RIA PRO: Market Advance Stalls As Liquidity Begins To Slow


  • Market Advance Stalls
  • Portfolio Position Review
  • MacroView: Elites View World Through “Market Colored” Glasses
  • Financial Planning Corner: 2-Things Advisors Shouldn’t Do
  • Sector & Market Analysis
  • 401k Plan Manager

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Catch Up On What You Missed Last Week


Market Advance Stalls

As noted last week, there have only been a few points over the previous 25-years where the market has been so overbought, extended, and bullishly optimistic. To wit:

“This is particularly the case given how extreme positioning by both institutions and individual investors has become. With investor cash and bearish positions, at extreme lows, with prices extremely extended, a reversion to the mean is likely and could lean toward to the 10% range.”

Importantly, this was the repeated message over the last few weeks as the Federal Reserve’s “repo” operations continue to fuel the market’s non-stop advance. As Howard Marks once quipped:

“Being right, but early, is the same as being wrong.” 

Clearly, we were early in reducing some of our long-equity exposure in portfolios two weeks ago, but we tend to lean toward the adage; “you never go broke taking profits.” We remain comfortable with our positioning, given the imbalance of risk and reward currently.

Friday, the market had its first real sell-off since early December. As shown in the chart below, the only other times were in early October before the Fed launched its current “Not QE” program. To put this into some context, since 1970, the market has averaged two 1% declines per month or about every 9-trading days. Since October 2nd, 2018, there have been ZERO days consisting of a 1% decline. Assuming historical averages apply, there should have been nine such events of a 1% decline, or more, by now.

While the media was quick to blame the “coronavirus” in China as the cause for concern, the reality is the markets just needed a reason to sell. As shown in the chart below, the market is so extremely extended, the sell-off barely failed to register. 

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

  1. Notice both the overbought/sold indicator (top) and price momentum (bottom) are pegged at market extremes. The previous peak in both indicators was in January 2018.
  2. More importantly, from the 2016 low to the “blow-off” January 2018 high, the market had a 50% Fibonacci retracement. A similar correction from the December 2018 lows to the recent high would correspond with the January 2018 highs.

In other words, a somewhat typical 15% correction from such an extended, overbought, and bullish position would wipe out 100% of the 2019 gains. 

Don’t Fight The Fed

I know, I know. 

Such a correction can’t happen because the Fed is expanding its balance sheet. That is true, except the balance sheet expansion is beginning to slow. As recently noted by BMO (courtesy of Zerohedge):

“BMO expects the monthly sizes of $60 billion, or $30 billion post assumed taper, would be composed of both bills and short coupons, ‘helping to reduce expected pressure in the bill market.'”

BMO is correct in its analysis; the Fed will convert its short-term bill purchases into longer-term notes to maintain the balance sheet at a higher level. However, maintaining the size of the balance sheet, and expanding it are two entirely different things. Moreover, the market has already been incorporating this reduction in liquidity in their positioning as noted by sharply falling bond yields.

As we discuss weekly with our RIAPRO subscribers (30-day Risk-Free Trial), the 10-year Treasury broke out of its downtrend last week and was signaling a “risk-off” market event. Last Monday we wrote:

Bond prices rallied last week, again, and are testing downtrend resistance. For now bonds remain in a bearish channel, suggesting higher yields (lower prices) are still likely short-term. I suspect we are going to get some economic turmoil sooner, rather than later, which will lead to a correction in the equity markets and an uptick in bond prices.”



As noted above, with stocks extremely extended, all participants needed was an excuse to “sell.” With a “risk-off” event materializing, the rotation from “risk” to “safety” was completed. The sharp push higher in the stock/bond ratio also suggested a correction was forthcoming.

If we are correct, the Fed will begin to taper their purchases and move to stabilize its balance sheet, which will leave the market “starved for liquidity.” If economic and earnings growth remains weak, such will lead to concerns over current valuations, making that 10-15% correction more likely. 

While we certainly have no intention of “Fighting the Fed,” do not dismiss changes to the balance sheet given its close correlation to the rise in equity prices as discussed last week. (Note the decline in the balance sheet which foretold of this week’s sell-off)

On Oct. 11, the central bank announced it would begin purchasing $60 billion of Treasury bills a month to keep control over short-term rates. The magnitude of the purchases resembles the quantitative easing program the Fed conducted during and after the financial crisis.”

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

Given the extreme extension of the markets currently, it is quite likely we will see some more corrective action over the next week.

In other words, it may not be the time to “buy the dip,” just yet. 

Economic Warnings

There is currently much hope that the economy is about to emerge from its sluggish growth over the past couple of quarters to support lofty earnings expectations and, potentially, a rise in corporate profitability. As noted previously, the last time the S&P 500 was this deviated from a period of “flat” corporate profit growth was from 1995-1999.

There are a few indicators which, by their very nature, should be signaling a surge in economic activity if there was indeed going to be one. Copper, energy prices, commodities in general, and the Baltic Dry index, should all be rising if economic activity is indeed beginning to recover. 

Not surprisingly, as the “trade deal” was agreed to, we DID see a pickup in commodity prices, which was reflected in the stronger economic reports as of late. However, while the media is crowing that “reflation is on the horizon,” the commodity complex is suggesting that whatever bump there was from the “trade deal,” is now over.

If economic data doesn’t significantly improve, the risk to further corporate profit weakness is of concern. It also puts extremely optimistic projections for S&P earnings through 2020 and 2021 at risk. (Estimates for 2020 have already collapsed, and 2021 is lower than initial 2020 estimates.)

Pay attention to the amount of risk in your portfolio. It will matter more than you think and always at the worst possible time.

Portfolio Positioning

After previously reducing exposure “slightly” to equities, we did not make any further changes to portfolios over the last few days. Given we have shortened our duration in our bond holdings and raised cash levels to roughly 10% of the portfolio, we can afford at the moment to allow our existing long positions to ride the market higher. 

This positioning paid off well on Friday, as portfolio drag was about 1/3rd of the market overall. Rate-sensitive holdings (bonds/reits) performed as rates fell, and defensive positions held their ground. 

As we move into next week, the market is still going to be “betting on the Fed” until ultimately “beaten into submission,” so we will use rallies to rebalance equity risk as needed, but also add to our fixed income exposure. 

With respect to bonds, make sure you are focusing on “credit quality,” rather than “chasing yield.” As shown in the chart below, and as discussed this past week, when the recession hits, you want to be in Treasuries, and literally nothing else. 

While that is hard to believe, just remember its happened twice before.



The Macro View

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

See You Next Week

By Lance Roberts, CIO


Financial Planning Corner

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Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite 


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Energy (XLE), Communications (XLC)

The improvement in Energy stalled again this week, as oil prices continued to fall suggesting that economic weakness may be gaining traction. With oil prices failing the 200-dma, as expected, we saw further deterioration across the energy complex. Remain underweight for now.

As recommended two weeks ago, we reduced our weighting in XLC slightly to take in some profits. That action worked out well with the rout to the sector on Friday.

Current Positions: 1/2 weight AMLP, Underweight XLC

Outperforming – Technology (XLK), Healthcare (XLV)

We previously recommended taking profits in Technology and Healthcare, which have not only been leading the market but have gotten extremely overbought. On Friday, both sectors started to correct, and Healthcare is heading back to oversold, so we may get another opportunity to add back to our holdings.

Current Positions:  Reduced from overweight to target weight XLK, XLV

Weakening – Financials (XLF)

We noted previously that Financials have been running hard on Fed rate cuts and more QE and that the sector was extremely overbought and due for a correction. That correction/consolidation started two weeks and continued this week. We recommended taking profits previously, but now the sector is getting back to oversold and is setting up for a potential entry point. The 50-dma needs to hold as support as a short-term sell signal has been registered.

Current Position: No Position

Lagging – Industrials (XLI), Real Estate (XLRE), Staples (XLP), Discretionary (XLY), Materials (XLB), and Utilities (XLU)

Note: LAGGING Sectors are all showing signs of relative improvement to the S&P 500 suggesting a rotation from LEADING to LAGGING may be underway.

Industrials, have been improving performance on a relative basis to the S&P 500 this past week and held up during Friday’s sell off. The sector is working off its overbought condition but is close to triggering a short-term sell signal. We are going to wait for this correction to play out before adding to our current position.

Staples continues to consolidate and hold above its 50-dma. Since taking profits previously, we are just maintaining our stop loss on the sector currently. The sector remains very overbought and there isn’t a good entry point available just yet.

Discretionary, after finally breaking out to new highs, has gotten very extended in the short-term. We reduced our position slightly to take in profits. That was a good move as the sector corrected sharply on Friday. We remain optimistic on the sector for now, but need the overbought condition to be corrected with violating our stop-loss. 

XLRE has been rallying as of late and relative strength is improving. With rates falling, REIT’s remain a solid defensive sector. We will look to add to our holdings if we get a bit of risk rotation next week to give us a bit of a pullback in Real Estate. 

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

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps broke out to new highs last week, but as I discussed, the extreme overbought suggested a pullback was likely. That occurred this week. With the 50-dma not too far away it is critical the market holds and doesn’t violate out stops. We are holding that position for now, but are tightening up our stops.

Current Position: KGGIX, SLYV

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

Emerging and International Markets, like small and mid-caps above, had gotten extremely overbought and needed to correct. With support close by, it will be important that international stocks work off the overbought condition without violating our stop levels. 

Current Position: EFV, DEM

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. However, with the S&P extremely extended a pullback was likely. Currently, there is nothing to worry about, however, we are watching the market closely. 

Current Position: RSP, VYM, IVV

Gold (GLD) – As noted two weeks ago, Gold was holding support at the $140 level and registered a buy signal. GDX has also held support and turned higher with a triggered buy signal. Over the last two weeks, gold has broken out to highs, but stalled at those levels. We previously took our holdings back to full-weights after taking profits earlier this year. However, we are tightening up our stop levels.

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

Bonds (TLT) – 

Bonds rallied back above the 50-dma on Friday as money rotated into bonds for “safety” as the market weakened on Friday. As noted last week: “There is a consolidation with rising bottoms occurring currently, which suggests we may see further weakness in the market with a “risk off” rotation into bonds.” That rotation occurred on Friday.

After previously recommending adding to bonds, hold current positions for now. 

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:

In case you haven’t taken the opportunity to watch the Market Outlook presentation with Michael Lebowitz and myself, here is the link. CLICK HERE TO WATCH:

There was no change to portfolios last week as the extremely overbought conditions prohibited us from adding to equity risk currently. 

As noted in the main missive this week, the market did correct on Friday, which will either be a “one-day blip,” or something that may mature into a bigger correction we can add money to. We just need some of the overbought condition to be removed to add money more reasonably into portfolios on a risk/reward basis. 

After previously taking actions to slightly reduce portfolio risk, and raise cash, we have the luxury to wait a bit for a better entry point. 

Let me address accounts that are in the ON-BOARDING process. 

When a new client portfolio arrives, Mike and I have two choices: 1) Sell everything and buy everything in our model, OR 2) sell some, buy what is reasonable, and then be patient to build out the rest of the portfolio. 

The problem with option 2) is that if the market goes into a melt-up phase, as we saw starting in October, the opportunity to safely add money to portfolios is not available. In hindsight, yes, we should have bought all of our overbought positions, which then went to extremely overbought. However, this is not a prudent, or sophisticated manner, in which to manage portfolio risk.

IF this current corrective process continues and brings our positions back to a near-term oversold condition without violating stop-levels or triggering sell signals, we will build out on-boarding models accordingly. 

If you have any questions, please don’t hesitate to email me.

There we no additional portfolio actions this past week.

  • New clients: See note above.
  • Dynamic Model: No actions required
  • Equity Model: No actions required
  • ETF Model: No actions required

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.


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MacroView: Elites View The World Through “Market Colored” Glasses

It is easy to suggest the economy is booming when your net worth is in the hundreds of millions, if not billions, of dollars, or when your business, and your net worth, directly benefit from surging asset prices. This was the consensus from the annual gaggle of the ultra-rich, politicians, and media stars in Davos, Switzerland this past week.

As J.P. Morgan Chase CEO Jamie Dimon told CNBC on Wednesday the stock market is in a “Goldilocks place.” 

Of course, it is when you bank receives an annual dividend from the Federal Reserve’s balance sheet expansion. This isn’t the first time I have picked on Dimon’s delusional view of the world. To wit:

“This is the most prosperous economy the world has ever seen and it’s going to be a very prosperous economy for the next 100 years. The consumer, which is 70% of the U.S. economy, is quite strong. Confidence is very high. Their balance sheets are in great shape. And you see that the strength of the American consumer is driving the American economy and the global economy. And while business slowed down, my current view is that, no, it just was a slowdown, not a petering out.”  

Jamie Dimon during a “60-Minutes” interview.

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

For everyone else, not so much. Here are some stats via the WSJ:

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

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

The problem that is missed is that the “stock market” is NOT the “economy.”

This is a point President Trump misses entirely when he tweets:

“Stocks are hitting record highs. You’re welcome.”

As discussed earlier this week, 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% and everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population. This is not economic prosperity. This is simply a distortion of economics.

Another example of President Trump’s misunderstanding of the linkage between the economy and the stock market was displayed in his presser on Wednesday.

“Now, had we not done the big raise on interest [rates], I think we would have been close to 4% [GDP]. And I – I could see 5,000 to 10,000 points more on the Dow. But that was a killer when they raised the [interest] rate. It was just a big mistake.”President Donald Trump via CNBC

That is not actually the case. From 2009-2016, the Federal Reserve held rates at 0%, and flooded the financial system with 3-consecutive rounds of “Quantitative Easing” or “Q.E.” During that period average real rates of economic growth rates never rose much above 2%.

Yes, asset prices surged as liquidity flooded the markets, but as noted above “Q.E.” programs did not translate into economic activity. The two 4-panel charts below shows the entirety of the Fed’s balance sheet expansion program (as a percentage) and its relative impact on various parts of the real economy. (The orange bar shows now many dollars of increase in the Fed’s balance sheet that it took to create an increase in each data point.)

As you can see, it took trillions in “QE” programs, not to mention trillions in a variety of other bailout programs, to create a relative minimal increase in economic data. Of course, this explains the growing wealth gap which currently exists. Furthermore, while the Fed did hike rates slightly off of zero, and reduce their bloated balance sheet by a negligible amount, there was very little impact on asset prices or the trajectory of economic growth.

Not understood, especially by the Fed, is that the natural rate of economic growth is declining due to their very practices which incentivize non-productive debt. While QE and low rates may boost growth a little and for a short period of time, they actually harm future growth.

The Goldilocks Warning

While Jamie Dimon suggests we are in a “Goldilocks economy,” and President Trump says we are in the “Greatest Economy Ever,” such really isn’t the case. Despite a severe economic slow down globally, Dimon believes the domestic economy will continue to chug along with not enough inflation to push the Fed into hiking rates, but also won’t fall into a recession.

It is a “just right” economy, which will allow corporate profits to grow at a strong enough rate for stocks to continue to rise at 8-10% per year. Every year, into eternity.

This is where Jamie’s delusion becomes most evident. As shown in the chart below, since 2014, the S&P 500 index has soared to record heights, yet corporate profits for the entire universe of U.S. corporations have failed to rise at all. This is the clearest evidence of the disconnect between the markets and the real economy.

Note: It is worth mentioning the last time we saw a period where corporate profits were flat, while stock market prices surged higher was from 1995-1999. Unfortunately, as is repeatedly the case throughout history, prices “catch down” with profits and not the other way around.

Interestingly, in the rush to come up with a “bullish thesis” as to why stocks should continue to elevate in the future, many have forgotten the last time the U.S. entered into such a state of “economic bliss.”

“The Fed’s official forecast, an average of forecasts by Fed governors and the Fed’s district banks, essentially portrays a ‘Goldilocks’ economy that is neither too hot, with inflation, nor too cold, with rising unemployment.” – WSJ Feb 15, 2007

Of course, it was just 10-months later that the U.S. entered into a recession, followed by the worst financial crisis since the “Great Depression.”

The problem with this “oft-repeated monument to trite” is that it’s absolute nonsense. As John Tamny once penned:

A “Goldilocks Economy,” one that is “not too hot and not too cold,” is very much the fashionable explanation at the moment for all that’s allegedly good. “Goldilocks” presumes economic uniformity where there is none, as though there’s no difference between Sausalito and Stockton, New York City and Newark. But there is, and that’s what’s so silly about commentary that lionizes the Fed for allegedly engineering “Goldilocks,” “soft landings,” and other laughable concepts that could only be dreamed up by the economics profession and the witless pundits who promote the profession’s mysticism.

