few companies used their windfall towards endeavors that generate economic activity. As we have harped on in the past, stock buybacks and larger dividends have little effect on economic growth.

These labor market revisions argue that the momentum in the economy is far weaker than previously believed.

The numbers in themselves are disappointing but more importantly and as described in previous articles, such revisions tend to reveal themselves points in time when the economy is at critical turning points. For investors, economic uncertainty may be further cause for defensive posturing.

The graph below shows the cyclical nature of the unemployment rate. Importantly to today, the rate tends to level out prior to rising into a recession. Today’s unemployment rate is showing signs of leveling off but has yet to increase. These revisions coupled with slowing growth makes employment a key indicator to follow.

NFIB Survey Trips Economic Alarms

Last week, I wrote an article discussing the August employment report, which clearly showed a slowdown in employment activity and an overall deterioration the trend of the data. To wit:

“While the recent employment report was slightly below expectations, the annual rate of growth is slowing at a faster pace. Therefore, by applying a 3-month average of the seasonally-adjusted employment report, we see the slowdown more clearly.”

I want to follow that report up with analysis from the latest National Federation of Independent Businesses monthly Small Business Survey. While the mainstream media overlooks this data, it really shouldn’t be.

There are 28.8 million small businesses in the United States, according to the U.S. Small Business Administration, and they have 56.8 million employees. Small businesses (defined as businesses with fewer than 500 employees) account for 99.7% of all business in the U.S. The chart below shows the breakdown of firms and employment from the 2016 Census Bureau Data.

Simply, it is small businesses that drive the economy, employment, and wages. Therefore, what the NFIB says is extremely relevant to what is happening in the actual economy versus the headline economic data from Government sources.

In August, the survey declined 1.6 points to 103.1. While that may not sound like much, it is where the deterioration occurred that is most important.

As I discussed previously, when the index hit its record high:

Record levels of anything are records for a reason. It is where the point where previous limits were reached. Therefore, when a ‘record level’ is reached, it is NOT THE BEGINNING, but rather an indication of the MATURITY of a cycle.” 

That point of “exuberance” was the peak.

It is also important to note that small business confidence is highly correlated to changes in, not surprisingly, small-capitalization stocks.

The stock market, and the NFIB report, confirm risk is rising. As noted by the NFIB:

“The Uncertainty Index rose four points in August, suggesting that small business owners are reluctant to make major spending commitments.”

Before we dig into the details, let me remind you this is a “sentiment” based survey. This is a crucial concept to understand.

“Planning” to do something is a far different factor than actually “doing” it.

For example, the survey stated that 28% of business owners are “planning” capital outlays in the next few months. That’s sounds very positive until you look at the trend which has been negative. In other words, “plans” can change very quickly.

This is especially the case when you compare their “plans” to the outlook for economic growth.

The “Trump” boom appears to have run its course.

This has significant implications to the economy since “business investment” is an important component of the GDP calculation. Small business “plans” to make capital expenditures, which drives economic growth, has a high correlation with Real Gross Private Investment.

As I stated above, “expectations” are very fragile. The “uncertainty” arising from the ongoing trade war is weighing heavily on that previous exuberance.

If small businesses were convinced that the economy was “actually” improving over the longer term, they would be increasing capital expenditure plans rather than contracting their plans. The linkage between the economic outlook and CapEx plans is confirmation that business owners are concerned about committing capital in an uncertain environment.

In other words, they may “say” they are hopeful about the “economy,” they are just unwilling to ‘bet’ their capital on it.

This is easy to see when you compare business owner’s economic outlook as compared to economic growth. Not surprisingly, there is a high correlation between the two given the fact that business owners are the “boots on the ground” for the economy. Importantly, their current outlook does not support the ideas of stronger economic growth into the end of the year.

Of course, the Federal Reserve has been NO help in instilling confidence in small business owners to deploy capital into the economy. As NFIB’s Chief Economist Bill Dunkleberg stated:

“They are also quite unsure that cutting interest rates now will help the Federal Reserve to get more inflation or spur spending. On Main Street, inflation pressures are very low. Spending and hiring are strong, but a quarter-point reduction will not spur more borrowing and spending, especially when expectations for business conditions and sales are falling because of all the news about the coming recession. Cheap money is nice but not if there are fewer opportunities to invest it profitably.”

Fantasy Vs. Reality

The gap between those employers expecting to increase employment versus those that did has been widening. Currently, hiring has fallen back to the lower end of the range and contrasts the stats produced by the BLS showing large month gains every month in employment data. While those “expectations” should be “leading” actions, this has not been the case.

The divergence between expectations and reality can also be seen in actual sales versus expectations of increased sales. Employers do not hire just for the sake of hiring. Employees are one of the highest costs associated with any enterprise. Therefore, hiring takes place when there is an expectation of an increase in demand for a company’s product or services. 

This is also one of the great dichotomies the economic commentary which suggests retail consumption is “strong.” While business remain optimistic at the moment, actual weakness in retail sales is continuing to erode that exuberance.

Lastly, despite hopes of continued debt-driven consumption, business owners are still faced with actual sales that are at levels more normally associated with the onset of a recession.

With small business optimism waning currently, combined with many broader economic measures, it suggests the risk of a recession has risen in recent months.

Customers Are Cash Constrained

As I discussed previously, the gap between incomes and the cost of living is once again being filled by debt.

Record levels of consumer debt is a problem. There is simply a limit to how much “debt” each household can carry even at historically low interest rates. In turn, business owners remain on the defensive, reacting to increases in demand caused by population growth rather than building in anticipation of stronger economic activity. 

What this suggests is an inability for the current economy to gain traction as it takes increasing levels of debt just to sustain current levels of economic growth. However, that rate of growth is on the decline which we can see clearly in the RIA Economic Output Composite Index (EOCI). 

All of these surveys (both soft and hard data) are blended into one composite index which, when compared to GDP and LEI, has provided strong indications of turning points in economic activity. (See construction here)

As shown, the slowdown in economic activity has been broad enough to turn this very complex indicator lower.

No Recession In Sight

When you compare this data with last week’s employment data report, it is clear that “recession” risks are rising. One of the best leading indicators of a recession are “labor costs,” which as discussed in the report on “Cost & Consequences Of $15/hr Wages” is the highest cost to any business.

When those costs become onerous, businesses raise prices, consumers stop buying, and a recession sets in. So, what does this chart tell you?


Don’t ignore the data.

Today, we once again see many of the early warnings. If you have been paying attention to the trend of the economic data, and the yield curve, the warnings are becoming more pronounced.

In 2007, the market warned of a recession 14-months in advance of the recognition. 

Today, you may not have as long as the economy is running at one-half the rate of growth.

However, there are three lessons to be learned from this analysis:

  1. The economic “number” reported today will not be the same when it is revised in the future.
  2. The trend and deviation of the data are far more important than the number itself.
  3. “Record” highs and lows are records for a reason as they denote historical turning points in the data.

We do know, with absolute certainty, this cycle will end.

“Economic cycles are only sustainable for as long as excesses are being built. The natural law of reversions, while they can be suspended by artificial interventions, cannot be repealed.” 

Being optimistic about the economy and the markets currently is far more entertaining than doom and gloom. However, it is the honest assessment of the data, along with the underlying trends, which are useful in protecting one’s wealth longer-term.

RIA PRO: Has The Narrative Been All Priced In?


  • The Bullish Narrative
  • Is It All Priced In?
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The Bullish Narrative

This past week was built for the “bulls” as just about every item on their “wish list.” was fulfilled. From a “trade deal” to more “QE,” what more could you want?

Trade Deal Near?

Concerning the ongoing “trade war,” our prediction that Trump would begin to back peddle on negotiations to get a “deal done” before the election came to pass.

Trump has once again delayed tariffs to allow the Chinese more time to position. China, smartly, is using the opportunity to buy soy and pork products (which they desperately need due to a virus which wiped out 30% of their pig population) to restock before the next meeting.

This is a not so insignificant point.

China is out for “China’s” best interest and will not acquiesce to any deal which derails their long-term plans. In the short-term, they may “play the game” to get what they need as a country, but in the long-run, they will protect their own interests. As we noted previously:

“If China does indeed increase U.S. imports, the stronger dollar will increase the costs of imports into China from the U.S., which negatively impacts their economy. The relationship between the currency exchange rate and U.S. Treasuries is shown below.”

“China uses U.S. Treasury bonds to “sanitize” trading operations. When the currency exchange rate is not favorable, China can adjust treasuries holdings to restore balance.”

However, don’t mistake China’s move as “caving” into Trump. Such is hardly the case.

While Beijing will allow Chinese businesses to purchase a “certain amount of farm products such as soybeans and pork” from the US, China has also cut a deal for soy meal from Argentina.

“China will allow the import of soymeal livestock feed from Argentina for the first time under a deal announced by Buenos Aires on Tuesday, an agreement that will link the world’s top exporter of the feed with the top global consumer.”

Hmmm…that sounds very familiar:

Trade is a zero-sum game. There is only a finite amount of supply of products and services in the world. If the cost of U.S. products and services is too high, China sources demand out to other countries which drain the supply available for U.S. consumers. As imbalances shift, prices rise, increasing costs to U.S. consumers.” – Game Of Thrones 05-10-19

As Hua Changchun, an economist at Guotai Junan Securities, a brokerage in the PRC, said:

“Beijing’s latest ‘gesture’ has increased the prospects for a narrow trade deal with the US. But it’s a small deal. It means that there would be no escalation of tariffs as China has agreed to make more purchases. It could provide a certain level of comfort to US farmers and give Trump something to brag about.”

China knows how to play this game very well, and they know that Trump needs a way “out” of the mess he has gotten himself into.

Not surprisingly, as Trump said on Thursday, while he prefers a broad deal, he left open the possibility of a more limited deal to start, which is also code for:

“Let’s get a deal on the easy stuff, call it a win, and go home.”

Hmm, this is what we wrote earlier this year:

 

“Importantly, we have noted that Trump would eventually ‘cave’ into the pressure from the impact of the ‘trade war’ he started.”

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

Kind of like that “Denuclearization deal” with North Korea.

ECB Goes All In

If the potential for a “trade deal” wasn’t enough to spur equities, then surely the ECB throwing in the monetary policy stimulus towel would do the trick. Last week, the ECB went “all in” by:

  • Cutting already negative deposit rates for the first time since 2016 to stimulate the sagging European economy, by 10bps to -0.50%.

  • Restarted QE by €20 billion per month and it will be open-ended

  • The ECB dropped calendar-based forward guidance and replaced it with inflation-linked guidance, noting that key ECB interest rates will “remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon.”

  • The ECB eased TLTRO terms with banks whose eligible net lending exceeds a benchmark.

  • Additionally, the maturity of the operations will be extended from two to three years.

  • Finally, the ECB will introduce a two-tier system for reserve remuneration in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate, in an attempt to mitigate the adverse impact to banks. 

(h/t Zerohedge)

We had previously stated the Central Banks are going to act to bail out systemically important banks which are on the brink of failure – namely, Deutsche Bank ($DB)

Not surprisingly, this was the same conclusion Bloomberg finally arrived at:

“Deutsche Bank AG will benefit the most by far from the European Central Bank’s new tiered deposit rate. Germany’s largest lender stands to save roughly 200 million euros ($222 million) in annual interest payments thanks to a new rule that exempts a big chunk of the money it holds at the ECB from the negative rate the central bank charges on deposits. That’s equivalent to 10% of the pretax profit the analysts expect the bank to report in 2020, compared with an average of just 2.5% for the EU banks included in the analysis.”

Duetsche Bank was heard singing:

“Thank you for the bailout,

On your way out,

Mr. Draghi.” 

But it isn’t just the ECB easy monetary policy to support global markets and economies. According to Charlie Bilello, everyone is doing it:

Importantly, QE and negative rates are destroying the banking system globally. These programs DO NOT stimulate economic growth or an incentive for productive investment. Rather, these programs only succeed in inflating asset prices, increasing demand for risky debt, and acting as a “wealth transfer” system from the middle-class to the wealthy.

The reality is that these interventions have been “required” just to hold the current construct up. As we will discuss in a moment, the Federal Reserve tried to normalize rates, but was only able to make minimal progress before the “wheels came off the cart.”  

The question is, what’s going to happen when a recession finally occurs?

That is a question for later.

The Economy Shows Signs Of Life

Adding fuel to the “bullish” case, the economy did show signs of improvement. 

Before you get all excited, all this indicator denotes is that economic data is “less bad” than it was previously. The chart below is our RIA Economic Output Composite Index which is a comprehensive measure of the U.S. economy from both the manufacturing and service side of the ledger. 

While the data may have surprised recently, the overall economy is not accelerating; it just isn’t declining as quickly. With the Citi index already much improved, the temporary run of “less bad” data will likely reverse in the next couple of months.

Then, there is the last “hold out.” 

The Fed Is On Deck

All the bulls need now is the Fed to “cut” rates at the meeting next week. 