What this tells us is that the Fed can’t engineer the falsehood that is Goldilocks, rather the Fed’s meddling is what some call Goldilocks, and sometimes worse. Not too hot and not too cold isn’t something sane minds aspire to, rather it’s the mediocrity we can expect so long as we presume that central bankers allocating the credit of others is the source of our prosperity.”

John is correct. An economy that is growing at 2%, inflation near zero, and Central banks globally required to continue dumping trillions of dollars into the financial system just to keep it afloat is not an economy we should be aspiring to.

The obvious question we should be asking is simply:

“If we are in a booming economy, as supposedly represented by surging asset prices, then why are Central Banks globally acting to increase financial stimulus for the market?”

The problem the Fed and other central banks confront is that, when market levels are predicated on ever-cheaper cash being freely available, even the faintest threat that the cash might become more expensive or less available causes shock waves.

This was clearly seen in late 2018, when the Fed signaled it might increase the pace of normalizing monetary policy, the markets imploded, and the Fed was forced to halt its planned continued shrinking of its balance sheet. Then, under intense pressure from the White House, and still choppy markets, they reduced interest rates to bolster asset markets and stave off a potential recessionary threat.

The reality is the Fed has left unconventional policies in place for so long after the “Financial Crisis,” the markets can no longer function without them. Risk-taking, and a build-up of financial leverage, has now removed their ability to “normalize” financial policy without triggering destructive convulsions.

Given there is simply too much debt, too much activity predicated on ultra-low interest rates, and confidence hinging on inflated asset values, the Fed has no choice but to keep pushing liquidity until something eventually “pops.”

Unfortunately, when trapped in a “Goldilocks” economy, realities tend to become blurred as inherent danger is quickly dismissed. A recent comment from another “Davos elite,” Bob Prince, who helps oversee the world’s biggest hedge fund at Bridgewater Associates, made this clear.

“The tightening of central banks all around the world wasn’t intended to cause the downturn, wasn’t intended to cause what it did. But I think lessons were learned from that and I think it was really a marker that we’ve probably seen the end of the boom-bust cycle.”

No more “booms” and “busts?”

Thomas Palley had an interesting take on this:

The US is currently enjoying another stock market boom which, if history is any guide, also stands to end in a bust.

For four decades the US economy has been trapped in a ‘Groundhog Day’ cycle in which policy engineered new stock market booms to cover the tracks of previous busts. But as each new boom ameliorates, it does not recuperate the prior damage done to income distribution and shared prosperity.”

Well, except for those at the top, as Sven Henrick concluded last week:

“In a world of measured low inflation and weak wage growth easy central bank money creates vast price inflation in the assets owned by the few making the rich richer, but also enables the taking on ever higher debt burdens leaving everyone else to foot the ultimate bill.

There are two guarantees in life: The rich get obscenely rich, everybody else gets to carry ever more obscene public debt levels.”

That is the measured outcome of the central bank easy money dynamic that has been with us now for decades, but has taken on new obscene forms in the past 10 years with absolutely no end in sight.”

While the elites are certainly taking in the “view through market colored” glasses, the reality is far different for most.

It is true the bears didn’t eat “Goldilocks” at the end of the story, but then again, there never was a sequel either.

#FPC: New Advisors: Stop Doing These Two Things.

The higher stocks ride a glide path of zero volatility, the greater the risks for investors and their financial partners to fall victim to overconfidence. After all, we are human;  when it comes to money and emotions our brains are no smarter than a lizard’s. 

As markets continue to be  hyper-fueled by unconventional monetary and fiscal policy in the form of tax cuts, it’s normal to suffer from chronic FOMO or Fear Of Missing Out. It feels like this charging bull is invincible.  You don’t hear much in mainstream financial media about corrections, bear markets, or recession, either. It’s at these times when things are going smoothly that I’m most suspicious. It doesn’t mean I’m going to take it out on a portfolio. Nor does it mean I’m bearish.  It does mean I’m going to aggressively seek out information that conflicts with the latest group think. In other words, at a time where there is apparently ‘no risk,’ and it’s deemed a Goldilocks period, I’m prepared to be eaten by a bear – emotionally, that is.

in addition, I’m greatly concerned that employers at big-box financial organizations  will fail to provide objective, historical information about market cycles especially as the decade-long bull market continues to validate the narrative that stocks ‘always go higher in the long run.’

I’m  worried that new professionals who never experienced a rough market or are too young to recall, cannot comprehend the fiscal damage a bear may inflict on retail households, especially those beginning their investment journey or close to retirement.  I’m convinced newly-minted brokers are not receiving the real story from the firms which employ them. Financial social media, especially Twitter (or FinTwit as the cool kids deem it),  for the most part is a dangerous information conduit as pros idolize financial celebrities who dissect time frames and use statistics that ignite confirmation bias.

I know that feeling. I fell hard for the hype on the brokerage side of the fence until 2006 when I took a deep dive into the catalysts of the Great Depression as purely by luck,  I began to notice how retail investors were progressively pulling money from their brokerage accounts and investing in real estate based on promises of big returns.  I knew that real estate busts, especially values of primary residences (thanks to the work of Robert Shiller),  had potential to create panic and wholesale societal and structural economic distress.

I read everything I could get my hands on including vintage volumes of Magazines Of Wall Street I purchased from the years 1925-1940; I studied Ben Bernanke’s, Christina D. Romer’s work.  The game changer for me was the book titled, “Only Yesterday – An Informal History of the 1920s,” by Frederick Lewis Allen.  A used copy may be purchased for less than 13 bucks on Amazon; the lessons within the pages remain invaluable.

Frederick Allen served on the editorial staff of Atlantic Monthly and editor-in-chief of Harper’s Magazine from 1941 until his death in 1954. What’s fascinating about this book besides the compelling, raw writing style, is Mr. Allen’s ability to showcase how the boom-to-bust affected everyday lives from the kitchen table, to music, to culture. The reader gains a feel of breaking bread with a family on any morning in 1929 and how the Great Depression overwhelmed people’s lives and the world around them. There is also a sordid accounting of what happened to real estate prices along with stock prices. If you seek to remain rational through periods of market euphoria, this book can assist.

As a professional responsible for growing and protecting a family’s wealth, it’s your job; no, it’s your highest aspiration, to avoid doing the following things:

1. Do not underestimate the effects of bear markets on the households you serve. 

Almost 80% of rolling decades since 1900 have
delivered returns 20% above or below the
historical average. For the U.S. stock market, this
means that there is an 80% chance that total
nominal return for the next decade will be either
above 12% or below 8%. Ed Easterling, Crestmont Research, April 2019.

Bear markets in most charts appear as a minor speed bump on an otherwise smooth destination to larger portfolios. 

Understand, to most investors it’s carnage. Average bear market losses can be devastating. Novices who do not comprehend the risks of stock investing, only rewards, have the potential to be blindsided, become distrustful and avoid stocks for a lifetime; pre-retirees or those who seek to begin a distribution plan within 3-5 years depend on their financial professionals to help them minimize losses significant enough to dramatically derail their plans. 

Industry pundits and strategists tout that bear markets are rare. Those who fall for such a dangerous fallacy will eventually lose client trust and ostensibly, accounts. If you dare to believe market cycles are ‘no big deal,’ or every cycle is a bull – Prepare to suffer the consequences.

Courtesy of www.dshort.com:

Based on history,  secular bears appear roughly 40% of the time, not 20%  which seems to be the popular, erroneous statistic touted by financial media. Most of the FinTwit universe tends to ignore the 120+ characters it takes to admit that bear markets actually do happen! (No, really, they do!). 

On a percentage basis, bears indeed appear to be no big deal.

However, take a look on a point basis. This is the chart that will mean the most to clients.

On a point basis, bears almost (and in some cases, completely), wipe out the gains of the previous bull. 

For me, the possible conversation with a client who experiences years of gains wiped out,  is the stuff that wakes me up at 1:30am with night sweats. Consider how much time in the span of a finite human life it takes to create wealth,  how quickly it can be lost, how long it will take to get back to even.  Now, you can repeatedly tout the line how ‘stocks always come back,’ but by then, the client will be done with you and either take over management of the account or find an advisor who appropriately answers the question – “what did you do to protect client wealth during the last bear market?”

I don’t provide this information to dissuade stock investing or suitable stock allocations. I provide it to keep advisors grounded at a time when most financial firms are going to hyper-spike the Kool-Aid to push corporate agendas without giving a d**** about personal growth or tenure of your career. As long as you communicate realistic information to help clients understand the potential bloodletting of bears, you’ll keep everybody’s emotions firmly in check and not mired in the clouds of euphoria.  You will forge trust that binds through any market cycle.

2. Avoid the crowded side of the boat or jump ship, altogether.

Never underestimate the seduction of emotional biases. Never discount the attraction to those who agree with your current point of view.

The objective isn’t to be a curmudgeonly contrarian or known as a wall flower at the bull market party, especially when global central banks keep turbo-spiking the punch bowl. Your overall responsibility is to be a an objective, holistic, eagle-eyed observer of the current period and study history to continue to safeguard the hard-earned savings of investors you serve.

In a paper for Investments & Wealth Institute – “The Psychology of Financial Professionals and Their Clients,” by H. Kent Baker PhD, CFA, CMA, Greg Filbeck, DBA, CFA, FRM, CAIA, CIPM, PRM and business professor/author Victor Riccardi, a behavioral specialist in his own right, outline the behavioral, cognitive and emotional biases financial professionals suffer; even more so than clients.

Overconfident professionals may underestimate the risks and overestimate the upside potential of their investment selections and the stock market, overall.  Even more so, I fear employers, along with mainstream financial media and the popular Fin kids, do nothing but inject steroids into the already bloated confirmation bias many of us are inflicted with, especially advisors who were running around the house in Underoos during the last bear cycle.

It’s worth it to deflate your emotional state, humble yourself a bit. During times of distress or euphoria, it’s crucial to aggressively seek out research that directly contradicts the popular  (or your), opinion. It’s a worthwhile exercise to equally document information that supports and throws a bit of headwind into your sails – Always keep an eye on the lifeboats. Clients will appreciate your objective, perhaps Stoic manner.

In the 70s, I recall a waste disposal space in Brooklyn. How in the spring, beautiful flowers would sprout among the mountains of garbage. Beautiful colors – yellow, purple, green. I never forgot what was underneath. Perspective…

Go ahead and fool yourself how it’s different this time. 

You may believe that bear markets are a part of the past. Or the financial crisis was merely a blip in the heartbeat of time. I mean, it can’t happen again, correct? Many investors and households would disagree.

Overall, American household wealth has not fully recovered from the Great Recession. In 2016, the median wealth of all U.S. households was $97,300, up 16% from 2013 but well below median wealth before the recession began in late 2007 ($139,700 in 2016 dollars). And even though overall racial and ethnic inequality in wealth narrowed from 2013 to 2016, the gap remains large. Pew Research Center.

Become a humble provider of objective information, never waiver from a fiduciary intent, and be assured you’ll retain clients for decades. 

I know that it’s worked for me. 

It will for you, too. 

#WhatYouMissed On RIA: Week Of 01-20-20

We know you get busy and don’t check 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 you might have missed.

The Week In Blogs


________________________________________________________________________________

Our Latest Newsletter

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What You Missed At RIA Pro

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

________________________________________________________________________________

The Best Of “The Lance Roberts Show

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Video Of The Week

Lance Roberts & Michael Lebowitz discuss the markets, Fed, the outlook for 2020 and how we are positioning our portfolios.

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Our Best Tweets Of The Week

See you next week!

Selected Portfolio Position Review: 01-23-2020

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.

ABBV – AbbVie, Inc.

  • We previously added a 1/2 ABBV near the lows as a trading opportunity which worked better than we anticipated. However, it never gave us an decent opportunity to build into the position.
  • However, currently, ABBV has been consolidating near the highs and has started working off the extended buy signal. With several layers of support between the current price and the 200-dma, we are likely going to get an opportunity to build out the rest of our holdings.
  • A pullback to $80-82.50 level will likely give us the right setup to add.
  • Stop is currently set at $75

AMLP – Alerian MLP

  • Like ABBV, we also added 1/2 position of AMLP near the lows on an expectation of a rally in oil prices.
  • The good news is AMLP is yielding 9% while we hold our position waiting for an opportunity to build it out.
  • The bad news is that oil prices have completely cratered which exposes AMLP to further downside risk. However, with a high yield and only 1/2 position, we can afford to be patient and look for the right setup to add to our holdings.
  • Stop loss is currently set at $7.50

AMZN – Amazon.com, Inc.

  • We added AMZN in October of last year in anticipation the Christmas shopping season boost. That bump in price came as expected, but AMZN hasn’t really done as well as the rest of the FANG space.
  • We are holding our position for now, but watching it closely. We need to see some improvement in participation.
  • We are moving our stop up to $1800

CHCT – Community Healthcare

  • CHCT has been a great performer since we added it to the portfolio.
  • With the recent correction, and very deep sell signal, this is a decent entry point to add positions if you need to.
  • We are currently maintaining a full weighting in the portfolio, but we may consider adding to the position in the next few days if we get a little more pullback.
  • Stop is set at $42

EFV – iShares MSCI EAFE Value ETF

  • We have started building “VALUE” positioning in portfolios as a hedge against a momentum shift which is eventually coming. EFV is one of those positions which hasn’t moved much since we added it but has a near 5% yield currently.
  • EFV is consolidating its recent advance and has started working off its very extended buy signal. If the position can hold the current levels, and consolidate a bit more, we will likely add to our current holdings.
  • Stop is set at $47.

KHC – Kraft Heinz Co.

  • We added KHC to our portfolio near the lows expecting a recovery in the stock, and earnings, following a major beating in the company shares.
  • The company has decent fundamentals and we continue to expect an earnings recovery in the coming quarter which should lift the shares higher.
  • We are currently waiting on next quarters earnings to see how progress is going, and if the stock responds positively we will add to our holdings.
  • We are maintaining our current positions with a stop at $27.50
  • Stop is set at $130.

MDLZ – Mondelez International

  • We sold MDLZ and took our gains in the position following a stellar run in the stock.
  • However, with MDLZ having consolidated for a while now, and completely reversing the extreme buy signal into an extreme sell signal, we are considering the position for an addition back into the portfolio.
  • We would like to see a little correction that continues to hold support to add exposure back into the the portfolio.
  • No stop currently.

SLYV – SPDR S&P 600 Small Cap Value

  • We recently added SLYV as part of our “VALUE” trade like EFV.
  • Like EFV, the performance has been lackluster currently, as we expected it would be, since investors are chasing momentum currently.
  • SLYV is very overbought and is working off its extreme buy signal. We will look to add to our holdings on a pullback that doesn’t violate our stop loss.
  • Stop-loss moved up to $52

VMC – Vulcan Materials Co.

  • VMC was a terrific performer for us in 2019 but has been consolidating those gains in recent months.
  • With VMC testing the 200-dma, positions can be added to portfolios with a stop at the moving average. We remain long our holding but are looking for an opportunity to increase exposure.
  • Stop loss moved up to $138.50

XOM – Exxon Mobil Corp.

  • XOM has been disappointing for us as a long-term position. We bought it in January of 2019 near the lows, sold 1/2 in May near the highs, and added back to the holding (taking it back to full weight) near the recent lows.
  • While the trading of the position has been profitable, the overall outlook for XOM remains disappointing.
  • This is particularly due to oil prices failing to hold above $60/bbl suggesting that mid to low-$50’s are possible for oil prices. (More downward pressure on oil companies)
  • We still like XOM fundamentally, but we may look to reduce or sell the position entirely on the next rally.
  • Stop loss remains $63

Yes, Rates Are Still Going To Zero

“If the U.S. economy entered a recession soon and interest rates fell in line with levels seen during the moderate recessions of 1990 and 2001, yields on even longer-dated Treasury securities could fall to or below zero.” – Senior Fed Economist, Michael Kiley – January 20, 2020

I was emailed this article no less than twenty times within a few hours of it hitting the press. Of course, this was not a surprise to us. To wit:

“Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. Given the current low level of interest rates, the next recessionary bout in the economy will very likely see rates near zero.” 

That article was written more than 3-years ago in August 2016. 

Of course, three-years ago, as the “Bond Gurus,” like Jeff Gundlach and Bill Gross, were flooding the media with talk about how the “bond bull market was dead,” and “interest rates were going to rise to 4%, or more,” I repeatedly penned why this could not, and would not, be the case.

While it seemed a laughable concept at the time, particularly as the Fed was preparing to hike rates and reduce their balance sheet, the critical aspect of leverage was overlooked.

“There is an assumption that because interest rates are low, that the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields, which pushes rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell above $1 Trillion in coming years. This will require more government bond issuance to fund future expenditures, which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion which will push the 10-year yield towards zero.”

Of course, since the penning of that article, let’s take a look at where we currently stand:

  1. Negative yielding debt surged past $17 trillion pushing more dollars into positive yielding U.S. Treasuries which led to rates hitting decade lows in 2019.
  2. The budget deficit has indeed swelled to $1 Trillion and will exceed that mark in 2020 as unbridled Government largesse continues to run amok in Washington.
  3. The Federal Reserve, following a very short period of trying to hike rates and reduce the bloated balance sheet, completely reversed the policy stance by cutting rates and flooding the system with liquidity by ramping up bond purchases.

The biggest challenge the Fed faces currently is how to deal with a recession. Given the current expansion is the longest on record; a downturn at some point is inevitable. Over the last decade, as shown in the chart below, the Federal Reserve has kept rates at extremely low levels, and flooded the system with liquidity, which did NOT have the effect of fostering either economic growth or inflation to any significant degree. (As noted the composite index is of inflation, GDP, wages, and savings which has closely tracked the long-term trend of interest rates.)

Naturally, at any point monetary accommodation is removed, an economic, and market downturn is almost immediate. This is why it is feared central banks do not have enough tools to fight the next recession. During and after the financial crisis, they responded with a mixture of conventional interest-rate cuts and, when these reached their limit, with experimental measures, such as bond-buying (“quantitative easing”, or QE) and making promises about future policy (“forward guidance”).

The trouble currently is that global short-term interest rates are still close to, or below zero, and cannot be cut much more, which has deprived central banks of their main lever if a recession strikes.

The Fed Is Trapped

While the Fed talks about wanting higher rates of inflation, as shown above, they can’t run the risk that rates will rise. Simply, in an economy that requires $5 of debt to create $1 of economic growth, the leverage ratio requires rates to remain low or “bad things” happen economically.

1) The Federal Reserve has been buying bonds for the last 10- years in an attempt to keep interest rates suppressed to support the economy. The recovery in economic growth is still dependent on massive levels of domestic and global interventions. Sharply rising rates will immediately curtail that growth as rising borrowing costs slows consumption.

2) Rising interest rates immediately slows the housing market, taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

3) An increase in interest rates means higher borrowing costs, which leads to lower profit margins for corporations. This will negatively impact the stock market given that a bulk of the “share buybacks” have been completed through the issuance of debt.

4) One of the main arguments of stock bulls over the last 10-years has been the stocks are cheap based on low interest rates. When rates rise, the market becomes overvalued very quickly.

5) The massive derivatives market will be negatively impacted, leading to another potential credit crisis as interest rate spread derivatives go bust.

6) As rates increase, so does the variable rate interest payments on credit cards. With the consumer being impacted by stagnant wages, higher credit card payments will lead to a rapid contraction in disposable income and rising defaults. 

7) Rising defaults on debt service will negatively impact banks, which are still not adequately capitalized and still burdened by large levels of risky debt.

8) Commodities, which are very sensitive to the direction and strength of the global economy, will plunge in price as recession sets in. (Such may already be underway.)

9) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits have already crumbled as the deficits have already surged to $1 Trillion and will continue to climb.

10) Rising interest rates will negatively impact already massively underfunded pension plans leading to insecurity about the ability to meet future obligations. With a $7 Trillion funding gap, a “run” on the pension system becomes a high probability.

I could go on but you get the idea.

The issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. This is because the vast majority of Americans are living paycheck-to-paycheck.

However, since average American’s requires roughly $3000 in debt annually to maintain their standard of living, interest rates are an entirely different matter.

As I noted last week, this is a problem too large for the Fed to bail out, which is why they are terrified of an economic downturn.

The Fed’s End Game

The ability of the Fed to use monetary policy to combat recessions is at an end. A recent article by the WSJ agrees with our assessment above.

“In many countries, interest rates are so low, even negative, that central banks can’t lower them further. Tepid economic growth and low inflation mean they can’t raise rates, either.

Since World War II, every recovery was ushered in with lower rates as the Fed moved to stimulate growth. Every recession was preceded by higher interest rates as the Fed sought to contain inflation.

But with interest rates now stuck around zero, central banks are left without their principal lever over the business cycle. The eurozone economy is stalling, but the European Central Bank, having cut rates below zero, can’t or won’t do more. Since 2008, Japan has had three recessions with the Bank of Japan, having set rates around zero, largely confined to the sidelines.

The U.S. might not be far behind. ‘We are one recession away from joining Europe and Japan in the monetary black hole of zero rates and no prospect of escape,’ said Harvard University economist Larry Summers. The Fed typically cuts short-term interest rates by 5 percentage points in a recession, he said, yet that is impossible now with rates below 2%.”

This too sounds familiar as it is something we wrote in 2017 prior to the passage of the tax reform bill:

The reality is that the U.S. is now caught in the same liquidity trap as Japan. With the current economic recovery already pushing the long end of the economic cycle, the risk is rising that the next economic downturn is closer than not. The danger is that the Federal Reserve is now potentially trapped with an inability to use monetary policy tools to offset the next economic decline when it occurs.

This is the same problem that Japan has wrestled with for the last 20 years. While Japan has entered into an unprecedented stimulus program (on a relative basis twice as large as the U.S. on an economy 1/3 the size) there is no guarantee that such a program will result in the desired effect of pulling the Japanese economy out of its 30-year deflationary cycle. The problems that face Japan are similar to what we are currently witnessing in the U.S.:

  • A decline in savings rates to extremely low levels which depletes productive investments
  • An aging demographic that is top heavy and drawing on social benefits at an advancing rate.
  • A heavily indebted economy with debt/GDP ratios above 100%.
  • A decline in exports due to a weak global economic environment.
  • Slowing domestic economic growth rates.
  • An underemployed younger demographic.
  • An inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases to offset reduced employment

The lynchpin to Japan, and the U.S., remains demographics and interest rates. As the aging population grows becoming a net drag on “savings,” the dependency on the “social welfare net” will continue to expand. The “pension problem” is only the tip of the iceberg.

It’s good news the WSJ, and mainstream economists, are finally catching up to analysis we have been producing over the last several years.

The only problem is that it is likely too little, too late.Save

Save

Save

Sector Buy/Sell Review: 01-22-20

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.

There is a common theme running through most of the sectors currently which is that they are trading more than 2-standard deviations above the 200-dma. I have added BOTH 2- AND 3-Standard Deviation levels (blue and tan shaded areas) to each graph which represents the bands of deviation from the green line which is the 200-dma. Deviations of this extreme tend not to last long.

Basic Materials

  • XLB tested and failed at all-time highs. While support exists at the previous breakout level of $59, XLB remains at the top of its deviation range and is on an extended “buy” signal currently.
  • The sector started to work off its previously extreme overbought condition, but quickly reversed back to overbought without providing a decent entry point.
  • We currently hold 1/2 a position and are still looking to add the second 1/2 during a corrective process.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with a tighter stop-loss.
    • Stop-loss moved back to $57 to allow for entry.
  • Long-Term Positioning: Neutral

Communications

  • As noted previously, XLC finally broke out to new highs and is now more than 3-standard deviations above the 200-dma. This is rare, and the last time we saw this was at the peak of the market in January and June of 2018 both of which preceded significant corrections.
  • Because of the extension we did reduce our allocation to the sector modestly. We will look to use a pullback to support to reweigh the sector.
  • With a “buy signal” in place, there is a bias to the upside, but a correction is coming. XLC must hold support at $50.
  • If you need to add a position, wait for a pull back to test the recent breakout support level and add there.
  • XLC is currently 2/3rds weight in our portfolios.
  • Short-Term Positioning: Bullish
    • Last Week: Hold trading positions
    • This Week: Reduced weighting in portfolio
    • Stop adjusted to $50
  • Long-Term Positioning: Neutral

Energy

  • Unlike most other sectors of the market, XLE is not extremely extended.
  • Unfortunately, we have been trying to add XLE to our portfolios but XLE broke back below the 200-dma which puts the top of the previous downtrend line into focus. We may be able to add if it holds support between $56-57.
  • The buy signal is extended and this correction will start to reduce that.
  • The reason we are cautious is that these rallies have repeatedly failed in the past and it appears it has happened again.
  • Short-Term Positioning: Bearish
    • Last week: Looking to add 1/2 XLE – patience.
    • This week: Looking to add 1/2 XLE – patience.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF is extremely extended above the 200-dma which puts the sector at risk of a more severe correction.
  • The buy signal is also extremely extended which suggests that you should be taking profits and reducing risk if you are long the sector.
  • We will look to add XLF to our portfolio on a pullback that doesn’t violate long-term support or break the current bullish trend. The buy signal has started to reduce and XLF has stalled in its recent advance. A correction is more likely than the 200-dma catching up to price, but either will give us an entry point.
  • Short-Term Positioning: Bullish
    • Last week: Hold Positions
    • This week: Hold Positions
    • Stop-loss adjusted to $28
  • Long-Term Positioning: Neutral

Industrials

  • XLI also is pushing well above the 200-dma with such previous extensions having led to fairly sharp corrections.
  • With XLI exceedingly overbought short-term, and on a very extended buy signal, be cautious chasing the sector currently.
  • We are looking for a bit of consolidation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • We have adjusted our stop-loss for the remaining position. We are looking to add back to our holdings on a reversal to a buy signal.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $77
  • Long-Term Positioning: Neutral

Technology

  • XLK is extremely overbought on both a price and momentum basis like most other sectors of the market. Like XLY, XLK is also pushing into the upper deviation bands.
  • We reduced our position in XLK from overweight to target portfolio weight due to the extreme extension currently. A correction is coming.
  • Be careful chasing the sector currently. Take profits and rebalance risks accordingly.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Reduce Overweight to Target Weight
    • Stop-loss adjusted to $80
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform better as money is just chasing “everything” now.
  • XLP continues to hold its very strong uptrend as has now broken out to new highs. However, XLP is back to more extreme overbought and extended above the 200-dma.
  • Importantly, a “buy signal” has been registered. Look for pullbacks to support to add weight to portfolios. Maintain a stop at the 200-dma.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $59
    • Long-Term Positioning: Bullish

Real Estate

  • XLRE was consolidating its advance within a very tight pattern but has now broken out back to new highs.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected which has now been completed.
  • XLRE is beginning to reverse its deep “sell signal” and while no longer-oversold, the breakout is bullish in the short-term.
  • As noted previously, we are holding our long-position, but trading positions can be added to portfolios. We are fully weighted the sector currently so there isn’t any change required in our portfolios at this time.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $35.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLU continues to maintain its bullish trend and recently rallied to break out to new highs.
  • XLU is also extremely extended above the 200-dma so look for a pullback to add holdings.
  • With the “sell signal” close to reversing, the bullish backdrop for XLU continues. As noted previously, the surge in XLU was confirmed by a drop in interest rates.
  • As noted two weeks ago, after taking profits, we had time to be patient and wait for the right setup. That opportunity came previously, so if you added exposure, hold for now with a stop at $61. If you need to add exposure to Utilities, you need to wait for a small correction.
  • The long-term trend line remains intact.
  • We are currently at full weight, so no change is required currently.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold current position / Use correction to add postions.
    • Stop-loss adjusted to support at $59.00, $61 for new positions.
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and is now more extended than we have seen it in quite some time.
  • XLV is extremely overbought which will give way sooner than later. Because of the extension we reduced the overweight position in our portfolios to target weight.
  • The move in Healthcare has been parabolic, and the sector is too extended to add positions currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Took profits – reduced overweight to target weight.
    • Stop-loss adjusted to $94
  • Long-Term Positioning: Bullish

Discretionary

  • We added to our holdings previously to participate with the current rally, but XLY is now pushing an extreme extension above the 200-dma.
  • We took profits last week and reduced the position slightly.
  • Hold current positions for now, but take profits and rebalance risks accordingly. New positions can be added on a pullback to the breakout level that holds and works off the overbought condition.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $120.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has broken out of consolidation but quickly ran into resistance at the 2-standard deviation level above the 200-dma.
  • We noted last week, that if XTN can breakout above current resistance there is a potential to test old highs. That occurred last week and failed.
  • Be patient, XTN has a good bit of work to do to prove its position in portfolios, look for a pullback to $64 to add holdings.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Gimme Shelter – Unlocked RIA Pro

Oh, a storm is threat’ning my very life today
If I don’t get some shelter oh yeah I’m gonna fade away
” – Rolling Stones

The graph below plots 15 years’ worth of quarterly earnings per share for a large, well known publicly traded company. Within the graph’s time horizon is the 2008 financial crisis and recession. Can you spot where it occurred? Hint- it is not the big dip on the right side of the graph or the outsized increase in the middle.

The purpose of asking the question is to point out that this company has very steady earnings growth with few instances of marked variation. The recession of 2008 had no discernable effect on their earnings. It is not a stretch to say the company’s earnings are recession-proof.

The company was formed in 1886 and is the parent of an iconic name brand known around the world. The company has matured into a very predictable company, as defined by steady earnings growth.

Fundamentally, this company has all the trappings of a safe and conservative investment the likes of which are frequently classified as defensive value stocks. These kinds of companies traditionally provide a degree of safety to investors during market drawdowns. Today, however, this company and many other “shelter stocks” are trading at valuations that suggest otherwise.

The following article was posted for RIA Pro subscribers last week.

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What is Value?

Determining the intrinsic value for an investment is a crucial baseline metric that investors must calculate if they want to properly determine whether the share price of a company is rich, cheap, or fair.

Investors use a myriad of computations, forecasts, and assumptions to calculate intrinsic value. As such, the intrinsic value for a company can vary widely based on numerous factors. 

We broadly define intrinsic value as the price that a rational investor would pay for the discounted cash flows, after expenses, of a company. More simply, what is the future stream of net income worth to you? As value investors, we prefer to invest in companies where the market value is below the intrinsic value. Doing so provides a margin of safety.

Jim Rogers, the former partner of George Soros, put it this way: “If you buy value, you won’t lose much even if you’re wrong.”

Calculating the intrinsic value with a high level of confidence is difficult, if not impossible, for some companies. For instance, many smaller biotech companies are formed to find a cure or treatment for one or two medical ailments. These firms typically lose money and burn through funding during the research and development (R&D) stage. If they successfully find a treatment or cure and financially survive the long FDA approval process, the shareholders are likely to receive hefty returns. The outcome may also be positive if they have a promising medication and a suitor with deep pockets buys the company. Because the outcome is uncertain, many biotech companies fail to maintain enough funding through the R&D stage.

Calculating an intrinsic value for a small biotech company can be like trying to estimate what you may win or lose at a roulette table. The number of potential outcomes is immense and highly dependent on your assumptions. 

Coca-Cola

At the other end of the spectrum, there are mature companies with very predictable cash flows, making intrinsic value calculations somewhat simple, as we will show.

Coca Cola (KO) is the company we referenced in the opening section. KO is one of the most well-known companies in the world, with an array of products sold in almost every country. KO is mature in its lifecycle with very dependable sales and earnings growth. The question we raise in this analysis is not whether or not KO is a good company, but whether or not its stock is worth buying.  To answer this question, we will determine its intrinsic value and compare it to the current value of the company.

The textbook way to calculate intrinsic value is to discount the future cash flows of the company. The calculation entails projecting net income for the next 30 years, discounting those annual income figures at an appropriate rate, and summing up the discounted cash flows. The answer is the present value of the total earnings stream based on an assumed earnings growth rate.

In our intrinsic value model for KO, we assumed an earnings growth rate of 4.5%, derived from its 20 year annualized earnings growth rate of 5.4% and it’s more recent ten year annualized growth rate of 2.9%. Recent trends argue that using 5.4% is aggressive. We used a discounting factor of 7% representing the historical return on equities. The model discounted 30 years of estimated future earnings.

The model, with the assumptions above, yields an intrinsic value of $157 billion. The current market cap, or value, of KO is $235 billion, meaning the stock is about 51% overvalued. Even if we assume the longer-term 20-year growth rate (5.4%), the stock is still 35% overvalued.

To confirm the analysis and illustrate it in a different format, we calculated what the stock price would be on a rolling basis had it grown in line with the prior rate of ten years of earnings growth. As shown in the graph and table below, the market value is currently 55% above the model’s valuation for KO.  The green and red areas highlight how much the stock was overvalued and undervalued.

To check our analysis, we enlisted our friend David Robertson from Arete Asset Management and asked him what intrinsic value his cash flow based model assigned to KO. The following is from David:

In looking at the valuation of KO, I see a couple of familiar patterns. The most obvious one is that the warranted value, based on a long-term model that discounts expected cash flows, is substantially below the current market value. Specifically, the warranted value per share is about $21, and nowhere near the mid-50s current market price. The biggest reason for this is that the discounted value of future investments has declined the last few years substantially due to lower economic returns and lower sustainable growth rates. In other words, as the company’s ability to generate future returns has diminished, its stock price has completely failed to capture the change.