It is expected the Fed will cut rates by 0.25% at the next meeting. However, what will be important is how they couch their views going forward. 

The problem for the Fed is two fold.  

  1. If they come out too “dovish,” they will appear to be “caving” to Trump’s demands which would threaten their “independence.” 
  2. If they come out too “hawkish,” they run the risk of disappointing the markets, and already weaker consumer confidence. 

The Fed is in really a tough spot. Given they have already cut rates once this year, they have already depleted what little bit of “ammunition” they have to combat the next recessionary downturn in the economy. 

Furthermore, core CPI jumped over the past month, which will lead the Fed’s preferred measure of inflation which is the Personal Consumption Expenditure (PCE) index.

With PCE forecasted to rise over the next several months, this potentially puts the Fed in a box. Interestingly,  when Fed began “hiking rates” in 2015, over concerns of rising inflationary pressures, PCE is now higher than back then. This is going to make it difficult to support the case for “zero interest rates.” 

With markets hovering at all-time highs, the unemployment rate near record lows, and inflationary pressures near their target levels, there is little reason to be cutting rates now. 

For the bulls, the good news is, they will cut rates anyway. 

Is It All Priced In?

With all the bullish news this past week, it is certainly not surprising that market rallied sharply.  

Oh, wait….it was only a 0.6% gain?

“But, it’s a lot higher for the month. “

Yes, the market has rallied 3.4% for the month so far, but since the May highs, the market has risen by only 1.9%. Given the volatility and angst of the summer months, bonds have provided a better return.

However, with all the “bullish” news one could hope for, it certainly seems like the markets would/should have responded better. 

Or, maybe its the fact that the markets have been front running this news ever since the December lows.  From December 24th to today, the market has already risen markedly. 

  • The Dow Jones Industrial Average has risen 5427 points
  • The S&P 500 has risen 656 points.
  • The Nasdaq Composite has surged 1983.79 points.

At the same time as markets were surging on hopes of a trade deal, Fed rate cuts, and more ECB QE, corporate profits have declined. (Note: Profits have fallen on a pre-tax basis and are barely stable at 2012 levels despite a full 5% decline in effective tax rate)

Earnings expectations have fallen.

Valuations have increased.

There is a decent argument to be made that whatever positive benefit may come from all these actions have already been priced into equities currently. 

As we noted last week, the “bulls” regained the narrative when the S&P 500 broke above 2945. Unfortunately, they just haven’t been able to do much with it so far. 

Currently, the risk/reward is not in the bulls favor short term. With the market back to very overbought conditions, the upside to the top of the bullish trend channel is about 1.9%. The downside risk is about 5.5%.

What about that bloodbath in bond yields?

Yes, we finally got the much-needed sell off in bonds. This is something we have been expecting now for several weeks as discussed with our RIAPRO subscribers:

  • Like GLD, Bond prices have surged on Trump ramping up the trade war.
  • The overbought condition is rather extreme, so be patient and wait for a correction back to the breakout level to add holdings.
  • Prices could pullback to the $135-137 range which would be a better entry point.
  • Long-Term Positioning: Bullish

That correction came last week with bonds taking it on the chin as shown in the chart below. 

However, let’s keep it in perspective for a moment. That little red square, if you can see it, is the rate jump this past week. 

I will note that previous overbought conditions (bonds are inverse from stocks) have led to decent reversals in rates, which have repeatedly been outstanding buying opportunities for bond investors. 

This is because higher rates negatively impact economic growth. It is also worth noting that collapsing bond prices tends to lead the S&P 500 as it suggests that something “just broke” in the market. 

While there are certainly many arguments supporting the “bullish case” for equities at the moment, the reality is that much of “news” has already been priced in. 

More importantly, if that is indeed the case, then where will the next leg of support for the bull market going to come from?

It is hard to suggest there will be a aggressive reversal of economic growth, profit margins, and confidence considering the current length of the economic cycle. 

I will reiterate from last week:

“This is why, despite the bullish overtone, we continue to hold an overweight position in cash (see 8-Reasons), have taken steps to improve the credit-quality in our bond portfolios, and shifted our equity portfolios to more defensive positioning. 

We did modestly add to our equity holdings with the breakout on Thursday from a trading perspective. However, we still maintain an overall defensive bias which continues to allow us to navigate market uncertainty until a better risk/reward opportunity presents itself. “

That remains the case this week as well. 

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

See you next week.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet  

 


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 has continued to fade and is close to turning negative. However, the sector is holding support and turned higher this past week. After taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

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

Our more defensive positioning continues to outperform relative to the broader market. Volatility has risen markedly, which makes markets tough to navigate for now. However, after taking some profits and re-positioning the portfolio, we will remain patient and wait for the market to tell us what it wants to do next. Real Estate, Staples and Utilities all continue to make new highs but are GROSSLY extended. We added to our position in XLC bringing it to full weight previously.

Current Positions: Target weight XLP, XLU, XLRE, and XLC

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

While Technology, and Discretionary did turn higher and are looking to set new highs. Relative performance is beginning to improve as well. We previously added to our position in Discretionary and continue to hold Technology. 

Current Position: Target weight XLY, XLK

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF), Materials (XLB)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. Energy has rallied over the last week and may give us an opportunity to add the position back to the portfolio. A one week advance doesn’t make up for the previous damage so we will be patient and look for the right opportunity. 

Current Position: 1/2 weight XLI, XLB

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps popped sharply last week on a rotation from large-cap stocks. We have seen these pops before which have quickly failed so we will need to give these markets some room to consolidate and prove up performance. With economic data weakening, which significantly impacts small-cap stocks, the risk of failure remains pretty high for now. 

Current Position: No position

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

We have been out of Emerging and International Markets for several weeks due to lack of performance. However, these markets rallied this past week on hopes of a “trade resolution,” and the ECB going all in on rates and QE. The spike was good but the markets remain unconvincing as we have seen the rallies before that failed. We will watch and wait for a better 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.

Current Position: RSP, VYM, IVV

Gold (GLD) – Gold FINALLY corrected this past week, so we added to our positions. We will do so again on a further pullback to support. This correction was much needed to work off the extreme overbought condition. 

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

Bonds (TLT) – 

Like Gold, bonds also finally corrected to work off some of the EXTREMELY overbought condition. Like gold, we used the pullback to lengthen the duration in our bond portfolios by swapping GSY (short-duration) for IEF (longer-duration.) We will continue to add to IEF as the reversal in rates continues. 

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 noted last week, the market did break above the consolidation to the upside. That has worked well for the positioning we added to portfolios, and we remain fully weighted in Technology, Discretionary, Communications, Healthcare, Staples and Utilities. We still remain underweight in Materials and Industrials (after taking profits previously) due to the ongoing “trade war.” 

For now, the markets are rallying on hopes of a “trade deal” and the Fed cutting rates next week. However, despite the ECB going all in, the markets didn’t move much which leads us to believe the bulk of the “news” is already priced in. 

We are renting this rally and will take profits when markets reach overbought and extended levels once again. We are getting close to that point currently. 

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

  • New clients: We have been onboarding slowly. Please contact your advisor with any questions. 
  • Equity Model: Added to our positions in GDX and IAU. Swapped GSY for IEF.
  • ETF Model:  Added to IAU. Swapped GSY for IEF.

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

401k-PlanManager-AllocationShift

Trade, ECB, Fed, Oh My!

More rhetoric on the “trade front” as China and Trump are seeking to get a deal done and get the “Trade War” off the table before the election. The Fed is set to cut rates next week, and the ECB went all-in on “Making Negative Rates Great Again.”

None of this is good news economically over the long-run but help push stocks marginally higher last week. This was what we have been suggesting over the last couple of weeks as the market broke above the previous consolidation. 

A break above that resistance will allow for a push back to all-time highs.”

We continue to remain underweight equities for now because the markets remain trapped within a fairly broad range and continues to vacillate in fairly wide swings. This makes it difficult to do anything other than just wait things out.

It will be important the market continues to rally next week. However, the overall action this past week was not great. Despite the rally this week, the downside risk is elevated, so we are maintaining underweight holdings for now. If you haven’t taken any actions as of late, it is not a bad time to do so. 

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

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

401k Plan Manager Beta Is Live

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

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

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

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

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

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

Current 401-k Allocation Model

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


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

 

Major Market Buy/Sell Review: 09-16-19

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

  • As noted in our daily portfolio commentary we added a 2x long with the breakout the week before last. We closed that position out at the high water mark this past week. (Got lucky)
  • We are still maintaining our core S&P 500 position as the market has not technically violated any support levels as of yet.
  • As we noted last week, it is unlikely the current advance is going to go far unless the “Sell” signal can be reversed. That process is trying to occur so we will watch accordingly.
  • The upside for this rally is the July highs but remains a rally to sell into. We are at that level so this is a good time to take profits and rebalance portfolio risk accordingly.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position.
    • Stop-loss moved up to $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • Like the SPY, DIA is broke above resistance and is now testing previous highs.
  • As noted last week, DIA has registered a “Sell” signal which needs to be reversed. That process is happening and the markets need to rally next week.
  • Look for this rally to fail likely next week.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $255.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • We noted that QQQ had rallied modestly, but was uninspiring. On Friday, QQQ rallied above short-term resistance putting previous highs into focus.
  • Like DIA and SPY, a “Sell signal” has been registered. It will be important for the market to rally enough next week to get above resistance and reverse the signal.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $175
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • The sell signal has reversed to a buy with the strong rally last week.
  • With SLY back to extreme overbought, and below previous resistance, and in a negative trend, this looks like a better selling opportunity rather than a buy.
  • However, as we have repeatedly stated, there are a lot of things going wrong with small-caps currently so the risk outweighs the reward of a trade at this juncture.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss previously violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY, like SLY, is technically not in great shape, but did manage to rally last week to the top of the downtrend line.
  • MDY has now registered a “sell” signal which must be reversed before considering adding exposure.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. The sector did rally last week on hopes of a trade resolution, and the ECB cutting rates, but that rally is simply another rally in a long-term downtrend.
  • A sell signal has been triggered as well.
  • EEM is running into heavy overhead resistance so next week will be important.
  • As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA continues to drag.
  • EFA remains in a downtrend and is testing the top of that range.
  • EFA has also triggered a sell signal so any further rally is required to reverse that signal and set up a tradeable opportunity.
  • As with EEM, we did add a trading position to our long-short portfolio model but it, like EEM, was not performing so we closed it.
  • 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)

  • Oil continues to languish and remains on a sell signal currently. This doesn’t really bode well for either economic growth, or energy stocks near-term.
  • While energy stocks did rally last week, if oil prices decline again, after failing at the downtrend line last week, there is a high risk of a reversal.
  • More importantly, oil is confined to its downtrend and continues to fail at the 200-dma which is trending lower. A break of support at $54 and oil will test $50/bbl fairly quickly.
  • Oil is not oversold and is in a downtrend. There is no reason to be long oil currently.
  • 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

  • Finally, Gold begin to correct its EXTREME overbought condition and buy signal.
  • We added to our Gold position last week, and will continue to add to any correction down to our support levels at $132-134.
  • Short-Term Positioning: Neutral
    • Last week: Added To Holdings
    • This week: Hold positions
    • Stop-loss for whole position move up to $132
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices finally cracked last week and are starting to reverse the EXTREME overbought condition.
  • As with GLD, we swapped bond positions this past week selling short-term bonds and swapping into longer duration Treasuries.
  • On a further decline in prices we will increase our exposure to bonds as well.
  • Short-Term Positioning: Bullish
    • Last Week: Swapped GSY for IEF
    • This Week: Hold positions
    • Stop-loss is moved up to $130
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar had rallied to our $99 target which we laid out back in June of this year when we started tracking the dollar.
  • With the dollar overbought look for a pullback in the dollar to $97 which will provide a decent entry point for long-dollar trades.
  • It is highly likely the dollar will continue its bullish trend with negative rates spreading all over Europe.
  • The rally has now triggered a “buy” signal which keeps us dollar bullish for now.

#WhatYouMissed On RIA: Week Of 09-09-19

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

Lance Roberts & Michael Lebowitz Discuss QE & The Impacts To Growth

Our Best Tweets Of The Week

Our Latest Newsletter


https://realinvestmentadvice.com/bulls-regain-the-narrative-as-they-want-to-believe-09-06-19/


What You Missed At RIA Pro

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

See you next week!

War Gaming The Trade War

People respond to incentives. So do national governments. This is foundational to both economics and geopolitics.

Carefully examining each side’s incentives can illuminate how a conflict will end. No one has infinite choices. They choose from limited options.

That applies to the US-China trade war, which is right now one of our top economic issues. So let’s think through what the players really want, and what each can actually do.

Outrageous or Flexible?

To begin, let’s note that the US and China really have two disputes.

One is about trade, the other is a struggle for military and technological dominance. These overlap. So knowing which drives any particular decision is hard. But for now, I’ll talk mostly about trade.