The chart below from David compares his model’s current and future intrinsic value (Arete target) with the annual high, low, and closing price for KO.  David’s graph is very similar to what we highlighted above; KO has been trading at a steep premium to its intrinsic value for the last few years.

Lastly, we share a few more facts about KO’s valuations.

  • Revenues (sales) have been in decline since 2012
  • Price to Sales (6.99) is at a 20 year high and three times greater than the faster growing S&P 500
  • Price to Earnings (25.83 –trailing 12 mos.) is at a 17 year high
  • Price to Book (11.24) is at an 18 year high
  • Enterprise Value to EBITDA is at an eight-year high
  • Capital Expenditures are at a 15 year low and have declined rapidly over the last eight years
  • Book Value is at a ten year low
  • Debt has tripled over the last ten years while revenues and earnings have grown at about 15-20% over the same period

When Value Becomes Growth

In 2018 we wrote a six-part RIA Pro series called Value Your Wealth. Part of the series was devoted to the current divergence between value and growth stocks and the potential for outsized returns for value investors when the market reverts to the mean. In the article, we explored mutual funds and S&P sectors to show how value can be defined, but also how the title “value” is being mischaracterized.

One of the key takeaway from the series is that finding value is not always as easy as buying an ETF or fund with the word “value” in it. Nor, as we show with KO, can you rely on traditional individual stock mainstays to provide true value. Today’s value hunters must work harder than in years past.

Based on our model, KO traded below the model’s intrinsic value from 2003 through 2013 and likely in the years prior. As noted, its average discount to intrinsic value during this period was 41%. Since 2014 KO has traded well above its intrinsic value.

In 2014 passive investing strategies started to gain popularity. As this occurred, many companies’ share prices rose faster than their earnings growth. These stocks became connected to popular indexes and disconnected from their fundamentals. The larger the company and the more indexes they are in, the more that the wave of passive investing helped the share price. KO meets all of those qualifications. As the old saying goes, if you buy enough of them, the price will go up.

Summary

Buying “Value” is not as easy as buying shares in well-known companies with great brand names, proven track records, and relative earnings stability. As we exemplified with KO, great companies do not necessarily make great investments.

The bull market starting in 2009 is unique in many aspects. One facet that we have written extensively on is how so many companies have become overpriced due to indiscriminate buying from passive investment strategies. This has big implications for the next equity market drawdown as companies like KO may go down every bit as much or even more than the broader market.

Be careful where you seek shelter in managing your portfolio of stocks; it may not be the safe bunker that you think it is.  

In a follow-up article for RIA Pro, we will present similar analysis and expose more “value” companies.

Recession Arithmetic: What Would It Take?

David Rosenberg explores Recession Arithmetic in today’s Breakfast With Dave. I add a few charts of my own to discuss.

Rosenberg notes “Private fixed investment has declined two quarters in a row as of 2019 Q3. Since 1980, this has only happened twice outside of a recession.”

Here is the chart he presented.

Fixed Investment, Imports, Government Share of GDP


Since 1980 there have been five recessions in the U.S.and only once, after the dotcom bust in 2001, was there a recession that didn’t feature an outright decline in consumption expenditures in at least one quarter. Importantly, even historical comparisons are complicated. The economy has changed over the last 40 years. As an example, in Q4 of 1979, fixed investment was 20% of GDP, while in 2019 it makes up 17%. Meanwhile, imports have expanded from 10% of GDP to 15% and the consumer’s role has risen from 61% to 68% of the economy. All that to say, as the structure of the economy has evolved so too has its susceptibility to risks. The implication is that historical shocks would have different effects today than they did 40 years ago.

So, what similarities exist across time? Well, every recession features a decline in fixed investment (on average -9.8% from the pre-recession period), and an accompanying decline in imports (coincidentally also about -9.5% from the pre-recession period). Given the persistent trade deficit, it’s not surprising that declines in domestic activity would result in a drawdown in imports (i.e. a boost to GDP).

So, what does all of this mean for where we are in the cycle? Private fixed investment has declined two quarters in a row as of 2019 Q3. Since 1980, this has only happened two other times outside of a recession. The first was in the year following the burst of the dotcom bubble, as systemic overinvestment unwound itself over the course of eight quarters. The second was in 2006, as the housing market imploded… and we all know how that story ended.Small sample bias notwithstanding, we can comfortably say that this is not something that should be dismissed offhand.

For now, the consumer has stood tall. Real consumption expenditures contributed 3.0% to GDP in Q2, and 2.1% in Q3. Whether the consumer can keep the economy from tipping into recession remains to be seen.

Dave’s comments got me thinking about the makeup of fixed investment. It does not take much of a slowdown to cause a recession. But there are two components and they do not always move together.

Fixed Investment Year-Over-Year

One thing easily stands out. Housing marked the bottom in 12 of 13 recessions. 2001 was the exception.

Fixed Investment Year-Over-Year Detail

Fixed Investment Tipping Point

We are very close to a tipping point in which residential and nonresidential fixed investment are near the zero line. The above chart shows recessions can happen with fixed investment still positive year-over-year.

Manufacturing Has Peaked This Economic Cycle

The above charts are ominous given the view Manufacturing Has Peaked This Economic Cycle

Key Manufacturing Details

  • For the first time in history, manufacturing production is unlikely to take out the previous pre-recession peak.
  • Unlike the the 2015-2016 energy-based decline, the current manufacturing decline is broad-based and real.
  • Manufacturing production is 2.25% below the peak set in december 2007 with the latest Manufacturing ISM Down 5th Month to Lowest Since June 2009.

Other than the 2015-2016 energy-based decline, every decline in industrial production has led or accompanied a recession.

Manufacturing Jobs

After a manufacturing surge in November due to the end of the GM strike, Manufacturing Sector Jobs Shrank by 12,000 in December.

PPI Confirmation

Despite surging crude prices, the December Producer Price Inflation was Weak and Below Expectations

Shipping Confirmation

Finally, please note that the Cass Year-Over-Year Freight Index Sinks to a 12-Year Low

Manufacturing employment, shipping, industrial production, and the PPI are all screaming the same word.

In case you missed the word, here it is: Recession.

Major Market Buy/Sell Review: 1-21-20

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

This week’s analysis should be titled “Extreme Extension” week. You are going to see in multiple charts the same major deviation from long-term moving averages which have ALWAYS led to a corrective event in the past. Pay attention – risk is extremely elevated currently. Reduce portfolio risk and rebalance accordingly.

S&P 500 Index

  • With the market now trading 12% above its 200-dma, and well into 3-standard deviations of the mean, a correction is coming.
  • The “buy signal” (lower panel) is back to levels of extensions normally only seen with short-term tops and corrective actions, particularly when combined with extreme extensions and deviations from long-term means.
  • As noted we took profits in both the ETF and Equity Model (See Portfolio Commentary) and we still recommend taking profits and rebalancing risks in positions accordingly. We will likely have a much better entry point in the next couple of months to buy into.
  • Short-Term Positioning: Neutral Due To Extension
    • Last Week: Hold position
    • This Week: Take profits and rebalance to target weights.
    • Stop-loss moved up to $300
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • sAs goes the S&P 500, goes the DIA, especially when MSFT & AAPL are the two top holdings and drivers of the advances in both markets. (We reduced both of those holdings last week.)
  • The “buy” signal is extremely extended along with a very overbought condition.
  • Hold current positions and take profits, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral due to extensions
    • Last Week: Hold current positions
    • This Week: Take profits and rebalance risk.
    • Stop-loss moved up to $275
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Again, like SPY, the Nasdaq is just “extremely” extended currently. With QQQ now pushing towards a 4-standard deviation event. A correction is inevitable, it is just a function of time now.
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a correction to add exposure.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold position
    • This Week: Take profits and rebalance risks.
    • Stop-loss moved up to $195
  • Long-Term Positioning: Neutral due to valuations

S&P 600 Index (Small-Cap)

  • As noted above, small-caps have also pushed above 2-standard deviations of the 200-dma.
  • With the buy signal also extremely extended, and the index overbought, like all the other markets, a correction will provide a better entry point to add to our positions.
  • That correction has started and the current support level is being tested. A failure here and the previous breakout levels will be the next important support and our stop level.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop loss moved up to $69
  • Long-Term Positioning: Neutral

S&P 400 Index (Mid-Cap)

  • Like SLY, MDY is also extremely extended and deviated above the 200-dma, and the market accelerated further into 3-standard deviation territory on Friday.
  • With MDY’s “buy” signal extremely extended, and very overbought, this is a prime setup for a correction. Hold off adding exposure until we see a better entry point.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bullish

Emerging Markets

  • EEM is just like every other market. The recent surge has taken it well into 3-standard deviation territory.
  • With the “buy signal” extremely extended, a correction is coming so be patient to add exposure assuming stop levels are not violated.
  • EEM has tested, and held the 61.8% Fibonacci retracement level, so if it can break above the recent high, that will continue the bullish trend.
  • The Dollar (Last chart) is the key to our international positioning. The dollar looks to have confirmed a break lower which should support our thesis of adding back international exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $43
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA rallied out of its consolidation channel, broke out, and has now rallied well into 3-standard deviation territory.
  • EFA is both EXTREMELY overbought and extended with the buy signal at levels which have normally preceded short- to intermediate term corrections.
  • As with EEM, the key to our positioning is the US Dollar.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $67
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • Oil finally broke above the downtrend resistance line from the 2018 highs, which was bullish, but unfortunately was not able to hold the breakout level.
  • With oil prices falling back below $60/bbl, it is imperative that oil maintains the 200-dma support level which it is currently testing. This keeps us on hold for now from adding to our positions until we get confirmation oil prices are going to hold.
  • As noted previously, with the short-term buy signal for oil is extended, the struggle we saw was not unexpected.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Hold positions
    • Stop-loss for any existing positions is $58.
  • Long-Term Positioning: Bearish

Gold

  • Gold rallied sharply during the brief “Iran crisis” but has failed to breakout and hold new highs.
  • While gold is overbought short-term, the “buy signal” is very close to triggering. If gold can muster a rally and break above recent highs, it is likely we will see a further advance.
  • With gold now testing old highs, our positioning looks good particularly given that gold remains on a sell-signal currently. A reversal of the signal could suggest further highs to come.
  • We used the recent weakness to add to our GDX and IAU positions taking them back to full weightings.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position adjusted to $137
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Bond prices rallied last week, again, and are testing downtrend resistance. For now bonds remain in a bearish channel, suggesting higher yields (lower prices) are still likely short-term.
  • I suspect we are going to get some economic turmoil sooner, rather than later, which will lead to a correction in the equity markets and an uptick in bond prices.
  • Use lower bounds of the downtrend, and the 200-dma, to add to holdings currently.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132
  • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously, we noted the dollar broke down below both the 200-dma and the bullish trend line. It then retested, and failed, at that previous support level which confirms a breakdown in the dollar from its previous bullish channel.
  • Last week, the dollar has rallied back to that all important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • As stated last time: “It may be too early for a sharper dollar decline currently, as the U.S. economy is still the “cleanest shirt in the dirty laundry.”
  • Be patient for now on commodity related exposures. Momentum still rules the market as a whole.
  • The “sell” signal remains intact currently suggesting there is further downside, if it begins to reverse that will be an important clue.

Technically Speaking: Extreme Deviations & Eventual Outcomes

The good news is that with the market closed yesterday, the extreme extensions of the market did not get any more extreme. Also, it doesn’t change our analysis much from this past weekend’s missive either:

“This week, the market pushed those deviations even further as the S&P 500 has now pushed into 3-standard deviation territory above the 200-WEEK moving average.”

“There have only been a few points over the last 25-years where such deviations from the long-term mean were prevalent. In every case, the extensions were met by a decline, sometimes mild, sometimes much more extreme.”

As we discussed, there is a potential the current “momentum” push, due to the Fed’s ongoing “NotQE,” which could drive markets higher in the short-term.

“With the Federal Reserve’s ongoing ‘Not QE,’  it is entirely possible the markets could continue their upward momentum towards S&P 3500, and Dow 30,000. Clearly, the ‘cat is out of the bag’ if CNBC even realizes it’s the Fed:

‘On Oct. 11, the central bank announced it would begin purchasing $60 billion of Treasury bills a month to keep control over short-term rates. The magnitude of the purchases resembles the quantitative easing program the Fed conducted during and after the financial crisis.’

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

There is much debate between the Fed, and their supporters, and virtually everyone else, about the implications of the Fed’s actions. The “Heisenberg Report” did a good job summing up our view on the issue:

“Neel Kashkari’s take is a bit different, as is Mary Daly’s. The whole ‘debate’ is somewhat silly. Both sides are being disingenuous. It’s not ‘QE.’ It probably will be, eventually, but for right now, the Fed isn’t buying coupons. And irrespective of any knock-on effects for risk assets, the overarching intent is to avoid another short-term funding squeeze by reestablishing an abundant reserves regime with a buffer. That, as opposed to a goal of compressing risk premia, driving investors out the risk curve and down the quality ladder to foster the wealth effect.

On the other hand, the idea that the distinction matters is a bit dubious. Regardless of what the overarching goal is, liquidity provision is liquidity provision and there’s a signaling effect too. Call it a ‘chart crime’ if you like, but I’d be more inclined to say that ‘it is what it is'”

He’s correct, and as he notes, even those sophisticated enough to be “short” something, are probably “net long” currently.

This is precisely our positioning, and why we discussed “taking profits” last week. While we are certainly not opposed to “shorting the market” to hedge our portfolio risk, the continued flood of liquidity by the Fed makes shorting a challenging proposition in the short-term. Therefore, our best option to reduce risk was to simply “ease back on the gas” by reducing position weights in the most egregiously “overbought” areas.

Most likely, this will be an exercise we repeat as long as the Fed is continuing to push liquidity into the market.



The Higher We Go…

At present, there is seemingly little to stop the markets from pressing higher, particularly once the push hits “rarefied air.” Weak fundamental and economic data is readily dismissed “hopes” those “soft spots,” will soon strengthen to catch up with price. More often than not, it is usually the opposite, which occurs.

The chart below shows the S&P 500 index versus its 200-WEEK moving average and the historical percentage deviation between the two. The chart assumes the market will continue to push higher through the end of the “seasonally strong period,” and attain the 3500 level by June. 

Historically, when the market becomes deviated from its 4-year (200-week) moving average by 20% or more, as it is currently, corrections have tended to follow. Some corrections were minor, such as the “Crash of 1987”,  the “LTCM crisis” in 1988, or the 2015-2016 “Taper Tantrum.” Other corrections from such deviations were much more severe such as the “Crash of 1974”, the “Dot.com Bust”, or the “Financial Crisis” of 2008.

The same deviation mismatch can be seen in the 60-month (5-year) moving average. At 3500, the S&P 500 will achieve a deviation only seen 3-times prior, which preceded the “Crash of 1987″, the “Dot.com Bust,” and the 2015-2016 “Taper Tantrum.”

The defining aspect of whether corrections were “mild” or “severe” really came down to whether the valuations were expanding from “cheap to expensive,” or if they were “expensive heading towards cheap.” At 30x trailing reported 10-year average earnings, and price-to-sales above 2x (the highest level on record for the S&P 500), it is hard to suggest that valuations are cheap. 

Our favorite way to look at the data is with our QUARTERLY analysis that combines both valuation, relative strength, and deviations into one chart.

There is little to suggest that investors who are extremely “long equity risk” in portfolios currently won’t eventually suffer a more severe “mean reverting event.” 

While valuations and long-term deviations suggest problems for the markets ahead, such can remain the case for quite sometime which always leads investors to believe “this time is different.” Because of the time required for long-term data to revert, monthly and quarterly data is more useful as a guide to manage allocations and longer-term exposures. In other words, this data is not useful as a short-term market-timing tool.

However, even the short-term data, has now reached more extreme technical levels which DO suggest caution. The chart below is our RIAPRO (Try 30-Days Risk Free) Technical Composite which combines short-term relative strength, momentum, and deviation into one indicator.

At 98.48, corrections from short-term market peaks tend not to be far off. In January of 2018, as the “tax cut” bill took effect, stocks were soaring in January pushing the technical composite to a similar level. It is worth remembering, the market dropped 10% heading into the first two weeks of February.

Currently, the market feels much like what we saw in early 2018, and a similar correction is likely in the short-term. However, longer-term it will be a reduction in corporate “share repurchases,” which will be a bigger factor in the sustainability of the market’s advance.