The first problem is that Donald Trump leads the US side. Understanding what he really wants from China is, well, difficult.

Often, he makes outrageous demands China could never accept. Possibly this is a negotiating tactic. Asking for the moon lets the other side think itself lucky to give anything less than the moon. And if that’s all you need, then you win.

But other times, US demands seem more flexible. We just want China to play fair, respect the rules, and open the Chinese market to US companies, just as the US is open to Chinese imports.

Underlying this is the fact Trump is a politician who wants to get re-elected. To do that, he needs to keep his base support. The base wants him to look tough against China. This limits his negotiating options.

Yet he also needs to keep the economy stable or growing. An extended trade standoff doesn’t help.

The one thing Trump can’t do is let China win. He needs Beijing to give him at least the appearance of significant concessions.

Excess Capacity

Xi Jinping doesn’t have to run for re-election, but he has a billion+ mouths to feed. He needs a growing domestic economy.

To date, much of that growth has come from building infrastructure and industrial production capacity. Someone has to buy what China produces with all that capacity—if not Westerners, then people in China.

Opening China to foreign competitors, as Trump demands, is inconsistent with Xi’s requirements. George Friedman of Geopolitical Futures explained in a recent analysis:

The Trump administration has used tariffs to try to force the Chinese to open their markets to U.S. competition. The problem is that the Chinese economy is in no position to accept such competition. The financial crisis severely affected China’s export industry as the global recession reduced the appetite for Chinese goods. This hurt the Chinese economy greatly, throwing it off balance in a crisis that still reverberates in China today.

China’s main solution to this problem has been to increase domestic consumption – a task that has proved difficult because of the distribution of wealth in China, the inability of financial markets to massively increase consumer credit, and the positioning of Chinese industry to target foreign, rather than domestic, consumers. Selling iPads to Chinese peasants isn’t easy.

Allowing the U.S. to access the Chinese market would have been painful if not disastrous. The Chinese domestic market was the only landing pad China had, and U.S. demands for greater access to it were impossible to meet.

If George is right, then we have the proverbial irresistible force meeting an immoveable object. Trump can’t reduce his demands. Xi can’t accept them.

Also, China’s government is communist. It allows some competition and other capitalist activities, but the kind of open markets that exist in the US are incompatible with China’s objectives.

That makes stalemate the likeliest near-term result… which is what we’ve seen.

This may explain why the US-China trade “negotiations” keep breaking down. They aren’t real negotiations. Agreement is impossible, but it serves both sides to look like they’re making progress.

Presenting that appearance is critical because the US and Chinese governments aren’t the only players here. Others are in the game, too.

Rational Choices

Business leaders are also part of this. What are their incentives?

They want to generate profits. That means making wise investments in new products and markets.

If, for instance, you lead a US manufacturer, the amount you invest in developing a new product depends on the number of potential buyers. That number is bigger if you can include China.

Likewise, your production costs depend on the availability and price of Chinese components.

When both those conditions are in doubt—as they are right now—then you have less incentive to invest in that new product.

You might use the cash that would have gone toward hiring workers and building new facilities to, say, repurchase your own stock. At least you’ll make shareholders happy.

That’s a perfectly rational choice, given the circumstances. But it has consequences.

The longer this drags on, the less confident businesses become, and the more reluctant they are to make growth investments. Eventually, it adds up to recession.

That is the outcome even if everyone involved—CEOs, Trump, and Xi—keeps doing what is reasonable to them, given their incentives and limitations.

Conclusion: This trade war has no off-ramp, so it will likely get worse, not better.

UPDATE: Profiting From A Steepening Yield Curve

In June we wrote an RIA Pro article entitled Profiting From A Steepening Yield Curve, in which we discussed the opportunity to profit from a steepening yield curve with specific investments in mortgage REITs. We backed up our words by purchasing AGNC, NLY, and REM for RIA Advisor clients. The same trades were shared with RIA Pro subscribers and can be viewed in the RIA Pro Portfolios under the Portfolio tab.

We knew when we published the article and placed the trades that the short term risk to our investment thesis was, and still is, a further flattening and even an inversion of the yield curve. That is precisely what happened. In mid to late August the curve inverted by four basis points but has since widened back out.

The graph below compares the 2s/10s yield curve (blue) with AGNC (orange) and NLY (green). Beneath the graph is two smaller graphs showing the rolling 20-day correlation between AGNC and NLY versus the yield curve.

Since writing the article and purchasing the shares, the securities have fallen by about 5%, although much of the price loss is offset by double digit dividends (AGNC 13.20%, NLY 10.73%, and REM 9.06%). While we are not happy with even a small loss, we are emboldened by the strong correlation between the share prices and the yield curve. The trade is largely a yield curve bet, so it is comforting to see the securities tracking the yield curve so closely.

We still think the yield curve will steepen significantly. In our opinion, this will likely occur as slowing growth will prompt the Fed to be more aggressive than their current posture. We also think that there is a high probability that when the Fed decides to become more aggressive they will reduce rates at a faster clip than the market thinks. As we discussed in Investors Are Grossly Underestimating the Fed, when the Fed is actively raising or reducing rates, the market underestimates that path.

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

Heading into the financial crisis, it took the Fed 15 months to go from a 5.25% Fed funds rate to zero. Given their sensitivities today, how much faster might they respond to an economic slowdown or financial market dislocation from the current level of 2.25%?”

Bolstering our view for a steeper yield curve is that the Fed, first and foremost, is concerned with the financial health of its member banks. The Fed will fight an inverted yield curve because it hurts banks profit margins and therefore reduces their ability to lend money. Because of this and regardless of the economic climate, the Fed will use words and monetary policy actions to promote a steeper yield curve.

We are very comfortable with the premise behind our trades, and in fact in mid-August we doubled our position in AGNC. We will also likely add to NLY soon.

For more on this investment thesis, please watch the following Real Vision interview Steepening Yield Curve Could Yield Generational Opportunities.

The Lunacy Of The Dow

I’ve been on Twitter (TWTR) quite a few times railing against the Dow Jones Industrial Average and its price-weighted calculation. And, of course, I am not alone. This index presents a distorted view of any given day’s events although most of the time its foibles are hidden in the performance of the rest of the market.

Let’s look at today, September 11, 2019. I am writing at about 2:30 in the afternoon and the Dow itself is up roughly 137 points on the day. All of that gain, and I mean all of it (within my writer’s margin of error) is attributable to three stocks and number three in that group is good for only 10 points.

That means for all practical purposes, only two stocks are responsible for the Dow’s gain. All the others more or less cancel each other out.

Right now, Boeing (BA) is up 3.4%. That’s a pretty substantial gain but since the stock carries such a high dollar price (381), that percentage yields a 12 point (rounded) gain. And that 12 points translate, through the magic of the Dow’s divisor, into 83 points for the DJIA, itself.

Boeing alone is responsible for the 83 of the Dow’s 127-point gain at this hour.

Apple (AAPL), fresh on the heels of its big tech reveal (no thanks, I do not need a phone with three camera lenses) is up 2.5% or 6 points. That’s 38 Dow points.

And for those of you keeping score, the third stock was Caterpillar (CAT), up 1.2% for 10 Dow points.

Why is this? Because the Dow is calculated by adding up all the changes on the day for the 30 stocks within and then dividing by some engineered number that is less than one. That means a one-point move in any stock, regardless of the stock’s actual price, results in a greater than one point move in the Dow itself.

Now, on days when the high-priced stocks such as Boeing, Apple, and Caterpillar have very small changes, the Dow Industrials will be in step with the other major market indices. But there are times, lots of times when the Dow will be higher on the day and every other major is lower.

Of course, the media will report that the market was up because they focus on the Dow. It does not matter (most of the time) that everything else was lower. Sure, you might hear a more advanced talking head say the market was mixed but that is an easy cop-out.

Here’s a recent tweet of mine – $BA responsible for 102 of the Dow’s 98-point gain.

Why? Because most everything else was lower or flat.

Lunacy!

A one-point change in UnitedHealth (UNH) is treated the same as a one-point move in Pfizer (PFE). At a price of 233, United’s one-point is good for 0.4%.  That’s just noise. Meanwhile, a one-point move in Pfizer at 37 is 2.7%.

Which stock had a more important day?

You know.

Fun with Fractions

And then comes the real fun. Every time they change the Dow, they have to change the divisor to keep the continuity of the historical price record. And every time a Dow stock splits, they have to do it again.

With each change, the divisor seems to get smaller and smaller and anyone who knows math just a little knows that the smaller the divisor (the bottom of the fraction) gets, the larger the value of the result gets.

By all means, track the Dow. It’s not always misleading and I personally more quickly absorb the level of the overall market and change on the day when I look at it, warts and all. However, if you want to really know what happened in the market, you need to look at a bunch of diverse indices, such as the Nasdaq, Russell and S&P 500. Toss in a few sector indices or ETFs, too.

The cheese may stand alone* but the Dow really cannot.


* Hi-ho, the derry-o, the cheese stands alone.

Selected Portfolio Position Review: 09-12-19

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.

AAPL – Apple, Inc.

  • Last week we stated: “AAPL continues to wrestle with its previous breakout of its downtrend. After selling 20% of position previously there is no reason to rush into adding back to the position until the stock makes a decision. Currently, on a buy signal, but overbought, we will likely have some resolution to AAPL over the next month as the “trade issues” become more apparent.”
  • Well, that didn’t actually turn out as planned and the move over the last couple of days on a less the stellar roll out of new products, sent investors scurrying into the stock.
  • With AAPL testing all-time highs we will just have to hold our position for now and wait for a better entry point.
  • Stop loss for the whole position is moved up to $200.

BA – Boeing Corp.

  • We bought 1/2 position in BA when the 737MAX crash occurred. Since then BA has continued to consolidate that decline building a strong base of support.
  • We have been patiently waiting to add to our position which will likely happen in the next day or two. Ideally, we are looking for the “buy signal” to turn up.
  • Stop is moved up to $330.

IAU – Ishares Gold Trust

  • We have been talking for weeks now about the need for a pullback to add to our Gold and Fixed Income holdings. We are finally getting that correction.
  • IAU is still overbought, but the correction is beginning to enter our range of $14-14.25 to add to our holdings.
  • We still think there is more corrective action which could occur which we will use to add to our holdings as well.
  • Stop loss is moved up to $13

DOV – Dover Corp.

  • After almost getting stopped out, DOV has turned up from support.
  • DOV is currently on a sell signal, but we are now looking for an entry point to add to our existing holdings after taking profits previously.
  • Stop loss is moved up to support at $87.50

NSC – Norfolk Southern Corp.

  • NSC has been a great performer and after taking profits, we have been looking for an entry opportunity. We are now getting there.
  • NSC is oversold and the “sell signal” is deeply oversold with NSC holding support following the recent sell-off.
  • This is an ideal setup to add to our holdings and we would like to see the “sell signal” begin to close the gap to confirm our entry point. A little more patience here.
  • Stop-loss moved up to $170

JNJ – Johnson and Johnson

  • JNJ has been under pressure as of late due to legal woes which will pass sooner than later. We previously added to our position at these lower levels and last week the stock has begun to turn up.
  • The stock is on a deeply oversold sell signal, so it will likely take little to get the stock moving higher soon. Fundamentals remain very solid and the position held the longer-term uptrend line.
  • We are going to add additional weight to this holding opportunistically.
  • Stop loss is moved up to $122.50

NLY – Annaly Capital Management

  • As noted previously, we added to “yield curve steepener” positions to our portfolios. NLY and AGNC are constructed in a manner that benefit from a steeper yield curve.
  • The recent flattening in the yield curve and inversion, pulled the positions lower but held our stop-loss levels and are now deeply oversold.
  • We are looking for the right setup to continue building out these positions which also carry a hefty yield of 10%+.
  • Stop-loss is set at $7.40

AGNC – AGNC Investment Corp.

  • Same as above, AGNC is the second position in our “steepener” duo.
  • We are looking to add to these positions opportunistically as the yield curve steepens.
  • Due to the rather large yields we are using wider stop-losses on both positions.
  • Stop-loss is set at $13.00

V – Visa Inc.

  • Last week we stated: “Despite concerns over economic woes, spenders keep on swiping their credit cards. V is currently close to triggering a sell signal, and is extremely overbought. After having taken profits we will look for a correction to add to our holdings.
  • Well, that didn’t take long as V had a large correction last week. This is not unusual for the stock so we are now looking for V to hold support to add back into our position.
  • Stop loss remains at $160.00

XOM – Exxon Mobil

  • As Maxwell Smart used to say: “Missed it by that much.”
  • I had noted a couple of weeks ago that XOM was deeply oversold and we were looking to add to the position. I didn’t get it done.
  • Since then the stock has bounced and I am reluctant to add to the trade just yet as we have seen the bounces fail numerous times previously.
  • We are looking for our “buy signal” to turn higher and some further price action which gives us more confidence in adding back to our holding after selling 1/2 the position earlier this year.
  • Stop loss remains at $67

The August Jobs Report Confirms The Economy Is Slowing

After the monthly jobs report was released last week, I saw numerous people jumping on the unemployment rate as a measure of success, and in this particular case, Trump’s success as President.

  • Unemployment November 2016: 4.7%
  • Unemployment August 2019: 3.7%

Argument solved.

President Trump has been “Yuugely” successful at putting people to work as represented by a 1% decline in the unemployment rate since his election.

But what about President Obama?

  • Unemployment November 2008: 12.6%
  • Unemployment November 2016: 4.7%

Surely, a 7.9% drop in unemployment should be considered at least as successful as Trump’s 1%.

Right?

Here’s a secret, neither one is important.

First, Presidents don’t put people to work. Corporations do. The reality is that President Obama and Trump had very little to do with the actual economic recovery.

Secondly, as shown below, the recovery in employment began before either President took office as the economic recovery would have happened regardless of monetary interventions. Importantly, note the drop in employment has occurred with the lowest level of annual economic growth on record. (I wouldn’t necessarily be touting this as #winning.)

Lastly, both measures of “employment success” are erroneous due to the multitude of problems with how the entire series is “guessed at.” As noted previously by Morningside Hill:

  • The Bureau of Labor Statistics (BLS) has been systemically overstating the number of jobs created, especially in the current economic cycle.
  • The BLS has failed to account for the rise in part-time and contractual work arrangements, while all evidence points to a significant and rapid increase in the so-called contingent workforce.
  • Full-time jobs are being replaced by part-time positions, resulting in double and triple counting of jobs via the Establishment Survey.  (Examples: Uber, Lyft, GrubHub, FedEx, Amazon)
  • A full 93% of the new jobs reported since 2008 were added through the business birth and death model – a highly controversial model which is not supported by the data. On the contrary, all data on establishment births and deaths point to an ongoing decrease in entrepreneurship.
  • Jobless claims have recently reached their lowest level on record which purportedly signals job market strength. Since hiring patterns have changed significantly and increasingly more people are joining the contingent workforce, jobless claims are no longer a good leading economic indicator. Part-time and contract-based workers are most often ineligible for unemployment insurance. In the next downturn, corporations will be able to cut through their contingent workforce before jobless claims show any meaningful uptick.

Nonetheless, despite a very weak payroll number, the general “view” by the mainstream media, and the Federal Reserve, is the economy is still going strong.

In reality, one-month of employment numbers tell us very little about what is happening in the actual economy. While most economists obsess over the data from one month to the next, it is the “trend” of the data which is far more important to understand.

The chart below shows the peak annual rate of change for employment prior to the onset of a recession. The current annual rate of employment growth is 1.4% which is lower than any previous employment level in history prior to the onset of a recession.

But while this is a long-term view of the trend of employment in the U.S., what about right now? The chart below shows the civilian employment level from 1999 to present.

While the recent employment report was slightly below expectations, the annual rate of growth is slowing at a faster pace. Moreover, there are many who do not like the household survey due to the monthly volatility in the data. Therefore, by applying a 3-month average of the seasonally-adjusted employment report, we see the slowdown more clearly.

But here is something else to consider.

While the BLS continually fiddles with the data to mathematically adjust for seasonal variations, the purpose of the entire process is to smooth volatile monthly data into a more normalized trend. The problem, of course, with manipulating data through mathematical adjustments, revisions, and tweaks, is the risk of contamination of bias. A simpler method to use for smoothing volatile monthly data is using a 12-month moving average of the raw data as shown below.

Near peaks of employment cycles, the employment data deviates from the 12-month average, but then reconnects as reality emerges.

Sometimes, “simpler” gives us a better understanding of the data.

Importantly, there is one aspect to all the charts above which remains constant. No matter how you choose to look at the data, peaks in employment growth occur prior to economic contractions, rather than an acceleration of growth. 

But there is more to this story.

A Function Of Population

One thing which is not discussed when reporting on employment is the “growth” of the working-age population. Each month, new entrants into the population create “demand” through their additional consumption. Employment should increase to accommodate for the increased demand from more participants in the economy. Either that or companies resort to automation, off-shoring, etc. to increase rates of production without increases in labor costs. The chart below shows the total increase in employment versus the growth of the working-age population.

The missing “millions” shown in the chart above is one of the “great mysteries” about the longest economic booms in U.S. history. This is particularly a conundrum when the Federal Reserve talks about the economy nearing “full employment.” The disparity shows up in both the Labor Force Participation Rate and those “Not In Labor Force.”

Note that since 2009, the number of those “no longer counted” has dominated the employment trends of the economy. In other words, those “not in labor force” as a percent of the working-age population has skyrocketed.

Of course, as we are all very aware, there are many who work part-time, are going to school, etc. But even when we consider just those working “full-time” jobs, particularly when compared to jobless claims, the percentage of full-time employees is still well below levels of the last 35 years.

It’s All The Baby Boomers Retiring

One of the arguments often given for the low labor force participation rate is that millions of “baby boomers” are leaving the workforce for retirement.

This argument doesn’t carry much weight given that the “Millennial” generation, which is significantly larger, is simultaneously entering the workforce. The other problem is shown below, there are more individuals over the age of 55, as a percentage of that age group, in the workforce today than in the last 50-years.

Of course, the reason they aren’t retiring is that they can’t. After two massive bear markets, weak economic growth, questionable spending habits,and poor financial planning, more individuals over the age of 55 are still working because they simply can’t “afford” to retire.

However, for argument sake, let’s assume that every worker over the age of 55 retires. If the “retiring” argument is valid, then employment participation rates should soar once that group is removed. The chart below is full-time employment relative to the working-age population of 16-54.

Nope.

The other argument is that Millennials are going to school longer than before so they aren’t working either. (We have an excuse for everything these days.)

The chart below strips out those of college-age (16-24) and those over the age of 55.

With the prime working-age group of labor force participants still at levels seen previously in 1988, it does raise the question o2f just how robust the labor market actually is?

Michael Lebowitz touched on this issue previously:

“Why are so many people struggling to find a job and terminating their search if, as we are repeatedly told, the labor market is so healthy? To explain the juxtaposition of the low jobless claims number and unemployment rate with the low participation rate and weak wage growth, a calculation of the participation rate adjusted unemployment rate is revealing.”

‘When people stop looking for a job, they are still unemployed, but they are not included in the U-3 unemployment calculation. If we include those who quit looking for work in the data, the employment situation is quite different. The graph below compares the U-3 unemployment rate to one that assumes a constant participation rate from 2008 to today. Contrary to the U-3 unemployment rate of 3.90%, this metric implies an adjusted unemployment rate of 8.69%.

Importantly, this number is much more consistent with the data we have laid out above, supports the reasoning behind lower wage growth, and is further confirmed by the Hornstein-Kudlyak-Lange Employment Index.”

(The Hornstein-Kudlyak-Lange Non-Employment Index including People Working Part-Time for Economic Reasons (NEI+PTER) is a weighted average of all non-employed people and people working part-time for economic reasons expressed as the share of the civilian non-institutionalized population 16 years and older. The weights take into account persistent differences in each group’s likelihood of transitioning back into employment. Because the NEI is more comprehensive and includes tailored weights of non-employed individuals, it arguably provides a more accurate reading of labor market conditions than the standard unemployment rate.)

One of the main factors which was driving the Federal Reserve to raise interest rates, and reduce its balance sheet, was the perceived low level of unemployment. However, now, they are trying to lower rates despite an even lower level of unemployment than previous.

The problem for the Federal Reserve is they are caught between a “stagflationary economy” and a “recession.” 

“With record low jobless claims, there is no recession on the horizon.” -says mainstream media.

Be careful with that assumption.

In November of 1969 jobless claims stood at 211,000, having risen slightly from the lows recorded earlier that year. Despite the low number of claims, a recession started a month later, and jobless claims would nearly double within six months.

This episode serves as a reminder that every recession followed interim lows in jobless claims and the unemployment rate. We are confident that the dynamics leading to the next recession will not be any different.

But then again, maybe the yield-curve is already giving us the answer.

Black Monday – Can It Happen Again?

The 1987 stock market crash, better known as Black Monday, was a statistical anomaly, often referred to as a Black Swan event. Unlike other market declines, investors seem to be under the false premise that the stock market in 1987 provided no warning of the impending crash. The unique characteristics of Black Monday, the magnitude and instantaneous nature of the drop, has relegated the event to the “could never happen again” compartment of investors’ memories.

On Black Monday, October 19, 1987, the Dow Jones Industrial Average (DJIA) fell 22.6% in the greatest one-day loss ever recorded on Wall Street. Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.

Stock markets, like in 1987, are in a state of complacency, donning a ‘what could go wrong’ brashness and extrapolating good times as far as the eye can see. Even those that detect economic headwinds and excessive valuations appear emboldened by the thought that the Fed will not allow anything bad to happen. 

While we respect the bullish price action, we also appreciate that investors are not properly assessing fundamental factors that overwhelmingly argue the market is overvalued. There is no doubt that prices and valuations will revert to more normal levels. Will it occur via a long period of market malaise, a single large drawdown like 1987, or something more akin to the crashes of 2001 and 2008? When will it occur? We do not have the answers, nor does anyone else; however, we know that those who study prior market drawdowns are better prepared and better equipped to limit their risk and avoid a devastating loss.

History provides us with the gift of insight, and though history will not repeat itself, it may rhyme. While we do not think a 1987-like crash is likely, we would be remiss if we did not at least consider it and assign a probability. 

Fundamental Causes

Below is a summary of some of the fundamental dynamics that played a role in the market rally and the ultimate crash of 1987.

Takeover Tax Bill- During the market rally preceding the crash, corporate takeover fever was running hot. Leveraged Buyouts (LBOs), in which high yield debt was used to purchase companies, were stoking the large majority of stocks higher. Investors were betting on rumors of companies being taken over and were participating in strategies such as takeover risk arbitrage. A big determinant driving LBOs was a surge in junk bond issuance and the resulting acquirer’s ability to raise the necessary capital. The enthusiasm for more LBO’s, similar to buybacks today, fueled speculation and enthusiasm across the stock market. On October 13, 1987, Congress introduced a bill that sought to rescind the tax deduction for interest on debt used in corporate takeovers. This bill raised concerns that the LBO machine would be impaired. From the date the bill was announced until the Friday before Black Monday, the market dropped over 10%.

Inflation/Interest Rates- In April 1980, annual inflation peaked at nearly 15%. By December of 1986, it had sharply reversed to a mere 1.18%.  This reading would be the lowest level of inflation from that point until the financial crisis of 2008. Throughout 1987, inflation bucked the trend of the prior six years and hit 4.23% in September of 1987. Not surprisingly, interest rates rose in a similar pattern as inflation during that period. In 1982, the yield on the ten-year U.S. Treasury note peaked at 15%, but it would close out 1986 at 7%. Like inflation, interest rates reversed the trend in 1987, and by October, the ten-year U.S. Treasury note yield was 3% higher at 10.23%. Higher interest rates made LBOs more costly, takeovers less likely, put pressure on economic growth and, most importantly, presented a rewarding alternative to owning stocks. 

Deficit/Dollar- A frequently cited contributor to the market crash was the mounting trade deficit. From 1982 to 1987, the annual trade deficit was four times the average of the preceding five years. As a result, on October 14th Treasury Secretary James Baker suggested the need for a weaker dollar. Undoubtedly, concerns for dollar weakness led foreigners to exit dollar-denominated assets, adding momentum to rising interest rates. Not surprisingly, the S&P 500 fell 3% that day, in part due to Baker’s comments.

Valuations- From the trough in August 1982 to the peak in August 1987, the S&P 500 produced a total return (dividends included) of over 300% or nearly 32% annualized. However, earnings over the same period rose a mere 8.1%. The valuation ratio, price to trailing twelve months earnings, expanded from 7.50 to 18.25. On the eve of the crash, this metric stood at a 33% premium to its average since 1924. 

Technical Factors

This section examines technical warning signs in the days, weeks, and months before Black Monday. Before proceeding, the chart below shows the longer-term rally from the early 1980s through the crash.

Portfolio Insurance- As mentioned, from the 1982 trough to the 1987 peak, the S&P 500 produced outsized gains for investors. Further, the pace of gains accelerated sharply in the last two years of the rally.

As the 1980s progressed, some investors were increasingly concerned that the massive gains were outpacing the fundamental drivers of stock prices. Such anxiety led to the creation and popularity of portfolio insurance. This new hedging technique, used primarily by institutional investors, involved conditional contracts that sold short the S&P 500 futures contract if the market fell by a certain amount. This simple strategy was essentially a stop loss on a portfolio that avoided selling the actual portfolio assets. Importantly, the contracts ensured that more short sales would occur as the market sell-off continued. When the market began selling off, these insurance hedges began to kick in, swamping bidders and making a bad situation much worse. Because the strategy required incremental short sales as the market fell, selling begat selling, and a correction turned into an avalanche of panic.