Clearly, the Federal Reserve is doing whatever it can to keep markets stable. With economic growth already fragile, a more serious correction in prices would collapse consumer confidence, lead to rising unemployment, and foster the onset of a full-blown recession. Such would be problematic for the Fed to counter, particularly if the trillions of dollars at play in leveraged hedge funds begin to lock up.

However, I agree with Wolf Richter’s recent comment.

In my decades of looking at the stock market, there has never been a better setup. Exuberance is pandemic and sky-high. And even after today’s dip, the S&P 500 is up nearly 29% for the year, and the Nasdaq 35%, despite lackluster growth in the global economy, where many of the S&P 500 companies are getting the majority of their revenues.

Mega-weight in the indices, Apple, is a good example: shares soared 84% in the year, though its revenues ticked up only 2%. This is not a growth story. This is an exuberance story where nothing that happens in reality – such as lacking revenue growth – matters, as we’re now told by enthusiastic crowds everywhere.

He’s right. The only period in history where we have seen a similar “set-up” was in 1999.

While we do realize this time “IS” different, we also know the “outcomes” will ultimately be the same. This is why we continue to look for opportunities to reduce risk, raise exposures to cash, and are ready to respond to market changes as they occur.

Yes, we are underperforming the market this year, but (to adapt a phrase from Popeye), we will gladly pay that price today for a “hamburger” on Tuesday.

Eric Hickman: Recession Is More Likely Than You Think

Eric Hickman is president of Kessler Investment Advisors, Inc., an advisory firm located in Denver, Colorado specializing in U.S. Treasury bonds.


Good economic news over the last couple months belies the fact that a recession could strike as soon as March 2020.

That good news has been plentiful: a phase one trade deal between the U.S. and China is presumably close to being signed, the December U.S. Labor jobs report exceeded expectations, the Federal Reserve didn’t lower rates at their December meeting, and developed-economy stock markets continue making new highs. The Fed’s mantra of, “the economy is in a good place” is the ethos of the moment.

But just behind those data points, many more are suggesting a deteriorating economy. The Citigroup U.S. Surprise index (which measures how far the aggregate of economic releases are above or below where economists estimate them to be) has fallen in recent months (see below). ISM Manufacturing, Durable Goods, Retail Sales, Leading Economic Indicators, and Existing Home Sales have all been lower than expectations in December and early January.

And yet the Fed repeats a version of the statement, “the economy is doing well because consumer spending and the labor market are strong”. And they are right – for now. Real personal consumption is growing at a reasonably healthy 2.4% (YoY%) and the 3.5% unemployment rate is at a near-50 year low (49.6 years). The problem is that these are the last segments of the economy to falter historically at the start of a recession. To the extent that the recession hasn’t started yet (I don’t think it quite has), the consumer and labor market should still be strong. In other words, there is an expected gap of time from when leading indicators (manufacturing, yield curve) show weakness to when coincident indicators (consumer and labor) show weakness. There is nothing to suggest one should extrapolate this consumer and labor strength, especially given the many leading recession signals we’ve already gotten.

In fact, the following five long-running standard recession signals triggered in 2019:

  • Yield curve inversion, signaled 3/27/2019, data back to January 1971.
  • Conference Board Jobs Gap YoY growth negative, signaled 11/30/2019, data back to February 1968.
  • Conference Board Leading Economic Indicators Peak, signaled 7/31/2019 (tentative because it could make a higher peak), data back to January 1959.
  • Initial Jobless Claims Trough, signaled 4/12/2019 (tentative because it could make a lower trough), data back to January 1967.
  • ISM Manufacturing first below 50 (contraction), signaled 8/31/2019, data back to January 1948.

The long history (49+ years) of these indicators can be used to get a sense of timing for when a recession may begin. I have measured historically how long these indicators signaled before (or after) the start of their accompanying recession. Comparing this time-frame to when these indicators triggered recently, suggests a range for when this recession may come. The chart below shows the time ranges (minimum amount of time historically to maximum amount of time historically) in which each indicator would suggest a recession start.

There are a few conclusions to this. First, five recession indicators have signaled. Second, there is nothing unusual in the timing that the recession hasn’t started yet. Third, no matter which of the five indicators you use, a recession will likely begin in 2020 and the average center-point of the indicators is in March, just a little over two months away. Don’t confuse the Fed’s “on-hold” stance to have any more meaning than the hope that the consumer and labor market’s strength will continue. History suggests that this is not a good bet to make.

RIA PRO: Market Continues “Euphoric” Advance As 3500 Becomes Next Target


  • Market Continues Euphoric Advance
  • Portfolio Position Review
  • MacroView: 2020 Market Outlook (Video)
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Catch Up On What You Missed Last Week


Market Continues Euphoric Advance

In last week’s missive, I discussed a couple of charts which suggested the markets are pushing limits which have previously resulted in fairly brutal reversions. This week, the market pushed those deviations even further as the S&P 500 has now pushed into 3-standard deviation territory above the 200-WEEK moving average.

There have only been a few points over the last 25-years where such deviations from the long-term mean were prevalent. In every case, the extensions were met by a decline, sometimes mild, sometimes much more extreme. 

The defining difference between whether those declines were mild, or more extreme, was dependent on the trend of financial conditions. In 1999, 2007, and 2015, as shown in the chart below, financial conditions were being tightened, which led to more brutal contractions as liquidity was removed from the financial system. 

Currently, the risk of a more “substantial decline,” is somewhat mitigated due to extremely easy financial conditions. However, such doesn’t mean a 5-10% correction is impossible, as such is well within market norms in any given year. 

This is particularly the case given how extreme positioning by both institutions and individual investors has become. With investor cash and bearish positions at extreme lows, with prices extremely extended, a reversion to the mean is likely and could lean toward to the 10% range.

One of the other big concerns remains the concentration of positions driving markets higher. Lawrence Fuller analyzed this particular extreme in the market. (H/T G. O’Brien)

“One similarity between the Four Horseman of 2000 and the mega-caps of 2020 is their tremendous influence on the overall market, as can be seen below by their cumulative weightings. The weighting of today’s top five names is now 17.3%. I’m not suggesting that history is going to repeat itself, but often it rhymes.

If you lived and invested through the 1990s, as I did, then you’ll understand what I am talking about when I say that the dot-com boom was a sentiment-driven rally. I’m starting to see the same explanation for the current rally, as there really haven’t been any concrete fundamental developments to explain or validate it. The momentum stocks are rising in price day after day on hopes and expectations, and Wall Street analysts are happy hop on board for the ride, as usual.”

Lawrence is correct. There has not been a fundamental improvement to support the rise in the market currently. As shown in the chart below, S&P just released its 2021 estimates for the S&P 500, which is estimated to come in at $171/share. 

What you should notice is that estimates for 2021 are now $3 LOWER than where estimates for the end of 2020 stood in April 2019. Importantly, between April 2019 and present, as earnings estimates were continually ratcheted lower, the S&P 500 index rose by 17.5%

While Apple, which we own, is the “cheapest” of the “4-horseman” currently, it is only “cheap” because of rather aggressive share repurchases. Here are some interesting stats:

In the 5-years from 2015:

  • Earnings per share (EPS) grew by just $2.69 per share or $0.53 per share annually.
  • Sales only grew by $26.45 billion or $5.29 billion/year.
  • Shares outstanding, however, declined by 1.13 billion

However, during that same 5-year period, Apple’s share price has risen by 210%.  

The only reason Apple “appears” to be cheap is because of the massive infusion of capital used to reduce the number of shares outstanding. As a business, it is a great company, but it is a fully mature company, which is struggling to grow revenues. With a P/E of 27 and price-to-sales (P/S) ratio of 5.36, investors are grossly overpaying for the earnings growth and will likely be disappointed with future return prospects. 

So why do we still own Apple? Because “fundamentals don’t matter” currently as the momentum chase, fueled by the Fed’s ongoing liquidity interventions, has led to a “runaway train.” But, understanding that eventually fundamentals will matter, is why we have taken profits out of our position twice since January 2019.

Just remember, “price is what you pay, value is what you get.” 



Next Stop, 3500

As noted last week, in July of 2019, we laid out our prognostication the S&P 500 could reach 3300 amid a market melt-up though the end of the year. On Friday, the S&P 500 closed at 3329, with the Dow pushing toward 29,350.

With the Federal Reserve continuing to pump liquidity into the market currently, we are raising our 2020 estimate for the S&P to 3500 as “the mania” goes mainstream. There is absolutely NO FUNDAMENTAL basis for raising the target; it is ONLY a function of the momentum chase.

This urgency to take on “risk,” as investors pile into “passive indexes” under a “no market risk” assumption, can be seen in the extreme lows of the put/call ratio.

With the Federal Reserve’s ongoing “Not QE,”  it is entirely possible the markets could continue their upward momentum towards S&P 3500, and Dow 30,000. Clearly, the “cat is out of the bag” if CNBC even realizes it’s the Fed:

“On Oct. 11, the central bank announced it would begin purchasing $60 billion of Treasury bills a month to keep control over short-term rates. The magnitude of the purchases resembles the quantitative easing program the Fed conducted during and after the financial crisis.”

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

With the Federal Reserve continuing to “ease” financial conditions, there is little to derail higher asset prices in the short-term. However, we continue to see cracks in the “economic armor,” like Friday’s plunge in “job openings,” continued deterioration in earnings estimates, weaker growth rates in employment, and negative revisions to data, like wages, which suggest the market is well ahead of the economy. (Last week, negative revisions wiped out all the wage growth for the bottom 80% of workers.)

But, as I said, “fundamentals” don’t matter currently. As CNBC noted:

“The problem front and center is how investors are looking past the continuous earnings rout, betting on a snapback as soon as the first quarter of 2020. S&P 500 earnings are expected to drop by 0.3% in the fourth quarter of 2019, marking the first back-to-back quarterly decline since 2016, according to Refinitiv.”

While “fundamentals” may not seem to matter much currently, eventually, they will.

Portfolio Positioning

After reducing exposure “slightly” to equities, as noted last week, we did not make any further changes to portfolios over the last few days. Given we have shortened our duration in our bond holdings, raised cash levels to roughly 10% of the portfolio, we can afford at the moment to allow our existing long positions to ride the market higher. 

In case you missed last week’s note, or are a new reader, here were the previous changes:

In the Equity Portfolios, we slightly reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we slightly reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now. 

The Dynamic Portfolio was allocated to a market neutral position by shorting the S&P index itself.

The reason we continue to derisk portfolios is that we have seen this “game” before. This was a point we made to our RIAPRO.NET Subcribers (Try RISK FREE for 30-Days) last week:

“The belief the markets can no longer have a correction is fueling an equity chase in companies with the poorest underlying fundamentals. The last time that we saw asset prices surge by 20%, or more, in a single month, particularly in companies with no revenue, negative valuations, and poor business models, was in 1999. The chart of Qualcom (QCOM) in late 1999 is a good example.”

“Unfortunately, for investors in QCOM, by the end of 2000, that 95% gain had been reversed to a 10% loss. But QCOM was not alone, the only difference is the vast majority of other companies like Global Crossing, Enron, Worldcom, Lucent Technologies, Sun Micro, and many others, no longer exist in their original forms, if at all. 

Another good example is Cisco Systems (CSCO). If you had bought it at the turn of the century, you would still be down 10% in your position 20-years later.”

“Today, we are seeing the same chase in companies which exhibit similar characteristics to what we saw in 1999:

  • Poor business models with little, or no, ‘protective moat.’
  • Little or no earnings
  • Excessively high or negative valuations
  • Prices are bid up on “hope” these companies will mature into valuations in the future.

Sure, companies from Tesla (TSLA) to Zoom Video (ZM) might just be the next Amazon (AMZN) of the “dot.com” mania to survive and prosper. However, the odds are highly stacked against that being the case.”

Being more conservative may “cost” you in the short-term. However, in the longer-term, where it matters for your money, it is highly likely we will eventually see some, most, or all of the gains of this past decade reversed. 

While that is hard to believe, just remember its happened twice before.



The Macro View

Michael Lebowitz and I discuss our outlook and reasoning

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

See You Next Week

By Lance Roberts, CIO


Financial Planning Corner

REGISTER NOW for our most popular workshop: THE RIGHT LANE RETIREMENT CLASS

  • The Westin, Austin at the Domain- 11301 Domain Drive, Austin, TX 78758
  • February 8th from 9-11am.

You’ll be hearing more about more specific strategies to diversify soon, but don’t hesitate to give me any suggestions or questions.

by Danny Ratliff, CFP®, ChFC®


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite 


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Energy (XLE), Communications (XLC)

The improvement in Energy stalled again this week, as oil prices continued to struggle. With oil prices testing the 200-dma, it is critical oil turns up next week, otherwise we will see further deterioration in energy stocks. 

As recommended last week, we reduced our weighting in XLC slightly on Friday just to take in some profits. With the entire sector extremely extended, take profits if you haven’t done so already and hold the balance for now.

Current Positions: 1/2 weight AMLP, Underweight XLC

Outperforming – Technology (XLK), Healthcare (XLV)

We previously recommended taking profits in Technology and Healthcare, which have not only been leading the market but have gotten extremely overbought. After taking profits in portfolios, we remain long the balance and are looking for our next opportunity. 

Current Positions:  Reduced from overweight to target weight XLK, XLV

Weakening – Financials (XLF)

We noted previously that Financials have been running hard on Fed rate cuts and more QE and that the sector was extremely overbought and due for a correction. That correction/consolidation started last week and continued this week. We recommended taking profits previously, and that remains good advice again this week with the sector still very overbought. However, the consolidation also dropped Financials from leading to weakening this past week. 

Current Position: No Position

Lagging – Industrials (XLI), Real Estate (XLRE), Staples (XLP), Discretionary (XLY), Materials (XLB), and Utilities (XLU)

Industrials, which perform better when the Fed is active with QE, has broken out to new highs, but is still consolidating at a high level and has begin to underperform on a relative basis to the S&P 500. That underperformance dropped it into the lagging category this past week.  Given the sector is extremely overbought, we will wait for this correction to play out  before adding to our current position.

After a run to new highs, Staples continues to consolidate and hold above its 50-dma. Since taking profits previously, we are just maintaining our stop loss on the sector currently. 

Discretionary, after finally breaking out to new highs, has gotten very extended in the short-term. We reduced our position slightly to take in profits. We remain optimistic on the sector for now. However, the sector is extremely overbought so a correction is needed that doesn’t violate support at the 50-dma to add back to our exposure.

XLRE has been rallying as of late and relative strength is improving. We remain weighted in the sector for now but may increase our weighting if the recent strength is confirmed. 

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

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps broke out to new highs this past week as the rotation to risk gained momentum. The relative performance remains flat as the focus has returned to chasing the largest of large-cap names. As noted two weeks ago, we added to our small-cap holdings with a small-cap value ETF. We are holding that position for now, but are tightening up our stops.

Current Position: KGGIX, SLYV

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

Emerging and International Markets, rallied recently on news of a “trade deal” and finally clearly broke above important resistance. However, like small and mid-caps above, international stocks relative performance remains muted but is improving. As discussed two weeks ago, we added positions in both emerging market and international value  positions, however, we are tightening up our stops to protect our capital investment. 

Current Position: EFV, DEM

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

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

Current Position: RSP, VYM, IVV

Gold (GLD) – As noted two weeks ago, Gold was holding support at the $140 level and registered a buy signal. GDX has also held support and turned higher with a triggered buy signal. Over the last two weeks, gold has broken out to highs, but stalled at those levels. We previously took our holdings back to full-weights after taking profits earlier this year. However, we are tightening up our stop levels.

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

Bonds (TLT) – 

Bonds rallied back above the 50-dma on Friday as money rotated into bonds for “safety” as the market weakened on Friday. There is a consolidation with rising bottoms occurring currently, which suggests we may see further weakness in the market with a “risk off” rotation into bonds.

Add to bonds here with a stop at $136 for TLT as a benchmark. 

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:

If you are a client of RIA Advisors, please take the opportunity to watch the Market Outlook presentation that Michael Lebowitz and I prepared last week. CLICK HERE TO WATCH:

“As we noted in last weekend’s newsletter, we recently took profits in our various portfolio strategies to raise cash slightly, and reduce excess portfolio risk. Given our portfolios are already hedged with early exposures to value positioning, gold, and short-duration Treasuries, there currently isn’t a need to become overly defensive given the ongoing, liquidity fueled, momentum of the markets. 

Currently, the bullish exuberance, extreme complacency, and technical deviations are issuing warning signs which investors should NOT readily dismiss. These are the issues we cover in the following video presentation:

  1. The “risks” to the current “bullish view,” 
  2. Why we reduced risk in portfolios
  3. The importance of valuations
  4. The Fed’s ongoing liquidity programs.
  5. Future expected returns, and more.”