Price Activity- The rally from 1982 peaked on August 25, 1987, nearly two months before Black Monday. Over the next month, the S&P 500 fell about 8% before rebounding to 2.65% below the August highs. This condition, a “lower high,” was a warning that went unnoticed. From that point forward, the market headed decidedly lower. Following the rebound high, eight of the nine subsequent days just before Black Monday saw stocks in the red. For those that say the market did not give clues, it is quite likely that the 15% decline before Black Monday was the result of the so-called smart money heeding the clues and selling, hedging, or buying portfolio insurance.

Annotated Technical Indicators

The following chart presents technical warnings signs labeled and described below.

  • A:  7/30/1987- Just before peaking in early August, the S&P 500 extended itself to three standard deviations from its 50-day moving average (3-standard deviation Bollinger band). This signaled the market was greatly overbought. (description of Bollinger Bands)
  • B: 10/5/1987- After peaking and then declining to a more balanced market condition, the S&P 500 recovered but failed to reach the prior high.
  • C: 10/14/1987- The S&P 500 price of 310 was a point of both support and resistance for the market over the prior two months. When the index price broke that line to the downside, it proved to be a critical technical breach.
  • D: 10/16/1987- On the eve of Black Monday, the S&P 500 fell below the 200-day moving average. Since 1985, that moving average provided dependable support to the market on five different occasions.
  • E: August 1987- The relative strength indicator (RSI – above the S&P price graph) reached extremely overbought conditions in late July and early August (labeled green). When the market rebounded in early October to within 2.6% of the prior record high, the RSI was still well below its peak. This was a strong sign that the underlying strength of the market was waning.  (description of RSI)

Volatility- From the beginning of the rally until the crash, the average weekly gain or loss on the S&P 500 was 1.54%. In the week leading up to Black Monday, volatility, as measured by five-day price changes, started spiking higher. By the Friday before Black Monday, the five-day price change was 8.63%, a level over six standard deviations from the norm and almost twice that of any other five-day period since the rally began.   

A longer average true range graph is shown above the longer term S&P 500 graph at the start of the technical section.

Similarities and differences

While comparing 1987 to today is helpful, the economic, political, and market backdrops are vastly different. There are, however some similarities worth mentioning.

Similarities:

  • While LBO’s are not nearly as frequent, companies are essentially replicating similar behavior by using excessive debt and leverage to buy their own shares. Corporate debt stands at all-time highs measured in both absolute terms and as a ratio of GDP. Since 2015, stock buybacks and dividends have accounted for 112% of earnings
  • Federal deficits and the trade deficit are at record levels and increasing rapidly
  • The trade-weighted dollar index is now at the highest level in at least 25 years. We are likely approaching the point where President Trump and Treasury Secretary Steve Mnuchin will push for a weak dollar policy
  • Equity valuations are extremely high by almost every metric and historical comparison of the last 100+ years
  • Sentiment and expectations are declining from near record levels
  • The use of margin is at record high levels
  • Trading strategies such as short volatility, passive/index investing, and algorithms can have a snowball effect, like portfolio insurance, if they are unwound hastily

There are also vast differences. The economic backdrop of 1987 and today are nearly opposite.

  • In 1987 baby boomers were on the verge of becoming an economic support engine, today they are retiring at an increasing pace and becoming an economic headwind
  • Personal, corporate, and public Debt to GDP have grown enormously since 1987
  • The amount of monetary stimulus in the system today is extreme and delivering diminishing returns, leaving one to question how much more the Fed can provide 
  • Productivity growth was robust in 1987, and today it has nearly ground to a halt

While some of the fundamental drivers of 1987 may appear similar to today, the current economic situation leaves a lot to be desired when compared to 1987. After the 1987 market crash, the market rebounded quickly, hitting new highs by the spring of 1989.

We fear that, given the economic backdrop and limited ability to enact monetary and fiscal policy, recovery from an episodic event like that experienced in October 1987 may look vastly different today.

Summary

Market tops are said to be processes. Currently, there are an abundance of fundamental warnings and some technical signals that the market is peaking.

Those looking back at 1987 may blame tax legislation, portfolio insurance, and warnings of a weaker dollar as the catalysts for the severe declines. In reality, those were just the sparks that started the fire. The tinder was a market that had become overly optimistic and had forgotten the discipline of prudent risk management.

When the current market reverses course, as always, there will be narratives. Investors are likely to blame a multitude of catalysts both real and imagined. Also, like 1987, the true fundamental catalysts are already apparent; they are just waiting for a spark. We must be prepared and willing to act when combustion becomes evident.

2020 Will Be The Most Volatile Year In History

The last few weeks marked a turning point in the global economy.

It’s more than the trade war. A sense of vulnerability is replacing the previous confidence—and with good reason.

We are vulnerable, and we’ll be lucky to get through the 2020s without major damage.

Let’s talk about the risks facing us in the next year or so and the economic environment in which we will face those risks.

Supply Shocks Ahead

In a recent Project Syndicate piece, NYU professor and economist Nouriel Roubini outlined three potential shocks, any one of which could trigger a recession:

  • A slower-brewing US-China technology cold war (which could have much larger long-term implications)
  • Tension with Iran that could threaten Middle East oil exports

The first of those seems to be getting worse. The second is getting no better. I consider the third one unlikely.

In any case, unlike 2008, which was primarily a demand shock, these threaten the supply of various goods. They would reduce output and thus raise prices for raw materials, intermediate goods, and/or finished consumer products.

Roubini thinks the effect would be stagflationary, similar to the 1970s.

Because these are supply and not demand shocks, if Nouriel is right, the kind of fiscal and monetary policies employed in 2008 will be less effective this time, and possibly harmful.

Interest rate cuts could aggravate price inflation instead of stimulating growth. That, in turn, would probably reduce consumer spending, which for now is the only thing standing between us and recession.

Subnormal Growth

Most of our problems come down to debt.

Debt isn’t bad and may even be good if it is used productively. Much of it isn’t.

In theory, an economy overloaded with unproductive debt should see rising interest rates due to the excess risk it is taking. Yet we are in a low and falling-rate world. Why?

Lacy Hunt of Hoisington Management proved that government debt accelerations depress business conditions. This reduces economic growth, so rates fall. The data shows the amount of GDP each dollar of new debt generates has been steadily declining.

This is a problem because, among other reasons, central banks still think lower rates are the solution to our problems. So does President Trump.

They are all sadly mistaken, but remain intent on pushing rates closer to zero and then below. This is not going to have the desired effect.

If Lacy is right, as I believe he is, the Federal Reserve is on track to do exactly the wrong thing by dropping rates further as the economy weakens.

The Fed also did the wrong thing by hiking rates in 2018. They should have been slowly raising rates in 2013 and after. They waited too long. This long string of mistakes leaves policymakers with no good choices now.

The best thing they can do is nothing, but that’s apparently not on the menu.

Paralyzed Business

All this bears down on us as other things are changing, too.

Many relate to shrinking world trade. Trump’s trade war hasn’t helped, but globalization was already reversing before he took office.

Industrial automation and other technologies are killing the “wage arbitrage” that moved Western manufacturing to low-wage countries like China. Higher wages in those places are also reducing the advantage. This will continue.

Ideally, this process would have happened gradually and given everyone time to adapt. Trump and his Svengali-like trade advisor, Peter Navarro, want it now. I think the president’s recent demand that US companies leave China wasn’t a bluff. He wants that outcome, and he has the tools to attempt to force it. The only question is whether he will.

I agree that we have to deal with China but the fact that we must do something doesn’t make everything feasible or advisable.

Tariffs are a counterproductive bad idea. Severing supply chains built over decades in less than a few years is, if possible, an even worse idea. It will kill millions of US jobs as factories shut down for lack of components.

Some say this is just more Trump negotiating bluster. Maybe so, but the mere threat paralyzes business activity.

CEOs and boards don’t make major capital commitments without some kind of certainty on their costs and returns. The president is making that impossible for many.

Europe in Shambles

Europe is rapidly turning into a major problem, too. Negative interest rates there are symptoms of an underlying disease. Italy is already in recession. Germany suffered its first negative quarter and may enter “official” recession soon.

Germany is highly export-dependent. The entire euro currency project was arguably a plot to boost German exports, and it worked pretty well.

But it boosted them too much, bankrupting countries like Greece which bought those exports. China, another big customer, is buying less as well.

A German recession will have a global effect. Automobile sales are down and Brexit could mean further declines. That would most assuredly deliver a German and thus a Europe-wide recession. And it will affect US exports and jobs.

Then there’s Brexit. At this point we still don’t know if the UK and EU will reach terms, but there is some risk of a hard end to this drama. News focuses on the damage within the UK, but it will also affect the EU countries, mainly Germany, who trade with the UK.

These supply chains are no less intricate and established than the US-China ones. Tearing them down and rebuilding them will take time and money. The transition costs will be significant.

Bumpy Ride

Remember when experts said to keep politics out of your investment strategy?

We no longer have that choice. Political decisions and election results around the globe now have direct, immediate market consequences. Brexit is just one example.

A far bigger one is the looming 2020 US campaign. None of the possible outcomes are particularly good. I think the best we can hope for is continued gridlock.

But between now and November 2020, none of us will know the outcome. Instead, a never-ending stream of poll results will show one side or the other has the upper hand.

That will generate high market volatility, inspiring politicians and central bankers to “do something” that will probably be the wrong thing.

As noted above, if Roubini is right then rate cuts aren’t going to help. Nor will QE. Both are simply ways of encouraging more debt which Lacy Hunt’s work shows is no longer effective at stimulating growth.

They are, however, effective at blowing up bubbles.

I expect 2020 to be one of the most volatile market years of my lifetime.


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

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

Sector Buy/Sell Review: 09-10-19

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • XLB remains confined to a very broad topping pattern currently BUT it continues to hold onto support at the 200-dma as rumors of a “trade deal” seem to always come just in the “nick of time.”
  • With the buy signal fading the risk remains to the downside for now particularly as trade wars continue to linger on and tariffs were hiked over the weekend.
  • XLB rallied last over the last three sessions on hopes of upcoming trade talks and is reversing the oversold condition.
  • There are multiple tops just overhead which will provide significant resistance.
  • We are remaining underweight the sector for now.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with tighter stop-loss
    • Stop-loss adjusted to $55
  • Long-Term Positioning: Bearish

Communications

  • As noted last week, XLC held support and bounced back towards highs.
  • With XLC not overbought yet, a further rally is possible if the market trades higher.
  • Support is held at $48.
  • XLC has a touch of defensive positioning from “trade wars” and given the recent pullback to oversold, a trading position was placed in portfolios.
  • Short-Term Positioning: Neutral
    • Last Week: Hold trading positions
    • This Week: Hold trading positions.
    • Stop adjusted to $46
  • Long-Term Positioning: Bearish

Energy

  • XLE continues to struggle with supply builds and a weakening economy.
  • As noted last week, with the sector oversold and the “sell signal” is getting extended, there is a decent probability for a retracement.
  • That rally occurred over the last couple of sessions. However, as noted, any rallies should be used as clearing rallies for now to reduce weightings to the sector until the technical backdrop improves.
  • We were stopped out of our position previously.
  • Short-Term Positioning: Bearish
    • Last week: Stopped out.
    • This week: Stopped out.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF has been in a long consolidation rage since the beginning of 2018.
  • XLF has triggered a “sell” signal and has gotten oversold. That oversold condition led to the reflexive bounce over the past few sessions on hopes of more Central Bank stimulus.
  • We closed out of positioning previously as inverted yield curves and Fed rate cuts are not good for bank profitability. Use this rally to reduce holdings accordingly.
  • Short-Term Positioning: Neutral
    • Last week: Closed Out/No Position.
    • This week: Closed Out/No Position.
    • Stop-loss adjusted to $26.00
  • Long-Term Positioning: Bearish

Industrials

  • XLI bounced back last week on hopes of a trade war “cease fire” but is about to run into major overhead resistance.
  • XLI is almost back to overbought and the sell signal remains intact.
  • We reduced our risk to the sector after reaching our investment target. We are now adjusting our stop-loss for the remaining position.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $72
  • Long-Term Positioning: Neutral

Technology

  • XLK remains one of the “safety” trades against the “trade war.”
  • XLK has moved back to short-term overbought, and remains a fairly extended and crowded trade.
  • XLK held support at $75 and is breaking its short-term consolidation. Next target are old highs and the top of the uptrend line.
  • The buy signal is close to reversing to a “sell.”
  • Short-Term Positioning: Bullish
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position
    • Stop-loss adjusted to $75.00
  • Long-Term Positioning: Neutral

Staples

  • As noted previously, defensive positioning is now a VERY crowded trade.
  • The “buy” signal (lower panel) is still in place and is very extended. We continue to recommend taking some profits if you have not done so.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $57
  • Long-Term Positioning: Bullish

Real Estate

  • As with XLP above, XLRE was consolidating its advance and has now pushed to new highs and is extremely extended.
  • XLRE is also a VERY CROWDED defensive trade.
  • XLRE is back to very overbought so be careful adding new positions and keep a tight stop for now.
  • We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That occurred.
  • Buy signal has been reduced and has turned positive which is bullish for now.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLRE and XLU are virtually the same commentary.
  • After taking profits, we have time to be patient and wait for the right setup.
  • Long-term trend line remains intact and the recent test of that trend line with a break to new highs confirms the continuation of the bullish trend.
  • Buy signal reversed and held and has now turned higher.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to support at $58.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has triggered a sell signal and will likely threaten our stop-loss.
  • However, in the meantime, XLV continues to flirt with support levels. The current correction was expected, A breakout of the current downtrend will be bullish.
  • We continue to maintain a fairly tight stop for now.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Hold position
    • Stop-loss adjusted to $88
  • Long-Term Positioning: Neutral

Discretionary

  • Despite the fact the latest round of tariffs directly target discretionary items, XLY rallied anyway on hopes to a resolution of the “trade war” before the holiday shopping season.
  • We added to our holdings last week to participate with the current rally, but are carrying a tight stop on the whole position.
  • XLY has now triggered a “sell signal.”
  • Short-Term Positioning: Neutral
    • Last week: Added 1/2 position.
    • This week: Hold position
    • Stop-loss adjusted to $115.
  • Long-Term Positioning: Neutral

Transportation

  • XTN spiked higher over the last couple of trading sessions on an “oversold” bounce.
  • XTN remains is a very broad trading range, and this rally is most likely going to fail at the previous highs for the range.
  • XTN has triggered a “sell” signal but remains confined to a consolidation which has lasted all year. The continued topping process continues to apply downward pressure on the sector.
  • There is still no compelling reason at this juncture to add XTN to portfolios. We will watch and see what happens.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

An Investor’s Desktop Guide To Trading – Part II

Read Part-1 Here

Currently, it seems that nothing can derail the bull market. Trade wars, weakening economic growth, deteriorating earnings, and inverted yield curves have all been dismissed on “hopes” that a “trade deal” will come, and the Federal Reserve will cut rates. While the last two items may indeed extend the current cycle by a few months, they won’t change the dynamics of the former.

Eventually, this cycle ends. Of that, there is little argument. It is the “when,” that is tirelessly debated.

As I have often stated, I am not bullish or bearish. My job as a portfolio manager is simple; invest money in a manner that creates returns on a short-term basis, but reduces the possibility of catastrophic losses which wipe out years of growth.

In the end, it does not matter IF you are “bullish” or “bearish.” The reality is that the “broken clock” syndrome owns both “bulls” and “bears” during the full-market cycle. However, what is grossly important in achieving long-term investment success is not necessarily being “right” during the first half of the cycle, but by not being “wrong” during the second half.

The second half of the cycle IS coming.

This is why, in times like these that we have to follow our investment rules. Those rules allow us to grow capital but reduces the risk of massive drawdowns when the cycle turns. While there are many promoting “buy and hold” strategies, it is interesting that not one of the great investors throughout history have ever practiced such an investment discipline. In fact, they have all had very specific rules they followed which helped them not only to make investments, but also when to sell them.

So, in following up with part one of this series, here are some more rules from great investors which we can all learn from.


William O’Neil’s 23 Trading Rules

William J. O’Neil is one of the greatest stock traders of our time, achieving a return of 5000% over a 25-year period. He uses a trading strategy called CANSLIM, which combines fundamental analysis, technical analysis, risk management and timing. CANSLIM is an acronym and stands for:

C: Current quarterly earnings per share (up at least 25% vs. year-ago quarter).

A: Annual earnings increases at a compound rate of no less than 25%.

N: New products, new management and new highs.

S: Supply and demand. Stocks with small floats experience greater price rises, plus big volume demand.

L: Leaders and laggards. Keep stocks that outperform and get rid of the laggards.

I: Institutional ownership. Follow the leaders.

M: Market direction. Three out of four stocks follow the trend of the market. When the intermediate trend is bearish, don’t invest.

Here are the rules:

  1. Don’t buy cheap stocks. Avoid the junk pile.
  2. Buy growth stocks that show each of the last three years annual earnings per share up at least 25% and the next year’s consensus earnings estimate up 25% or more. Most growth stocks should also have annual cash flow of 20% or more above EPS.
  3. Make sure the last two or three-quarters earnings per share are up by a minimum of 25% to 30%. In bull markets, look for EPS up 40% to 500%.
  4. See that each of the last three-quarter’s sales is accelerating in their percentage increases, or the last quarter’s sales are up at least 25%.
  5. Buy stocks with a return on equity of 17% or more. The best companies will show a return on equity of 25% to 50%.
  6. Make sure the recent quarterly after-tax profit margins are improving and near the stock’s peak after-tax margins.
  7. Most stocks should be in the top five or six broad industry sectors..
  8. Don’t buy a stock because of its dividend or P/E ratio. Buy it because it’s the number one company in its particular field in terms of earnings and sales growth, ROE, profit margins, and product superiority.
  9. Buy stocks with a relative strength of 85 or higher.
  10. Any size capitalization will do, but the majority of your stocks should trade an average daily volume of several hundred thousand shares or more.
  11. Learn to read charts and recognize proper bases and exact buy points. Use daily and weekly charts to materially improve your stock selection and timing.
  12. Carefully average up, not down, and cut every single loss when it is 7% or 8% below your purchase price with absolutely no exception.
  13. Write out your sell rules that show when you will sell and nail down a profit in your stock.
  14. Make sure your stock has at least one or two better-performing mutual funds who have bought it in the last reporting period. You want your stocks to have increasing institutional sponsorship over the last several quarters.
  15. The company should have an excellent new product or service that is selling well. It should also have a big market for its product and the opportunity for repeat sales.
  16. The general market should be in an uptrend and either favor small or big cap companies.
  17. The stock should have ownership by top management.
  18. Look for a “new America” entrepreneurial company rather than laggard, “old America” companies.
  19. Forget your pride and ego; the market doesn’t know or care what you think.
  20. Watch for companies that have recently announced they are buying back 5% to 10% or more of their common stock. Find out if there is new management in the company and where it came from.
  21. Don’t try to buy a stock at the bottom or on the way down in price, and don’t average down
  22. If the news appears to be bad, but the market yawns, you can feel more positive. The tape is telling you the underlying market may be stronger than many believe. The opposite is also true.
  23. 37% of a stock’s price movement is directly tied to the performance of the industry group the stock is in. Another 12% is due to strength in its overall sector. Therefore, half of a stock’s move is due to the strength of its respective group.

Richard Rhodes 16 Investing Rules

  1. The first and most important rule is – in bull markets, one is supposed to be long. In a bull market, one can only be long or on the sidelines. Remember, not having a position is a position.
  2. Buy that which is showing strength – sell that which is showing weakness. The public continues to buy when prices have fallen. The professional buys because prices have rallied. The rule of survival is not to “buy low, sell high”, but to “buy higher and sell higher.”
  3. When putting on a trade, enter it as if it has the potential to be the biggest trade of the year. Don’t enter a trade until it has been well thought out, a campaign has been devised for adding to the trade, and contingency plans set for exiting the trade.
  4. In bull markets, add to the trade on minor corrections back into support levels. In bear markets, add on corrections into resistance. Use the 33-50% corrections level of the previous movement or the proper moving average as a first point in which to add. 
  5. Be patient. If a trade is missed, wait for a correction to occur before putting the trade on.
  6. Be patient. Once a trade is put on, allow it time to develop and give it time to create the profits you expected.
  7. Be patient. The real money in trading is made from the one, two or three large trades that develop each year. You must develop the ability to patiently stay with winning trades to allow them to develop into that sort of trade.
  8. Be patient. Once a trade is put on, give it time to work; give it time to insulate itself from random noise; give it time for others to see the merit of what you saw earlier than they.
  9. Be impatient. As always, small loses and quick losses are the best losses. It is not the loss of money that is important. Rather, it is the mental capital that is used up when you sit with a losing trade that is important.
  10. Never, ever under any condition, add to a losing trade, or “average” into a position. If you are buying, then each new buy price must be higher than the previous buy price. If you are selling, then each new selling price must be lower. This rule is to be adhered to without question.
  11. Do more of what is working for you, and less of what’s not. Each day, look at the various positions you are holding, and try to add to the trade that has the most profit while subtracting from that trade that is either unprofitable or is showing the smallest profit. 
  12. When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge “to get the money back” is extreme, and should not be given in to.
  13. When adding to a trade, add only 1/4 to 1/2 as much as currently held. That moves the average price of your holdings less than half of the distance moved, thus allowing you to sit through 50% corrections without touching your average price.
  14. Think like a guerrilla warrior. We wish to fight on the side of the market that is winning. Our duty is to earn profits by fighting alongside the winning forces. If neither side is winning, then we don’t need to fight at all.
  15. Markets form their tops in violence; markets form their lows in quiet conditions.
  16. The final 10% of the time of a bull run will usually encompass 50% or more of the price movement. Thus, the first 50% of the price movement will take 90% of the time and will require the most backing and filling and will be far more difficult to trade than the last 50%.

Ed Seykota’s 21-Investment Guidelines

  1. In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading.
  2. If I am bullish, I neither buy on a reaction, nor wait for strength; I am already in. I turn bullish at the instant my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical.
  3. If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk
  4. I set protective stops at the same time I enter a trade. I normally move these stops in to lock in a profit as the trend continues. Sometimes, I take profits when a market gets wild. This usually doesn’t get me out any better than waiting for my stops to close in, but it does cut down on the volatility of the portfolio, which helps calm my nerves. Losing a position is aggravating, whereas losing your nerve is devastating.
  5. Before I enter a trade, I set stops at a point at which the chart sours.
  6. The markets are the same now as they were five to ten years ago because they keep changing – just like they did then.
  7. Risk is the uncertain possibility of loss. If you could quantify risk exactly, it would no longer be risk.
  8. Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth.
  9. I usually ignore advice from other traders, especially the ones who believe they are on to a “sure thing”. The old timers, who talk about “maybe there is a chance of so and so,” are often right and early.
  10. Pyramiding instructions appear on dollar bills. Add smaller and smaller amounts on the way up. Keep your eye open at the top
  11. Trend systems do not intend to pick tops or bottoms. They ride sides.
  12. The key to long-term survival and prosperity has a lot to do with the money management techniques incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
  13. The manager has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important—often more important than trade timing.
  14. The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and under-capitalized, and inexperienced traders will get shaken out. Longevity is the key to success.
  15. Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible.
  16. I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
  17. Trading Systems don’t eliminate whipsaws. They just include them as part of the process.
  18. The trading rules I live by are:
    1. Cut losses.
    2. Ride winners.
    3. Keep bets small.
    4. Follow the rules without question.
    5. Know when to break the rules.
  19. The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.
  20. If you can’t take a small loss, sooner or later you will take the mother of all losses.
  21. One alternative is to keep bets small and then to systematically keep reducing risk during equity draw downs. That way you have a gentle financial and emotional touchdown.

But, did you spot what was missing?

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

You will notice that not one of the investing greats in history ever had “buy and hold” as a rule.

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

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

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

Importantly, you will notice that many of the same lessons are repeated throughout. This is because there are only a few basic “truths” of investing that all of the great investors have learned over time. I hope you will find the lessons as beneficial as I have over the years and incorporate them into your own practices.