As noted in the main missive this week, the market is extremely extended, overbought, and complacent. As such, market corrections occur regularly in this type of environment regardless of the underlying bullish thesis.

We previously took actions to slightly reduce portfolio risk, and raise cash. While this may lead to some short-term underperformance in portfolios, you will appreciate the reduced volatility if a correction occurs over the next 3-4 weeks as expected. 

There we no additional portfolio actions this past week.

  • New clients: We are holding off onboarding new client assets until we see some corrective action or consolidation in the market.
  • Dynamic Model: No actions required
  • Equity Model: No actions required
  • ETF Model: No actions required

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

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

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

See below for an example of a comparative model.


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

401k Plan Manager Live Model

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

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

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

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

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

FPC: Do You Have A “Financial Vulnerability” Cushion?

REGISTER NOW for our most popular workshop:

THE RIGHT LANE RETIREMENT CLASS

  • The Westin Austin at the Domain- 11301 Domain Drive, Austin, TX 78758
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Everyone has heard of having emergency funds, but how many have heard of a financial vulnerability cushion (FVC)? Common, old rule of thumb financial rules typically dictate savings rates, but in times like we currently face should we be doing something different?

I know, I know times are great. Markets are hitting all-time highs daily, unemployment is better than anything we have seen in 50 years, tax brackets are low, and the list goes on and on. These are just a few of the more common themes and I’m not here to argue any of them.

I am here to hopefully provide an ounce of clarity.

What happens after some of the best times? What happens when life can’t get you down? What happens after some of the worst times? Markets eb and flow and not just financial markets, but job markets as well.

They don’t say when it rains it pours for nothing.

We want you to be prepared.

I’m not talking about building a bunker, but I am talking about going above and beyond the typical 3-6 months of expenses held in a fully funded emergency fund.  In times like these it’s difficult to think about putting funds anywhere but in the market. After all, the market has been red hot. I visit with people daily who question their need for additional savings or any money in savings accounts while the market’s notching all-time highs weekly. FOMO or “Fear of missing out” is very real.

Have you ever wondered why Wall Street tells everyone that buy and hold is the only strategy, yet they don’t utilize it themselves?

Have you ever wondered how so many people end up in difficult financial positions? Many times, it’s because they choose the present over the future in terms of spending or believe the future will improve and things will only get better. I’ll get that raise or bonus this year, but unfortunately as many know sometimes things are as good as they get.  Don’t get me wrong I’m an eternal optimist, but when it comes to things I literally have no control over I know a little better.

We’d like for you to start thinking a little differently when it comes to where to put your funds and how much you should have saved that are easily accessible and low risk.

Emergency Funds

These funds should be in a savings account and accessible, but not so accessible you can go to the ATM and make a withdrawal. Emergency funds are for real emergencies, your A/C goes out, the car breaks down, your kid breaks their leg, the list goes on. (I’ve actually encountered all within the last 12 months) so don’t say it can’t happen!

We like online banks that are still FDIC insured or a brick and mortar that pays a higher interest rate. Don’t leave these funds in a bank that pays you very little or next to nothing. The banks are using your funds to make money, so should you. Every little bit helps.

A resource to find a credible bank could be www.bankrate.com or www.nerdwallet.com. Just type in High Yield Savings. Recently there have been many more banks popping up in the search que so do your research on each institution or give us a call if you have any questions.

Financial Vulnerability Cushion or (FVC)-

These are funds that you can think of a little differently, what if I lose my job/have a disability/illness AND the A/C goes out and the car breaks down.  Instead of putting funds in your savings account go ahead and structure these a bit different.

It’s ok to ladder CD’s to lock in higher or current rates. If using CD’s, you would ladder these in the event rates rise so a portion is always coming due. Example 3 months, 6 months, 9 months, 12 months. This may be difficult to stomach because these rates will be similar to what you will earn in a high yield savings account but will also provide a better rate should rates decrease. Short term bond funds or ETF’s could also be suitable for these funds. Safety and liquidity are key here.  We currently favor short term, high credit quality bonds or Treasury bond ETF’s. Remember, you’re not putting these funds here forever and these should be monitored like any other investment. While these are safer investment’s they are not cash and carry some risk and loss of principal.

While the main purpose of the Financial Vulnerability Cushion is to fortify your financial house, these funds can also be utilized for opportunities as well.

How many times have you thought to yourself if only I had the funds to invest or if you only did something differently? Well, congratulations you can now be one of the few investors with additional cash to buy low. This especially makes sense since Wall Street wants you to ride it out and you can’t time the markets, but they sure can. Wall Street will also tell you that cash is a terrible investment. Ever wonder why? How does Wall Street get paid on cash? Long term cash can be a terrible investment, but as our Director of Financial Planning Richard Rosso says you can fall on one of two swords in regards to having cash:

  1. The inflation sword or
  2. The loss of principal sword.

Our thoughts are this isn’t a forever holding. While I do think this strategy could be used indefinitely for all of the reasons above. This is a strategic investment to be used in late stage cycles. This is your chance to pounce when the market is on sale or that business opportunity falls in your lap. After all true financial freedom is earned not given in markets and often times it is taken away just as quickly.

Bet On Yourself.

Bet on yourself to make the right decision, to be prudent, to be wise. When everyone and I mean everyone is doing one thing does it make sense to be a bit of a contrarian, protect assets and give yourself an opportunity in the future?

This is a great time to review your financial plan and take a look at your assets. Where are you making your contributions? What impact will that make when you make withdrawals? What will give you the most opportunity for success. Most success isn’t given overnight and neither are investment returns.

No one knows what tomorrow brings, but we do know as Roman philosopher Seneca once said “Luck is what happens when preparation meets opportunity.”

Call your advisor, and ask them about your Financial Vulnerability Cushion.

Do you have one?

MacroView: 2020 Market & Investment Outlook

On Tuesday, Michael Lebowitz and I held private events with our high net worth clients to review our investment strategy and outlook for the rest of the year. The purpose of these events was to provide clarity on portfolio allocation, weightings,  and the risks that could potentially lead to large losses of capital.

As we noted in last weekend’s newsletter, we recently took profits in our various portfolio strategies to raise cash slightly, and reduce excess portfolio risk. Given our portfolios are already hedged with early exposures to value positioning, gold, and short-duration Treasuries, there currently isn’t a need to become overly defensive given the ongoing, liquidity fueled, momentum of the markets. 

Currently, the bullish exuberance, extreme complacency, and technical deviations are issuing warning signs which investors should NOT readily dismiss. These are the issues we cover in the following video presentation:

  1. The “risks” to the current “bullish view,” 
  2. Why we reduced risk in portfolios
  3. The importance of valuations
  4. The Fed’s ongoing liquidity programs.
  5. Future expected returns, and more.

If you have any questions, please email us.


 

#WhatYouMissed On RIA: Week Of 01-13-20

We know you get busy and don’t check 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 you might have missed.

The Week In Blogs


The Best Of “The Lance Roberts Show

Video Of The Week

Lance Roberts & Michael Lebowitz discuss how the Federal Reserve has gotten itself trapped in its own liquidity program.

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!

Special Chart Report: Party Like It’s 1999

We have written rather extensively lately about the extreme extension we are seeing in the markets as the Fed’s ongoing “repo” operations and QE are directly fueling a sharp rise in asset prices. The problem is prices are surging at a time when both corporate profits and earnings growth remain weak. 

Importantly, the ongoing Fed policies have lured investors into an extreme sense of complacency as witnessed by the sharp drop in “short-interest” in the S&P 500. This belief the markets can no longer have a correction is fueling an equity chase in companies with the poorest underlying fundamentals.

The last time that we saw asset prices surge by 20%, or more, in month, particularly in companies which have no revenue, negative valuations, and poor business models, was in 1999. The chart of Qualcom (QCOM) in late 1999 is a good example.

Unfortunately, for investors in QCOM, by the end of 2000, that 95% gain had been completely reversed into a 10% loss. But QCOM was not alone, the only difference is that the vast majority of the other companies like Global Crossing, Enron, Worldcom, Lucent Technologies, Sun Micro, and many others no longer exist in the original forms today, if at all. 

Here is another good example, if you had bought CSCO at the turn of the century, you would still be down by 10% on your position 20-years later.

Today, we are seeing the same chase in companies which exhibit similar characteristics to what we saw in 1999:

  • Poor business models with little, or no, “protective moat.” 
  • Little or no earnings
  • Excessively high or negative valuations
  • Prices are bid up on “hope” these companies will mature into valuations in the future.

Sure, companies from Tesla (TSLA) to Zoom Video (ZM) might just be the next Amazon (AMZN) of the “dot.com” mania to survive and prosper. However, the odds are highly stacked against that being the case. 

Here are a few examples of why it looks like investors are once again “Partying Like It’s 1999.” 

Zoom Video

10x Genomics

Twilo, Inc.

Tesla, Inc.

Shake Shack, Inc.

Pope Resource Partners

Pinterest, Inc.

NIO, Inc.

iRhythm Technologies, Inc.

CrowdStrike Holdings, Inc.

Beyond Meat, Inc.

Alteryx, Inc.

While we are not saying the markets are going to “crash” tomorrow, there is mounting evidence that “irrational exuberance” and “extreme complacency,” due to the ongoing Federal Reserve interventions, has begun to manifest itself in equity prices of companies with the poorest fundamentals. 

Historically, this has not worked out well for investors. 

“History doesn’t always repeat itself, but it often rhymes.” – Samuel Clemens

The Fed Won’t Avert The Next “Crisis,” They Will Cause It.

John Mauldin recently penned an interesting piece:

“Ignoring problems rarely solves them. You need to deal with them—not just the effects, but the underlying causes, or else they usually get worse. In the developed world, and especially the US, and even in China, our economic challenges are rapidly approaching that point. Things that would have been easily fixed a decade ago, or even five years ago, will soon be unsolvable by conventional means.

Yes, we did indeed need the Federal Reserve to provide liquidity during the initial crisis. But after that, the Fed kept rates too low for too long, reinforcing the wealth and income disparities and creating new bubbles we will have to deal with in the not-too-distant future.

This wasn’t a ‘beautiful deleveraging’ as you call it. It was the ugly creation of bubbles and misallocation of capital. The Fed shouldn’t have blown these bubbles in the first place.”

John is correct. The problem with low interest rates for so long is they have encouraged the misallocation of capital. We see it everywhere throughout the entirety of the financial system from consumer debt, to subprime auto-loans, to corporate leverage, and speculative greed.

Misallocation Of Capital – Everywhere

Debt, if used for productive purposes, can be beneficial. However, as discussed in The Economy Should Grow Faster Than Debt:

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

Currently, throughout the entire monetary ecosystem, there is a rising consensus that “debt doesn’t matter” as long as interest rates and inflation remain low. Of course, the ultra-low interest rate policy administered by the Federal Reserve is responsible for the “yield chase,” and the massive surge in debt since the “financial crisis.” 

Yes, current economic growth is good, but not great. Inflation, and interest rates, remain low, which creates an “illusion” that using debt remains opportunistic. However, as stated, rising levels of non-productive debt has negative long-term economic consequences.

Before the deregulation of the financial industry under President Reagan, which led to an explosion in consumer credit issuance, it required just $1.00 of total system-wide debt to create $1.00 of economic growth. Today, it requires $3.97 to create the same $1 of economic growth. This shouldn’t be surprising, given that “debt” detracts from economic growth as the “debt service” diverts income from productive investments and leads to a “diminishing rate of return” for each new dollar of debt.

The irony is that while it appears the economy is growing, akin to the analogy of “boiling a frog,” we accept 2% economic growth as “strong,” whereas such growth rates were previously considered near recessionary.

Another conundrum is that corporations, and financial institutions, appear to be healthier, not to mention wealthier than ever. If such is indeed the case, then why is the Federal Reserve still needing to engage in “emergency monetary measures” to support the financial markets and economy after more than a decade?

As John stated above, the Fed’s actions are only “ignoring the problems” which, combined, is a problem too large for the Federal Reserve to fix.

The Dark Side Of Stock Buybacks

While many argue that “share buybacks” are just a method by which corporations can return cash to shareholders, there is a dark side. In moderation, repurchases can be a beneficial method for a company to deploy capital when no better options are available. (It’s the least best use of cash.)

But, as with everything in life, when taken to “excess” the beneficial effects, can become detrimental.

The rules now reward management, not for generating revenue, but to drive up the price of the share price, thus making their options and stock grants more valuable.” – John Mauldin

The problem for the Fed was, despite the best of intentions, lowering interest rates to zero did not spark a “bank lending spree” throughout the economy. Instead, the excess liquidity flowed directly back into the financial system, creating a global wealth gap, rather than supporting stronger economic growth.

The most vivid example of this “closed loop” was in corporate share repurchases. Corporations, able to borrow cheaply due to low rates, used debt and cash to repurchase shares to increase earnings per share. This was the easiest route to create “executive wealth,” rather than deploying capital in more risky endeavors. As the Financial Times penned:

Corporate executives give several reasons for stock buybacks but none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay and in the short-term buybacks drive up stock prices.

Importantly, as noted by the Securities & Exchange Commission:

“SEC research found that many corporate executives sell significant amounts of their own shares after their companies announce stock buybacks.”

Again, buybacks may not be an issue, but when taken to excess such can have the negative side effects of inflating asset bubbles. As John Authers pointed out:

“For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.”

“Stock buybacks” are only a short-term benefit. With liquid cash, or worse debt, used for a one-time benefit, there is a long-term negative return on uses of capital for non-productive investments.

All Levered Up

Currently, total corporate debt has surged to $10.1 trillion – its highest level relative to U.S. GDP (47%) since the financial crisis. In just the last two years, corporations have issued another $1.2 trillion of new debt NOT for expansion, but primarily used for share buybacks.

For the last 10-years, the Fed’s “zero interest rate policy” has left investors chasing yield, and corporations were glad to oblige. The end result is the risk premium for owning corporate bonds over U.S. Treasuries is at historic lows, and debt has allowed many “zombie companies” to remain alive.

During the next market reversion, the 10-year rate will fall towards “zero” as money seeks the stability and safety of the U.S Treasury bond. However, corporate bonds will be decimated. When “high yield,” or “junk bonds,” begin to default in large numbers, as they always do in a recession, which is why they are called “junk bonds,” investors will face sharp losses on the one side of their portfolio they “thought” was safe. 

As the credit market falls into crisis, the Fed will have to ramp up additional stimulus to bail out the financial institutions caught long with an exceeding amount of poor-quality debt. As shown below, Treasuries will gain a bid as yields fall to zero, while corporate bonds lose value.

“In just the last 10 years, the triple-B bond market has exploded from $686 billion to $2.5 trillion—an all-time high. To put that in perspective, 50% of the investment-grade bond market now sits on the lowest rung of the quality ladder.

And there’s a reason BBB-rated debt is so plentiful. Ultra-low interest rates have seduced companies to pile into the bond market and corporate debt has surged to heights not seen since the global financial crisis.” John Mauldin:

As noted previously, there is a large tranche of BBB bonds on the verge of being downgraded to “junk.” When this occurs, there will be an avalanche of selling as pension, mutual, and hedge fund managers dump bonds simultaneously into what will be an illiquid market.

Pensions Are Broke

But it is NOT just “share buybacks” and debt, which are problems hiding in plain sight.

“Moody’s Investor Service estimated last year that the total pension funding gap in the U.S. is $4.4 trillion. A few months ago, the American Legislative Exchange Council estimated it at nearly $6 trillion.”

With pension funds already wrestling with largely underfunded liabilities, the aging demographics are further complicating funding problems.

The $6 Trillion “Pension Crisis” is just one sharp market downturn away from imploding. As I wrote in “The Next Financial Crisis Will Be The Last:”

“The real crisis comes when there is a ‘run on pensions.’ With a large number of pensioners already eligible for their pension, the next decline in the markets will likely spur the ‘fear’ that benefits will be lost entirely. The combined run on the system, which is grossly underfunded, at a time when asset prices are declining, will cause a debacle of mass proportions. It will require a massive government bailout to resolve it.”

This $6 trillion hit is going to come at a time where the Federal Reserve will already be at “full tilt” monetizing debt to stabilize declining financial markets to keep a “debt crisis” from spreading.

Strike Three, You’re Out

While investors have become extremely complacent over the last decade that Central Banks have gained control of the financial markets, this is likely an illusion. There are numerous catalysts which could pressure a downturn in the equity markets:

  • An exogenous geopolitical event
  • A credit-related event
  • Failure of a major financial institution
  • Recession
  • Falling profits and earnings
  • A loss of confidence by corporations which contacts share buybacks

Whatever the event is, which is currently unexpected and unanticipated, the decline in asset prices will initiate a “chain reaction.”