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

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

  • As noted in our daily portfolio commentary we added a 2x long with the breakout last week.
  • We are still maintaining our core S&P 500 position as the market has not technically violated any support levels as of yet.
  • However, with the market now on a registered “Sell” signal, it is unlikely the current advance is going to go far unless that signal can be reversed.
  • The upside for this rally is the July highs but remains a rally to sell into.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position.
    • Stop-loss moved up to $285
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • Like the SPY, DIA is broke above resistance and the next target is the previous highs.
  • DIA has registered a “Sell” signal which will put pressure on DIA to the downside. This rally needs to last long enough to reverse that signal.
  • Look for this rally to fail likely next week.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions
    • This Week: Hold current positions.
    • Stop-loss moved up to $255.00
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • We noted that QQQ had rallied modestly, but was uninspiring. On Friday, QQQ rallied into resistance.
  • Like DIA and SPY, a “Sell signal” has been registered. It will be important for the market to rally enough next week to get above resistance and reverse the signal.
  • Short-Term Positioning: Bullish
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $175
  • Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

  • The buy signal has reversed to a sell, and performance continues to deteriorate.
  • The rally last week was uninspiring and failed to get above important resistance. With a sell signal in place there is nothing suggesting taking on exposure currently.
  • As we have repeatedly stated, there are a lot of things going wrong with small-caps currently so the risk outweighs the reward of a trade at this juncture.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY, like SLY, is technically not in great shape, but did manage to hold the 200-dma support for now.
  • MDY has now registered a “sell” signal which must be reversed before considering adding exposure.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • EEM continues to underperform. The sector did rally last week on hopes of a trade resolution, but that is an outcome that will not come soon. Look for this rally to fail.
  • A sell signal has been triggered as well.
  • EEM is running into heavy overhead resistance so next week will be important.
  • As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position
    • Stop-loss violated at $41
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA continues to drag.
  • EFA broke its downtrend line while maintaining a “buy signal” but did hold support at the 200-dma.
  • EFA has also triggered a sell signal
  • As with EEM, we did add a trading position to our long-short portfolio model but it, like EEM, was not performing so we closed it.
  • 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)

  • Oil continues to languish and remains on a sell signal currently. This doesn’t really bode well for either economic growth, or energy stocks near-term.
  • More importantly, oil is confined to its downtrend and continues to fail at the 200-dma which is trending lower. A break of support at $54 and oil will test $50/bbl fairly quickly.
  • Oil is not oversold and is in a downtrend. There is no reason to be long oil currently.
  • 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 remains extremely overbought including its longer-term “buy signal.”
  • As noted a month ago, we said that if support holds we will be able to move our stop-loss levels higher. That was indeed the case and we moved stops higher.
  • Gold is too extended to add to positions here and we have been looking for a pullback which now seems to be in the works. We are looking to add further to our holding between $136-138 or whenever an oversold condition is achieved.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position move up to $134
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Like GLD, Bond prices have surged on Trump ramping up the trade war.
  • The overbought condition is rather extreme, so be patient and wait for a correction back to the breakout level to add holdings.
  • Prices could pullback to the $135-137 range which would be a better entry point.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions after taking profits.
    • This Week: Hold positions
    • Stop-loss is moved up to $130
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar had rallied above, and is holding support, at its 200-dma. This is bullish and suggests a stronger dollar as foreign dollars flow into U.S. Treasuries for yield and safety.
  • We noted previously the dollar broke above key overhead resistance and suggests a move back towards $98-99 is likely. We have hit our target for now so take profits if you are long a dollar trade.
  • USD is holding support at the previous resistance line. The rally has now triggered a “buy” signal.

The Costs & Consequences Of $15/Hour – The Update

In 2016, I first touched on the impacts of hiking the minimum wage.

“What’s the big ‘hub-bub’ over raising the minimum wage to $15/hr? After all, the last time the minimum wage was raised was in 2009.

According to the April 2015, BLS report the numbers were quite underwhelming:

‘In 2014, 77.2 million workers age 16 and older in the United States were paid at hourly rates, representing 58.7 percent of all wage and salary workers. Among those paid by the hour, 1.3 million earned exactly the prevailing federal minimum wage of $7.25 per hour. About 1.7 million had wages below the federal minimum.

Together, these 3.0 million workers with wages at or below the federal minimum made up 3.9 percent of all hourly-paid workers. Of those 3 million workers, who were at or below the Federal minimum wage, 48.2% of that group were aged 16-24. Most importantly, the percentage of hourly paid workers earning the prevailing federal minimum wage or less declined from 4.3% in 2013 to 3.9% in 2014 and remains well below the 13.4% in 1979.'”

Hmm…3 million workers at minimum wage with roughly half aged 16-24. Where would that group of individuals most likely be found?

Minimum-Wage-Workers

Not surprisingly, they primarily are found in the fast-food industry.

“So what? People working at restaurants need to make more money.”

Okay, let’s hike the minimum wage to $15/hr. That doesn’t sound like that big of a deal, right?

My daughter turned 16 in April and got her first summer job. She has no experience, no idea what “working” actually means, and is about to be the brunt of the cruel joke of “taxation” when she sees her first paycheck.

Let’s assume she worked full-time this summer earning $15/hour.

  • $15/hr X 40 hours per week = $600/week
  • $600/week x 4.3 weeks in a month = $2,580/month
  • $2580/month x 12 months = $30,960/year.

Let that soak in for a minute.

We are talking paying $30,000 per year to a 16-year old to flip burgers.

Now, what do you think is going to happen to the price of hamburgers when companies must pay $30,000 per year for “hamburger flippers?”

Not A Magic Bullet

After Seattle began increased their minimum wage, the NBER published a study with this conclusion:

“Using a variety of methods to analyze employment in all sectors paying below a specified real hourly rate, we conclude that the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent. Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

This should not be surprising as labor costs are the highest expense to any business. It’s not just the actual wages, but  also payroll taxes, benefits, paid vacation, healthcare, etc. Employees are not cheap, and that cost must be covered by the goods or service sold. Therefore, if the consumer refuses to pay more, the costs have to be offset elsewhere.

For example, after Walmart and Target announced higher minimum wages, layoffs occurred (sorry, your “door greeter” retirement plan is “kaput”) and cashiers were replaced with self-checkout counters. Restaurants added surcharges to help cover the costs of higher wages, a “tax” on consumers, and chains like McDonald’s, and Panera Bread, replaced cashiers with apps and ordering kiosks.

A separate NBER study revealed some other issues:

“The workers who worked less in the months before the minimum-wage increase saw almost no improvement in overall pay — $4 a month on average over the same period, although the result was not statistically significant. While their hourly wage increased, their hours fell substantially. 

The potential new entrants who were not employed at the time of the first minimum-wage increase fared the worst. They noted that, at the time of the first increase, the growth rate in new workers in Seattle making less than $15 an hour flattened out and was lagging behind the growth rate in new workers making less than $15 outside Seattle’s county. This suggests that the minimum wage had priced some workers out of the labor market, according to the authors.”

Again, this should not be surprising. If a business can “try out” a new employee at a lower cost elsewhere, such is what they will do. If the employee becomes an “asset” to the business, they will be moved to higher-cost areas. If not, they are replaced.

Here is the point that is often overlooked.

Your Minimum Wage Is Zero

Individuals are worth what they “bring to the table” in terms of skills, work ethic, and value. Minimum wage jobs are starter positions to allow businesses to train, evaluate, and grow valuable employees.

  • If the employee performs as expected, wages increase as additional duties are increased.
  • If not, they either remain where they are, or they are replaced.

Minimum wage jobs were never meant to be a permanent position, nor were they meant to be a “living wage.”

Individuals who are capable, but do not aspire, to move beyond “entry-level” jobs have a different set of personal issues that providing higher levels of wages will not cure.

Lastly, despite these knock-off effects of businesses adjusting for higher costs, the real issue is that the economy will quickly absorb, and remove, the benefit of higher minimum wages. In other words, as the cost of production rises, the cost of living will rise commensurately, which will negate the intended benefit.

The reality is that while increasing the minimum wage may allow workers to bring home higher pay in the short term; ultimately they will be sent to the unemployment lines as companies either consolidate or eliminate positions, or replace them with machines.

There is also other inevitable unintended consequences of boosting the minimum wage.

The Trickle Up Effect:

According to Payscale, the median hourly wage for a fast-food manager is $11.00 an hour.

Therefore, what do you think happens when my daughter, who just got her first job with no experience, is making more than the manager of the restaurant? The owner will have to increase the manager’s salary. But wait. Now the manager is making more than the district manager which requires another pay hike. So forth, and so on.

Of course, none of this is a problem as long as you can pass on higher payroll, benefit and rising healthcare costs to the consumer. But with an economy stumbling along at 2%, this may be a problem.

A report from the Manhattan Institute concluded:

By eliminating jobs and/or reducing employment growth, economists have long understood that adoption of a higher minimum wage can harm the very poor who are intended to be helped. Nonetheless, a political drumbeat of proposals—including from the White House—now calls for an increase in the $7.25 minimum wage to levels as high as $15 per hour.

But this groundbreaking paper by Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, and Ben Gitis, director of labormarket policy at the American Action Forum, comes to a strikingly different conclusion: not only would overall employment growth be lower as a result of a higher minimum wage, but much of the increase in income that would result for those fortunate enough to have jobs would go to relatively higher-income households—not to those households in poverty in whose name the campaign for a higher minimum wage is being waged.”

This is really just common sense logic but it is also what the CBO recently discovered as well.

The CBO Study Findings

Overall

  • “Raising the minimum wage has a variety of effects on both employment and family income. By increasing the cost of employing low-wage workers, a higher minimum wage generally leads employers to reduce the size of their workforce.
  • The effects on employment would also cause changes in prices and in the use of different types of labor and capital.
  • By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some of those families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers. For those reasons, the net effect of a minimum-wage increase is to reduce average real family income.”

Employment

  • First, higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices, and those higher prices, in turn, lead consumers to purchase fewer goods and services.
  • The employers consequently produce fewer goods and services, so they reduce their employment of both low-wage workers and higher-wage workers.
  • Second, when the cost of employing low-wage workers goes up, the relative cost of employing higher-wage workers or investing in machines and technology goes down.
  • An increase in the minimum wage affects those two components in offsetting ways.
    • It increases the cost of employing new hires for firms
    • It also makes firms with raise wages for all current employees whose wages are below the new minimum, regardless of whether new workers are hired.

Effects Across Employers.

  • Employers vary in how they respond to a minimum-wage increase.
  • Employment tends to fall more, for example, at firms whose sales decline when they raise prices and at firms that can readily substitute machines or technology for low-wage workers.
  • They might  reduce workers’ fringe benefits (such as health insurance or pensions) and job perks (such as employee discounts), which would lessen the effect of the higher minimum wage on total compensation. That, in turn, would weaken employers’ incentives to reduce their employment of low-wage workers.
  • Employers could also partly offset their higher costs by cutting back on training or by assigning work to independent contractors who are not covered by the FLSA.

Macroeconomic Effects.

  • Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.
  • A higher minimum wage shifts income from higher-wage consumers and business owners to low-wage workers. Because low-wage workers tend to spend a larger fraction of their earnings, some firms see increased demand for their goods and services, which boosts the employment of low-wage workers and higher-wage workers alike.
  • A decrease in the number of low-wage workers reduces the productivity of machines, buildings, and other capital goods. Although some businesses use more capital goods if labor is more expensive, that reduced productivity discourages other businesses from constructing new buildings and buying new machines. That reduction in capital reduces low-wage workers’ productivity, which leads to further reductions in their employment.

Don’t misunderstand me.

Hiking the minimum wage doesn’t affect my business at all as no one we employee makes minimum wage. This is true for MOST businesses.

The important point here is that the unintended consequences of a minimum wage hike in a weak economic environment are not inconsequential.

Furthermore, given that businesses are already fighting for profitability, hiking the minimum wage, given the subsequent “trickle up” effect, will lead to further increases in automation and the “off-shoring” of jobs to reduce rising employment costs. 

In other words, so much for bringing back those manufacturing jobs.

RIA PRO: Bulls Regain The Narrative As They Want To Believe


  • Market Review & Update
  • The Last Hoorah?
  • They Want To Believe
  • Sector & Market Analysis
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Market Review & Update

Last week, we laid out 6-points about the market as the risk to the downside outweighed the potential reward. 

  1. Historically, September is one of the weakest months of the year, particularly when it follows a weak August.
  2. The market remains range bound and failed at both the 50-dma and downtrend line on Friday
  3. The oversold condition has now reversed. (Top panel)
  4. Volatility is continuing to remain elevated.
  5. Important downside support moves up to 2875
  6. The bulls regain control of the narrative on a breakout above 2945. 

The chart above is updated through Friday’s close. As noted, the bulls did regain control of the narrative for now as the breakout above consolidation sets the market up to rally towards 3000 and the July highs. However, with the markets already pushing back into overbought conditions, in conjunction with an extended buy signal, there is not a lot of “upside” in the markets currently. 

As we have reiterated over the last several weeks, this continues to be an opportunity to reduce portfolio risk and raise cash levels.

I say this because it took a bevy of positive overtones to reverse the selloff early in the week. After a sloppy Monday and Tuesday, the rally started on Wednesday with numerous Fed speakers all suggesting the Fed was likely to move forward with cutting rates and increasing monetary accommodation. (H/T Zerohedge)

Williams (Dovish): “Ready to act as appropriate”, July cut was right move, economy mixed (admitted consumer spending not a leading indicator), international news matters, low inflation biggest problem.

Kaplan (Dovish): “Monetary policy a potent force”, worried about yield curve inversion, economy mixed (factories weak due to trade, consumer strong), watching for “psychological effects” on consumers, “if you wait for consumer weakness, it might be too late.”

Kashkari (Dovish): Tariffs, “trade war are really concerning business”, job market not overheating, slower global growth will impact US, most concerned about inverted yield curve. Fed’s policy is “moderately contractionary.”

Bullard/Bowman (Looked Dovish): Took part in “Fed Listens” conference but made no comment on policy but then again when has Jim Bullard ever not been dovish.

Beige Book (Mixed): Moderate expansion but trade fears are mounting, but optimism remains, despite what Kashkari says: “although concerns regarding tariffs and trade policy uncertainty continued, the majority of businesses remained optimistic about the near-term outlook”

Evans (Dovish): Trade policy increases uncertainty and immigration restrictions lower trend growth to 1.5%, Auto industry especially challenged

Furthermore, on Tuesday, we suggested it wouldn’t be long before the Trump Administration dropped an announcement for “trade deal negotiation.” 

Of course, on Thursday, our wish was granted as the Administration announced that “trade talks” were back on for October. 

“China’s Ministry of Commerce said Thursday that the leaders of the U.S. and Chinese trade talks held a phone call in the morning and agreed to meet in early October for another round of negotiations. 

In a statement to CNBC, a U.S. Trade Representative spokesperson confirmed the phone call, but not the October meeting.

Beijing said the two sides agreed to hold another round of trade negotiations in Washington, D.C. — at the beginning of next month, and consultations will be made in mid-September in preparation for the meeting.”

While the markets once again rallied on the news, this is the same news we have repeatedly seen for the last 18-months. As @stockcats aptly noted:

The last few months has been this gyration of exuberance and disappointment as the market has lived from one “trade headline” to the next.

Then, of course, on Friday, Jerome Powell spoke suggesting there was “no recession” in sight but gave confidence to the markets the Fed would cut rates at the next meeting. To wit:

“As we move forward, we’re going to continue to watch all of these factors, and all the geopolitical things that are happening, and we’re going to continue to act as appropriate to sustain this expansion.”

This was all enough to spark investor’s “animal spirits” and force a rotation from “defense” back to “offense.” This is an outcome we discussed with our RIAPRO subscribers last week specifically as it related to adding to our Gold positions. To wit: (Chart updated through Friday)

  • Both GDX and IAU look identical.
  • A near-vertical spike has taken these holdings to extreme overbought and extended conditions.
  • We need a decent pullback, or consolidation, to add to holdings at this juncture. A rally in the market should give us that opportunity as it will pull Gold and Rates back to support.
  • Looking for an entry point between $14-14.25 to add to holdings.

On Thursday, rates and gold both pulled back as the equity rally accelerated above the breakout level. This pulled the algo’s out of defensive holdings and back into equities confirming the breakout short-term. 

The next major hurdle is going to be the 3000-level initially, but our bullish target for 2019 could be challenged which resides at the top of the trend channel.

That is assuming that nothing disrupts the current bullish narrative. 

But, there are many issues from failed trade talks, to earnings, to economic disappointment which could do just that. 

This is why, despite the bullish overtone, we continue to hold an overweight position in cash (see 8-Reasons), have taken steps to improve the credit-quality in our bond portfolios, and shifted our equity portfolios to more defensive positioning. 

We did modestly add to our equity holdings with the breakout on Thursday from a trading perspective. However, we still maintain an overall defensive bias which continues to allow us to navigate market uncertainty until a better risk/reward opportunity presents itself. 



The Last Hoorah?

September 11, 2018, I wrote “3000 or Bust” and almost precisely one-year later we are finally, for the second time, approaching that level. 

Here is the problem.

The rally has been driven almost entirely by multiple expansion rather than improving fundamentals. This was a point made in last Tuesday’s missive:

“Investing is ultimately about buying assets at a discounted price and selling them for a premium. However, so far in 2019, while asset prices have soared higher on ‘optimism,’ earnings and profits have deteriorated markedly. This is shown in the attribution chart below for the S&P 500.

In 2019, the bulk of the increase in asset prices is directly attributable to investors ‘paying more’ for earnings, even though they are ‘getting less’ in return.”

The discrepancy is even larger in small-capitalization stocks which don’t benefit from things like “share repurchases” and “repatriation.” 

Just remember, at the end of the day, valuations do matter. 

Here is another way to look at the data. Since the beginning of 2018, to support the bullish meme that companies are “beating expectations,” those expectations have been, and continue to be, dramatically lowered. 

This is particularly important given that “operating earnings” (which are fantasy earnings before any of the “bad sh**,”) are extremely elevated above reported profits. 

Of course, this all shows up in how much investors are currently “over-paying” for equity ownership.

As is always the case, investors forget during their momentary bout of exuberance, that valuations are all that matter over the long-term. The greater that over-valuation, the great the reversion to mean will ultimately be. 

But Lance, the markets just keep going up because Central Banks have it all under control.” 

I know it certainly seems that way currently. However, this is a market driven by “financial engineering” rather than fundamental measures. As noted previously, stock buybacks have continued to be a major support for asset prices since the financial crisis accounting for the bulk of the advance in the S&P 500. 

Not surprisingly, as rates of buybacks have slowed, so has the advance of the market. However, they have remained strong enough to offset the effects of negative economic news and trade wars. 

At least, so far. 

Importantly, as the benefit of “repatriation” from the tax reform legislation fades, it has been the rush to the corporate debt market to leverage up balance sheets to facilitate those repurchases. 

“On Wednesday new investment-grade issuance accelerated even more, rising to $28.8bn across 15 deals today, bringing the total for the two days of the week to a whopping $54.3 billion, as refinancing trades continued to dominate with $21.1bn of today’s issuance partially towards commercial paper, credit revolver, term loan, short and long-term debt repayments, according to BofA’s Hans Mikkelsen.” – Via Zerohedge

So, what was the reason for the rush to gobble up more debt at lower costs?

To refinance existing debt at lower rates for longer maturities, and, as Apple noted with their $5 Billion offering, to repurchase shares and issue dividends. 

At the same time, due to excessive confidence and complacency in the financial markets, investors are willing to take substantial credit risk without getting paid for it. Such previous periods of exuberance have also always ended badly.

With corporate debt to GDP levels now at record levels, it is only a function of time until something breaks.

All this brings to mind a note from my friend Doug Kass this past week that summed up well what investors are currently doing.

They Want To Believe

“Price has a way of changing sentiment.” – The Divine Ms M

“It is remarkable to me that the many that hated stocks a large percentage ago (when some of us were buying in the face of a more favorable reward vs. risk) are now bullish and buying.

Investors and traders seem to want to believe.

  • They want to believe that the trade talks between the U.S. and China will be real this time.
  • They want to believe that there is no “earnings recession” even though S&P profits through the first half of 2019 are slightly negative (year over year) and that S&P EPS estimates have been regularly reduced as the year has progressed. (see above)
  • They want to believe that stocks are cheap relative to bonds even though there is little natural price discovery as central banks are artificially impacting global credit markets and passive investing is artificially buoying equities.
  • They want to believe that technicals and price are truth – even though the markets materially influenced by risk parity and other products and strategies that exaggerates daily and weekly price moves.
  • They want to believe that today’s economic data is an “all clear” – forgetting the weak ISM of a few days ago, the lackluster auto and housing markets, the U.S. manufacturing recession and the continued overseas economic weakness.
  • They want to believe that, given no U.S. corporate profit growth, that valuations can continue to expand (after rising by more than three PEs year to date).
  • They want to believe though that the EU broadly has negative interest rates and Germany is approaching recession (while the peripheral countries are in recession) – that the Fed will be able to catalyze domestic economic growth through more rate cuts.
  • They want to believe that the U.S. can be an oasis of growth even though the economic world is increasingly flat and interconnected and the S&P is nearly 50% dependent on non U.S. economies.

I don’t know with certainty where the markets will be three or six months from today.

But I do know that, given the recent rise in the stock market, the reward vs. risk is vastly diminished and less favorable compared to other opportunities that existed since December, 2018.”

When it comes to investing, believing in “fairy tales” and “We Work” uhm, I mean, “unicorns” has repeatedly led to terrible outcomes. 

The data continues to deteriorate as the late-stage economic cycle advances.

This is as it should be as we move into a late-stage economy.

It is not a bad thing; it is just part of a healthy cycle. It is when entities take action to “extend” the cycle beyond norms, and into extremes, which leads to extremely poor outcomes. 

While none of this means the markets will crash tomorrow, next month, or even next year, it also doesn’t mean that it can’t, or won’t. 

Complacency is an investor’s worst enemy.

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

See you next week, and have a great Labor Day.


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet  


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 continued to fade and is close to turning negative. However, the sector is holding support and remaining above stop-loss levels. The pickup in volatility in the market has hit all sectors, so after taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

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

Our more defensive positioning continues to outperform relative to the broader market. Volatility has risen markedly, which makes markets tough to navigate for now. However, after taking some profits and re-positioning the portfolio we will remain patient and wait for the market to tell us what it wants to do next. Real Estate, Staples and Utilities all continue to make new highs but are GROSSLY extended. We added to our position in XLC bringing it up to full weight.

Current Positions: Target weight XLP, XLU, XLRE, and XLC

Weakening – Technology (XLK), Discretionary (XLY), Materials (XLB)

While Technology, and Discretionary did turn higher, the performance is dragging slightly on a relative basis. However, the sectors are very close to beginning to outperform once again, so we added to our position in Discretionary and continue to hold Technology. We remain underweight Materials as the “trade war” rages on. 

Current Position: Target weight XLY, XLK, 1/2 weight XLB

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. We were close to getting stopped out on that position as well but it rallied nicely this past week on hopes of a trade resolution. There is tremendous overhead resistance for the sector so we will remain patient for now.  

Current Position: 1/2 weight XLI

Market By Market

Small-Cap and Mid Cap – Small- and Mid-caps continue to struggle and are grossly under-performing relative to large capitalization stocks. While both markets did rally this past week, the performance remains underwhelming for now relative to large caps. We are watching the sector for a buy signal and will evaluate accordingly if we see an opportunity occur. For now, this continues to be an opportunity to reduce holdings in these markets.

Current Position: No position

Emerging, International & Total International Markets

We have been out of Emerging and International Markets for several weeks due to lack of performance. However, the addition of tariffs are not good for these markets. While these markets rallied this past week on hopes of a “trade resolution,” one is not coming any time soon. This is likely another good opportunity to reduce exposure to these markets. 

Current Position: No Position

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

Current Position: RSP, VYM, IVV

Gold – Gold begin to correct a little this past week which may give us an opportunity soon to add to our current holdings. We are holding out positions for now, and getting a decent entry point is requiring a lot of patience. 

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

Bonds 

Like Gold, bonds continued to attract money flows as investors search for “safety.” There has also been a massive short-covering rally with all those “bond bears” being forced to cover. However, as noted previously, bonds are EXTREMELY overbought. Yields did pull back slightly this week, so we may get an opportunity to add to our duration and credit quality here soon. We aren’t expecting much of a correction, so we will likely scale into additional holdings during a correction process. 

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

Current Positions: DBLTX, SHY, TFLO, GSY, IEF

Sector / Market Recommendations

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

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

Portfolio/Client Update:

Over the last couple of weeks, we have been repeating that we were stuck in a trading range to which we needed some resolution. Last week, as noted above, we got that resolution with the market breaking out of that consolidation to the upside. 

After taking some action previously to reduce financial exposure, we needed to add to positions which may be somewhat sheltered from tariffs to a degree. From that standpoint, since we are fully weighted in Technology, we added 1/2 position of communication and discretionary each. This brought those positions up to full portfolio weights for now.

For now, the markets are rallying on hopes of a “trade deal” and the Fed cutting rates later this month.

While the Fed will very likely cut rates by .25% at the next meeting, the risk is a disappointment with any indication it is the last cut for a while. 

The other disappointment is coming from the White House as there will be NO trade resolution in October, or any other month for that matter, and tariffs will be increased further in December. 

In other words, we are renting this rally and will take profits when markets reach overbought and extended levels once again. 

For newer clients, we are keeping accounts primarily in cash as our onboarding model is currently on a “sell signal” suggesting that risk outweighs reward currently. 

We continue to carry tight stop-loss levels, and any new positions will be “trading positions” initially until our thesis is proved out.

  • New clients: We added XLC, XLY and IAU to portfolios. We continue to onboard fixed income accordingly and sell out of position holdings. 
  • Equity Model: No change this week.
  • ETF Model:  Added 1/2 position in XLY and XLC.

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

401k-PlanManager-AllocationShift

Here We Go Again

More rhetoric on the “trade front” sent stocks running last week on hopes a trade deal is just a couple of weeks away. At the same time, the Fed took extra steps to assure a “rate cut” is set for the September meeting. 

This set the markets up to break above resistance which we noted last week:

A break above that resistance will allow for a push back to all-time highs.”

However, the employment report on Friday continues to show the economy is slowing down, and the underlying data suggests it is much weaker than headlines state. Corporate profits are also weakening, and there is a rising possibility that investors could begin to reprice valuations, particularly following the Fed meeting. 

Furthermore, just understand there will be NO trade deal which means very soon the markets are going to be disappointed again. So, look for more volatility this month. 

We continue to remain underweight equities for now because the markets remain trapped within a fairly broad range and continues to vacillate in fairly wide swings. This makes it difficult to do anything other than just wait things out.

Despite the rally this week, the downside risk is elevated, so we are maintaining underweight holdings for now. If you haven’t taken any actions as of late, it is not a bad time to do so. 

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

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

401k Plan Manager Beta Is Live

We have rolled out a very early beta launch to our RIA PRO subscribers

Be part of our Break It Early Testing Associate” group by using CODE: 401

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

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

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

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

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

Current 401-k Allocation Model

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


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