  • Investors will begin to panic as asset prices drop, curtailing economic activity, and further pressuring economic growth.
  • The pressure on asset prices and weaker economic growth, which impairs corporate earnings, shifts corporate views from “share repurchases” to “liquidity preservation.” This removes a major support of asset prices.
  • As asset prices decline further, and economic growth deteriorates, credit defaults begin triggering a near $5 Trillion corporate bond market problem.
  • The bond market decline will pressure asset prices lower, which triggers an aging demographic who fears the loss of pension benefits, sparks the $6 trillion pension problem. 
  • As the market continues to cascade lower at this point, the Fed is monetizing nearly 100% of all debt issuance, and has to resort to even more drastic measures to stem selling and defaults. 
  • Those actions lead to a further loss of confidence and pressures markets even further. 

The Federal Reserve can not fix this problem, and the next “bear market” will NOT be like that last.

It will be worse.

As John concluded:

Coordinated monetary policy is the problem, not the solution. And while I have little hope for change in that regard, I have no hope that monetary policy will rescue us from the next crisis.

Let me amplify that last line: Not only is there no hope monetary policy will save us from the next crisis, it will help cause the next crisis. The process has already begun.” – John Mauldin

Rosso’s 2020 Reading List – Part II

“A reader lives a thousand lives before he dies… The man who never reads lives only one.” – George R.R. Martin.

I’m not sure what I would do without books. On weekends, I can be found in antique stores searching out volumes written in many instances, over 100 years ago from authors most of us never knew existed. These treasures don’t cost much. The words are priceless.

I find that absorbing fiction and self-improvement as well as financial or economic titles, fosters an ability to think creatively.  As much as you’ll hear that money is about numbers, it’s equally about emotions and intuition.

After all, what are investments but stories?

The next 5 tomes for 2020 are mostly tied to emotional and physical health. The health + wealth connection is one of the most important equations of our lifetimes.  Although, one of my favored authors on economics, Robert Shiller also appears.

Narrative Economics: How Stories Go Viral and Drive Major Economic Events – Robert J. Shiller.

Professor Shiller’s latest is off the beaten path when compared to  previous writings. In this book, he explores how stories go viral and have the force to fuel major economic events. It’s a very human analysis for a man usually immersed in math, which many Shiller zealots find disconcerting.  I find it refreshing. As I lament often – Economics is a social science and as humans, we live and breathe the subject every day  The world is one big Petri dish; investors cannot discount emotions or ‘animal spirits’ to shift economic winds. The professor shares plenty of historical references to make his case; he studies how  words spread throughout society. Think about how specific narratives have sparked economic tinderboxes on Main Street – Houses always go up in value,  we’re in a stock market bubble (or not),  robots are stealing jobs. What are stocks but stories spread by biased sell-side analysts and investors, overall? What Shiller doesn’t adequately cover is why certain phrases infiltrate the lingo of the masses while others die in transit.  Regardless, this book is a fascinating read into the economic wildfire of emotions.

Love Yourself Like Your Life Depends On It – Kamal Ravikant.

My friend Kamal revisits, refreshes his work on torturous personal growth. Kamal is a modern-day Stoic; he objectively examines his life as a successful CEO who fell apart emotionally after his company failed. Kamal documents his trials of ‘getting in his own way.’ How many of us do the same? The urge to self-sabotage must be exposed, brought to the light, and cleansed. Kamal examines how living in the past can destroy the present. His methods to emerge from a dark place will provide profound sense of encouragement for those who feel lost. We all play, re-play patterns in our heads. They in turn, trigger feelings.  The loops that roll in our minds, our thoughts, can free or imprison. Once caught in a negative-feedback loop, how do you break it? Kamal shares what he’s done to free and love himself because his life depended on it.  This book never leaves my nightstand.

Super Human: The Bulletproof Plan to Age Backward and Maybe Even Live Forever –  Dave Asprey.

Ok, so Dave’s goal to live to 180 is indeed, lofty. However, as the ultimate human bio-hacker, in book 5 of his “Bulletproof” series, he does provide worthwhile tips on how to gain and maintain health. As a child, he was classified as “premature aging.” His body was its own worst enemy. Dave improved his health dramatically based on aggressive diet, lifestyle, supplementation and specific biohacking methods outlined in the book. There are several unconventional tactics that require further homework. However, Dave is also solid about reminding us about the basics of better sleep and intermittent fasting. Last, readers are provided with specific ideas on the proper supplements and strategies to not only live a longer life, but a robust healthier one. I see his methods as a pathway to lowering healthcare costs. Keep in mind, a couple may incur anywhere from $280,000 to $387,000 in total healthcare expenses throughout retirement. Good habits employed to become aggressively preventative will ostensibly lead to lower expenses and an increasingly active lifestyle.

The Simple Life Guide to Financial Freedom – Gary Collins, MS.

Gary has been a guest on our  700AM KSEV radio show on numerous occasions. He’s a minimalist, ‘ruralist’ and many other ‘ists’ that pertain to financial independence through small yet enriched living. He employs simple math – addition, subtraction, division (unlike the mainstream financial industry which wields obfuscation like a Japanese sword), to make clear the reasons as to why the vast majority of Americans live one paycheck away from disaster, why the health=wealth connection is most important, how primary residence can be your greatest American nightmare, and presents a primer on basic consumer debt. Gary is my brother from another mother; he walks the talk of  financial independence. His philosophy is almost in perfect alignment with RIA’s Financial and Debt Guardrails. Want the financial truth such as what you read in our RIA blog? Here’s the book. My copy is highlighted, dog-eared and resides on a bookshelf in my office.

Blood – Allison Moorer.

In 1986, Allison Moorer awoke to a gunshot. Her father shot and killed her mother then turned the gun on himself.  Blues, folk, country singer/songwriter Allison Moorer and recording artist sister Shelby Lynne,  live in this shadow every day.  This work is Allison’s story of recovery written in a form only a songwriter can pen. The words, her perceptions, are poetic, biting and flow like a  dark song which transforms into a melody of warmth and sunlight. For those who have suffered a family trauma and carry it daily, Allison’s writing style is overwhelmingly healing and loving. I’ve already recommended her tome to friends who bear similar burdens. Candidly,  a topic such as this is a departure from my usual reading material. However,  I’m personally fond of Allison and her award-winning older sister Shelby Lynne, a songwriter and actress in her own right.  The sentiments shared in this book will stick with me. I bet they will with you, too.

I consider the written word a tap dance for the synapses. With each step, new visions are born and new thoughts forged.

Through a tumultuous childhood, books were one of my greatest escapes; a salvation of sanity and calm. During summer break as a boy I’d grab a stack of paperback books, depart our apartment early and head to the interior of a local funeral parlor (a friend’s dad was the director), where I’d sit in the corner nearest the largest plate-glass window I’ve ever seen. The morning sun at maximum light was all I needed. I loved the feel of the luxurious wall-to-wall deep red carpet of that place. Quiet floated on the faint aroma of flowers. The time made my reading that much more rewarding and memorable. Today, that large window is replaced with concrete. However, the memories of my reading time can never be sealed away.

This spring, I’ll provide my next five for your summer reading pleasure.  I read, study, highlight, 40-50 books a year and happily share my top selections.  Currently, I’m re-reading several classics including – Jack London’s White Fang, Shelley’s Frankenstein and Stoker’s Dracula.

If you read any of these selections, please let me know what you learned!

Seth Levine: The Unsurprising Repo Surprise

Have you heard? There’s trouble in the repo markets. Even casual investment market participants probably know that something’s amiss. While only a handful of investors participate in repo, this obscure corner of the investment markets rests at the epicenter of the financial system—hence all the attention. The turmoil caught many by surprise, prompting the Federal Reserve (Fed) into emergency action. However, the real surprise is, in my opinion, why this took any of us by surprise to begin with?

What is Repo

Repo is financial jargon for a repurchase agreement. While it sounds complex, repo is simply a form of short-term, secured lending. The borrower sells collateral (typically a high quality bond) to a lender. At the same time, it agrees to repurchase the same collateral back at a later date for a predetermined and higher price; hence the moniker repurchase agreement. The borrower receives the use of currency for this short period. The lender receives interest in the form of the price difference.

If this sounds overly complicated, it’s because it is. The details, however, are unimportant for our discussion. One need only grasp that repo sits at the bottom of the financial system pyramid. It’s a primary funding source for many large institutions that comprise the plumbing of financial markets. Due to leverage, small disturbances in the repo (and other money) markets can ripple through the entire system. This is what some fear.

What Went Wrong

Repo rates dramatically spiked on September 17, 2019, more than doubling the previous day’s (using SOFR as a proxy). This is highly unusual for the most illiquid of all markets, let alone one of the most trafficked. Arbitrage should render this behavior anomalous as the rise in repo rates represented a highly profitable opportunity. Why weren’t the big banks picking up all this free money? With the Great Financial Crisis (GFC) still fresh in the minds of many, the rumor mill kicked into overdrive surmising why.

Repo rates (estimated with SOFR) unexpectedly spiked on September 17, 2019.

The cause of this unexpected rate spike is still a matter of speculation. The financial system is highly complex with innumerable inputs and outputs making it difficult to establish direct, behavioral links. However, it’s likely that routine balance sheet mismanagement by the Fed was the culprit (as discussed by George Selgin here and Zoltan Pozar of Credit Suisse here).

The Fed’s responsibilities expanded as a result of the GFC. These, and other regulatory changes, might have created some idiosyncrasies that underpinned the unexpected rise in repo rates. One is that the Fed now banks the U.S. Treasury. The Treasury used to have bank accounts with private institutions. It now keeps its money at the Fed in an account called the Treasury General Account (TGA). Another important development is the increased size of the foreign repo pool. The Fed avails its balance sheet to “about 250 central banks, governments and international official institutions.” While not new, the aptly named foreign repo pool usage is up nearly 3-fold since 2014.

The significant growth in the TGA (blue) and foreign repo pool (red) after the GFC creates new balance sheet volatility for the Fed to manage.

The chart above illustrates that both the TGA and foreign repo pool are large and volatile. They are also relatively new in their importance to the Fed from an operational perspective. Let’s not forget that while the Fed is a central bank, it’s nonetheless just a bank. Unpredictable and violent swings in account balances are difficult to manage—community, commercial, and central bank alike. Too be sure, we may later discover different reasons for the repo rate spike … but not until later.

Centralization Breeds Instability

It’s easy to get bogged down in the details when analyzing the financial system. After all, it may be the most complex one we’ve built. Thus, applying some more macroscopic principles can help in understanding the system as a whole.

Generally speaking, decentralized systems are more stable than centralized ones. We intuitively get this and can witness its widespread application throughout the man-made and natural worlds. We diversify our investment portfolios, manufacturers source from multiple suppliers, organisms spawn many offspring, and successful animals eat varied diets. Decentralization is a primary thesis for Bitcoin, breeds a fear of monopolies, and is why I find capitalism so attractive (among other reasons).

Imagine if you kept your entire net worth in a single account at a single bank and it failed (ignoring FDIC insurance, which protect against just this). Your wealth would disappear overnight. What if your investment portfolio comprised of a single stock and it went bankrupt? Such reckless behaviors are rightfully condemned. Yet, we expect differently from our financial system; why?

For some reason we believe that centralizing our monetary system reduces volatility and increases stability. Thus, the financial system is either a complete outlier or the premise is false. Modern day economies are built on the belief of the former, yet the evidence is underwhelming.

Merely a Matter of Time

I find no reason to believe that centralizing our financial system holds unique benefits. It’s just another type system. From a stability perspective, all benefit from decentralization. It follows that our financial one should too. Thus, I believe it was (is) only a matter of time until the monetary system broke (breaks) again. It happened in 2008—which I see as a run on banking collateral rather than a housing market collapse (ask me to explain in the comment section if you’re interested in my view)—and it will inevitably happen again. It has to because the future is unknowable and risks are concentrated.

It’s not that decentralization breed omniscience. No, omniscience doesn’t exist. Rather, it allows for discovery. Decentralized systems have more actors striving towards the same goals. However, all will not proceed in the same way. Inevitably, some will fail and some will succeed and to varying degrees. Diversity ensures that the failures are inconsequential to the system as a whole. Yet, we all benefit from the knowledge that those who succeed discover. Hence, human prosperity advances.

Following the GFC we changed a bunch of rules and allegedly strengthened regulations. Despite the best of intentions, these actions further homogenized behavior ensuring that the system breaks again! Remember, centralized systems are most fragile. Further centralization—which is what laws and regulations actually do—limits diversity by raising the barriers to entry (compliance costs money) and conforms incentive schemes (to comply with regulatory demands). Thus, we got fewer actors behaving in more similar fashions. The financial system became more fragile as a result, not stronger. Here we are, a decade later, and low and behold trouble’s a brewin’ in financial markets again, and in new and unforeseen ways.

Principles Bring Clarity

In the end, the presence of a central bank and the myriad of rules and regulations are counterproductive. They work to limit competition, stymie diversity, and ultimately increase frailty. Progress requires failure and centralized systems are not flexible enough to allow for this. If a centralized actor goes down, so goes the whole. “Too big to fail” is only a feature of centralized systems.

While unexpected, the breakdown of repo markets should come as no surprise. Further centralization of the financial system increased its fragility qua system. Of course, predicting how and when it might fail ex ante is nearly impossible. If the current problems were obvious they wouldn’t have escalated to this point.

That said, the inevitability of a system failure doesn’t make it an investible theme, especially for casual observers. In fact, waiting for a repeat of the GFC may be expensive in opportunity cost terms and cause one to miss out on other profitable investments. Rather, I plan to simply keep this analysis in the back of my mind. If financial markets seize up (again), I know what to look for: decentralizing, market fixes.

Following causal chains of events is one of the many challenges of macro investing. While the spike in repo rates is perplexing, proper first principles can bring some clarity. Faulty ones, however, breed only surprises.

Yeah…But

Yeah… Barry Bonds, a Major League Baseball (MLB) player, put up some amazing stats in his career. What sets him apart from other players is that he got better in the later years of his career, a time when most players see their production rapidly decline.

Before the age of 30, Bonds hit a home run every 5.9% of the time he was at bat. After his 30th birthday, that rate almost doubled to over 10%. From age 36 to 39, he hit an astounding .351, well above his lifetime .298 batting average. Of all Major League baseball players over the age of 35, Bonds leads in home runs, slugging percentage, runs created, extra-base hits, and home runs per at bat. We would be remiss if we neglected to mention that Barry Bonds hit a record 762 homeruns in his MLB career and he also holds the MLB record for most home runs in a season with 73.

But… as we found out after those records were broken, Bond’s extraordinary statistics were not because of practice, a new batting stance, maturity, or other organic factors. It was his use of steroids. The same steroids that allowed Bonds to get stronger, heal quicker, and produce Hall of Fame statistics will also take a toll on his health in the years ahead.  

Turn on CNBC or Bloomberg News, and you will inevitably hear the hosts and interviewees rave on and on about the booming markets, low unemployment, and the record economic expansion. To that, we say Yeah… As in the Barry Bonds story, there is also a “But…” that tells the whole story.

As we will discuss, the economy is not all roses when one considers the massive amount of monetary steroids stimulating growth. Further, as Bonds too will likely find out at some point in his future, there will be consequences for these performance-enhancing policies.

Wicksell’s Wisdom

Before a discussion of the abnormal fiscal and monetary policies responsible for surging financial asset prices and the record-long economic expansion, it is important to impart the wisdom of Knut Wicksell and a few paragraphs from a prior article we published entitled Wicksell’s Elegant Model.

“According to Wicksell, when the market rate (of interest) is below the natural rate, there is an incentive to borrow and reinvest in an economy at the higher natural rate. This normally leads to an economic boom until demand drives up the market rate and eventually chokes off demand. When the market rate exceeds the natural rate, borrowing slows along with economic activity eventually leading to a recession, and the market rate again falls back below the natural rate. Wicksell viewed the divergences between the natural rate and the market rate as the mechanism by which the economic cycle is determined. If a divergence between the natural rate and the market rate is abnormally sustained, it causes a severe misallocation of capital.

Per Wicksell, optimal policy should aim at keeping the natural rate and the market rate as closely aligned as possible to prevent misallocation. But when short-term market rates are below the natural rate, intelligent investors respond appropriately. They borrow heavily at the low rate and buy existing assets with somewhat predictable returns and shorter time horizons. Financial assets skyrocket in value while long-term, cash-flow driven investments with riskier prospects languish. The bottom line: existing assets rise in value but few new assets are added to the capital stock, which is decidedly bad for productivity and the structural growth of the economy.

Essentially, Wicksell warns that when interest rates are lower than they should be, speculation in financial assets is spurred and investment into the real economy suffers. The result is a boom in financial asset prices at the expense of future economic activity. Sound familiar? 

But… Monetary Policy

The Fed’s primary tool to manage economic growth and inflation is the Fed Funds rate. Fed Funds is the rate of interest that banks charge each other to borrow on an overnight basis. As the graph below shows, the Fed Funds rate has been pinned at least 2% below the rate of economic growth since the financial crisis. Such a low relative rate spanning such a long period is simply unprecedented, and in the words of Wicksell not “optimal policy.” 

Until the financial crisis, managing the Fed Funds rate was the sole tool for setting monetary policy. As such, it was easy to assess how much, if any, stimulus the Fed was providing at any point in time. The advent of Quantitative Easing (QE) made this task less transparent at the same time the Fed was telling us they wanted to be more transparent.  

Between 2008 and 2014, through three installations of QE, the Fed bought nearly $3.2 trillion of government, mortgage-backed, and agency securities in exchange for excess banking reserves. These excess reserves allowed banks to extend more loans than would be otherwise possible. In doing so, not only was economic activity generated, but the money supply rose which had a positive effect on the economy and financial markets.

Trying to quantifying the amount of stimulus offered by QE is not easy. However, in 2011, Fed Chairman Bernanke provided a simple rule in Congressional testimony to allow us to transform a dollar amount of QE into an interest rate equivalent. Bernanke suggested that every additional $6.6 to $10 billion of excess reserves, the byproduct of QE, has the effect of lowering interest rates by 0.01%. Therefore, every trillion dollars’ worth of new excess reserves is equivalent to lowering interest rates by 1.00% to 1.50% in Bernanke’s opinion. In the ensuing discussion, we use Bernanke’s more conservative estimate of $10 billion to produce a .01% decline in interest rates.

The graph below aggregates the two forms of monetary stimulus (Fed Funds and QE) to gauge how much effective interest rates are below the rate of economic growth. The blue area uses the Fed Funds – GDP data from the first graph. The orange area representing QE is based on Bernanke’s formula. 

Since the financial crisis, the Fed has effectively kept interest rates 5.11% below the rate of economic growth on average. Looking back in time, one can see that the current policy prescription is vastly different from the prior three recessions and ensuing expansions. Following the three recessions before the financial crisis, the Fed kept interest rates lower than the GDP rate to help foster recovery. The stimulus was limited in duration and removed entirely during the expansion. Before comparing these periods to the current expansion, it is worth noting that the amount of stimulus increased during each expansion. This is a function of the growth of debt in the economy beyond the economy’s growth rate and the increasing reliance on debt to generate economic growth. 

The current expansion is being promoted by significantly more stimulus and at much more consistent levels. Effectively the Fed is keeping rates 5.11% below normal, which is about five times the stimulus applied to the average of the prior three recessions. 

Simply the Fed has gone from periodic use of stimulus to heal the economy following recessions to a constant intravenous drip of stimulus to support the economy.

Moar

Starting in late 2015, the Fed tried to wean the economy from the stimulus. Between December of 2015 and December of 2018, the Fed increased the Fed Funds rates by 2.50%. They stepped up those efforts in 2018 as they also reduced the size of their balance sheet (via Quantitative Tightening, “QT”) from $4.4 trillion to $3.7 trillion.

The Fed hoped the economic patient was finally healing from the crisis and they could remove the exorbitant amount of stimulus applied to the economy and the markets. What they discovered is their imprudent policies of the post-crisis era made the patient hopelessly addicted to monetary drugs.

Beginning in July 2019, the Fed cut the target for the Fed Funds rate three times by a cumulative 0.75%. A month after the first rate cut they abruptly halted QT and started increasing their balance sheet through a series of repo operations and QE. Since then, the Fed’s balance sheet has reversed much of the QT related decrease and is growing at a pace that rivals what we saw immediately following the crisis. It is now up almost a half a trillion dollars from the lows and only $200 billion from the high watermark. The Fed is scheduled to add $60 billion more per month to its balance sheet through April. Even more may be added if repo operations expand.

The economy was slowing, and markets were turbulent in late 2018. Despite the massive stimulus still in place, the removal of a relatively small amount of stimulus proved too volatility-inducing for the Fed and the markets to bear.

Summary

Wicksell warned that lower than normal rates lead to speculation in financial assets and less investment into the real economy. Is it any wonder that risk assets have zoomed higher over the last five years despite tepid economic growth and flat corporate earnings (NIPA data Bureau of Economic Analysis -BEA)? 

When someone tells you the economy is doing fine, remind them that Barry Bonds was a very good player but the statistics don’t tell the whole story.

To provide further context on the extremity of monetary policy in America and around the world, we present an incredible graph courtesy of Bianco Research. The graph shows the Bank of England’s balance sheet as a percentage of GDP since 1700. If we focus on the past 100 years, notice the only period comparable to today was during World War II. England was in a life or death battle at the time. What is the rationalization today? Central banker inconvenience?

While most major countries cannot produce similar data going back that far, they have all experienced the same unprecedented surge in their central bank’s balance sheet.

Assuming today’s environment is normal without considering the but…. is a big mistake. And like Barry Bonds, who will never know when the consequences of his actions will bring regret, neither do the central bankers or the markets. 

Selected Portfolio Position Review: 1-15-2020

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.

  • There is a common denominator to all of the charts this week, which is they are at or above 3-standard deviations of the 200-dma. These extreme extensions tend not to last long and generally result in a 3-5% corrective process, or more.
  • We sold a small bit of AAPL last week to take profits and reduce our weighting to roughly a 1/2 position in the portfolio. We will look to reweight the position between $220-230.
  • Besides the large deviation in price, the buy signal and the overbought condition are also at extremes.
  • Stop is set at $260 for profits, and $220 for whole position.

JNJ – Johnson & Johnson

  • We bought JNJ when it was out of favor with the market over their “talc” lawsuit issues.
  • With the bulk of the those issues behind them, the stock has rebounded sharply.
  • As noted last week, we took profits in the position. At 3-standard deviations, combined with extreme overbought conditions and buy signal, a correction is likely.
  • We will look to buy the position back to weight on a correction that holds our stop level.
  • We are moving our stop up to $135.00

AGNC – Agency Mortgage REIT

  • We bought 2 positions to benefit from a steepening of the 10-2 yield curve which has indeed come to pass.
  • Since we are at full weight in AGNC, and only 1/2 weight in NLY, we took profits in AGNC as recommended last week.
  • We are maintaining our stop at $14 as we will add back to the position following some corrective action.

CVS – CVS Health Corp.

  • We bought CVS in mid-last year and the reversal in price has led to a terrific add. We like this position long-term and are watching the correction process closely.
  • With the buy signal being reduced and support holding around $72, we would like to see the overbought condition fully reverse and give us an entry point between $64 and $66.
  • Be patient for now, and we will update the position accordingly.
  • Stop is set at $62

DEM – Emerging Markets High Dividend Fund

  • We added a small position in international exposure with the weakening of the U.S. Dollar. While we are slightly positive in the position currently, it is extremely overbought and will correct with the overall market.
  • Importantly, DEM needs to remain above the 200-dma and work off the overbought condition before adding further weight to the sector or position.
  • Since this was a “trading position” to begin with, we are maintaining a fairly tight “discretionary stop,” but our “full stop” remains the 200-dma currently.
  • Stop is set at $42.

HCA – HCA Healthcare

  • We reduced our position in HCA from overweight following the sharp rally to 3-standard deviation territory.
  • We will look to add back into our holding on a pullback that doesn’t violate our stop level and reduced the massive overbought condition and or completely reverse the buy signal.
  • Hold remaining positions for now but move stops up to the 200-dma.
  • Stop is set at $130.

DOV – Dover Corp.

  • DOV has been a great performer for the portfolio particularly as the “trade war” has gotten resolved.
  • DOV is exceedingly overbought (Yes, 3-standard deviations) and the buy signal extremely extended. A correction is inevitable.
  • We have taken profits previously, but we take additional profits soon.
  • Stop loss moved up to $100

MU – Micron Technology

  • MU was an add for us in 2019. We had bought it previously but got stopped out, however, our second entry has performed much better.
  • MU is now exceedingly overbought with an extended buy signal and deviation in price.
  • As noted last week, we have taken profits and reduced our weighting slightly. A pullback that holds support and doesn’t violate our stop can be used to reweight the position.
  • Stop-loss moved up to $45

UNH – United Healthcare

  • UNH has surged higher in recent months after struggling with “Medicare for all” from Democratic candidates last year. (Along with the rest of our Healthcare stocks)
  • We love this position and will continue to hold it, however, the position is SO extremely extended we took profits as noted last week.
  • We will add back on a correction that holds support, and doesn’t violate our stop levels.
  • Stop loss moved up to $250

MSFT – Microsoft

  • MSFT has been grinding higher as money is chasing AAPL and MSFT now. It’s a SoftApple market!
  • MSFT, like many other of our positions, is now extremely overbought and extended above the 200-dma.
  • We reduced our position slightly to take in some profits for now, however, we will look to add back to MSFT at a lower price.
  • Stop loss is moved up to $140

Sector Buy/Sell Review: 01-14-20

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.

There is a common theme running through most of the sectors currently which is that they are trading more than 2-standard deviations above the 200-dma. I have added a blue shaded area to each graph which represents this band of deviation from the green line which is the 200-dma. Deviations of this extreme tend not to last long.

Basic Materials

  • XLB tested and failed at all-time highs. While support exists at the previous breakout level of $59, XLB remains at the top of its deviation range and is on an extended “buy” signal currently.
  • The sector is working off its previously extreme overbought condition, so a setup to add to our current position is coming. It will be important that XLB doesn’t violate our stop-loss during this corrective process.
  • We currently hold 1/2 position and are looking to add the second 1/2 during this corrective process. We will update this analysis when we add to our holdings.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with a tighter stop-loss.
    • Stop-loss moved back to $57 to allow for entry.
  • Long-Term Positioning: Neutral

Communications

  • XLC finally broke out to new highs and is now more than 2-standard deviations above the 200-dma.
  • Because of the extension we did reduce our allocation to the sector modestly. We will look to use a pullback to support to reweigh the sector.
  • With a “buy signal” in place, there is a bias to the upside, but a correction is coming. XLC must hold support at $50.
  • If you need to add a position, wait for a pull back to test the recent breakout support level and add there.
  • XLC is currently 2/3rds weight in portfolios.
  • Short-Term Positioning: Bullish
    • Last Week: Hold trading positions
    • This Week: Reduced weighting in portfolio
    • Stop adjusted to $50
  • Long-Term Positioning: Neutral

Energy

  • Unlike most other sectors of the market, XLE is not extremely extended.
  • XLE finally broke above the 200-dma but is currently wrestling with previous support, now resistance, and is extremely overbought. The buy signal is also getting extended.
  • As noted previously, we added 1/2 position of AMLP to our portfolios. On any weakness which does not violate the 200-dma we will add 1/2 position of XLE to the portfolio. The reason we are cautious is that these rallies have repeatedly failed in the past.
  • Short-Term Positioning: Bearish
    • Last week: Added 1/2 AMLP to Portfolios
    • This week: Looking to add 1/2 XLE – patience.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • XLF is extremely extended above the 200-dma which puts the sector at risk of a more severe correction.
  • The buy signal is also extremely extended which suggests that you should be taking profits and reducing risk if you are long the sector.
  • We will look to add XLF to our portfolio on a pullback that doesn’t violate long-term support or break the current bullish trend.
  • Currently, XLF is holding near highs but not participating with the rally in the broader market.
  • Short-Term Positioning: Bullish
    • Last week: Hold Positions
    • This week: Hold Positions
    • Stop-loss adjusted to $28
  • Long-Term Positioning: Neutral

Industrials

  • XLI also is pushing well above the 200-dma with such previous extensions having led to fairly sharp corrections.
  • With XLI exceedingly overbought short-term, and on a very extended buy signal, be cautious chasing the sector currently.
  • We are looking for a bit of consolidation and/or pullback to work off some of the extreme overbought condition before increasing our weighting.
  • We have adjusted our stop-loss for the remaining position. We are looking to add back to our holdings on a reversal to a buy signal.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $77
  • Long-Term Positioning: Neutral

Technology

  • XLK is extremely overbought on both a price and momentum basis like most other sectors of the market.
  • We reduced our position in XLK from overweight to target portfolio weight due to the extreme extension currently. A correction is coming.
  • Be careful chasing the sector currently. Take profits and rebalance risks accordingly.
  • Short-Term Positioning: Bullish
    • Last week: Hold position
    • This week: Reduce Overweight to Target Weight
    • Stop-loss adjusted to $80
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors have started to perform better as money is just chasing “everything” now.
  • XLP continues to hold its very strong uptrend as has now broken out to new highs. However, XLP is back to more extreme overbought and extended above the 200-dma.
  • Importantly, a “buy signal” has been registered. Look for pullbacks to support to add weight to portfolios. Maintain a stop at the 200-dma.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $59
    • Long-Term Positioning: Bullish

Real Estate

  • XLRE has been consolidating its advance within a very tight pattern but is holding support at previous support levels and the uptrend line.
  • We had previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected which has now been completed.
  • XLRE is now on a VERY deep “sell signal” and is very oversold. Both of those conditions are showing signs of reversing.
  • With support holding current longs, and trading positions can be added to portfolios. We are fully weighted the sector currently so there isn’t any change required in our portfolios at this time.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold position.
    • Stop-loss adjusted to $35.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLU continues to maintain its bullish trend and recently rallied to test previous highs.
  • If the “sell signal” is reversed, this will be very bullish for XLU, and should suggest a decline in interest rates is simultaneously occurring.
  • We noted previously that after taking profits, we had time to be patient and wait for the right setup. That opportunity came last week, so if you added exposure, hold for now with a stop at $61. If you need to add exposure to Utilities, you can still do so with a tight stop.
  • The long-term trend line remains intact but XLU and the sell signal are beginning to reverse.
  • We are currently at full weight, so no change is required currently.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Hold current position / Add trading positions if needed
    • Stop-loss adjusted to support at $59.00, $61 for new positions.
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and is now more extended than we have seen it in quite some time.
  • XLV is extremely overbought which will give way sooner than later. Because of the extension we reduced the overweight position in our portfolios to target weight.
  • The move in Healthcare has been parabolic, and the sector is too extended to add positions currently.
  • Short-Term Positioning: Neutral
    • Last week: Hold position.
    • This week: Took profits – reduced overweight to target weight.
    • Stop-loss adjusted to $94
  • Long-Term Positioning: Bullish

Discretionary

  • We added to our holdings previously to participate with the current rally, but XLY is now pushing an extreme extension above the 200-dma.
  • We took profits last week and reduced the position slightly.
  • Hold current positions for now, but take profits and rebalance risks accordingly. New positions can be added on a pullback to the breakout level that holds and works off the overbought condition.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $120.
  • Long-Term Positioning: Neutral

Transportation

  • XTN has broken out of consolidation but quickly ran into resistance at the 2-standard deviation level above the 200-dma.
  • If XTN can breakout above current resistance there is a potential to test old highs.
  • Be patient, XTN has a good bit of work to do to prove its position in portfolios.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: This Is Nuts – Part Deux

In this past weekend’s newsletter, we discussed the exceedingly deviated price, and overbought conditions, not to mention valuations, as key reasons why we slightly reduced risk in our portfolios.

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels. 

In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now.”

Not surprisingly, I received more than a few emails chastising me for “bailing on the bull market, which is clearly going higher.” 

Such is hardly the case. We simply reduced our weighting in some of the companies which have had substantial gains over the last year. We remain primarily long-biased in our portfolios, but given the extreme technical overbought, and deviated conditions, it was prudent to raise some cash and protect our gains.

However, it wasn’t just the conditions we discussed which have us concerned about the markets in the short term. Investor positioning has also reached rather extreme levels. As Bob Farrell once wrote:

“When all experts agree, something else is bound to happen.”

Currently, with investors all extremely long equity exposure, the risk of a correction has become elevated.

Our composite “fear/greed” indicator, which is comprised of investor positioning, shows much the same as “bullish sentiment” has become rather extreme.

Every week, we provide RIAPRO subscribers (Try Free for 30-Days) with the latest updated technical composite score as well. This composite gauge combines extension, deviation, and momentum into a single weekly measure. Readings above 90 (Currently 92.31) are always associated with corrective actions in the market.

With all of these conditions aligned, the “probability” of a short-term correction has increased. Given that risk outweighs reward in the short-term, we decided it was prudent to reduce the numerator of that equation.

Why We Reduced Risk

It may seem irrational that we would reduce our risk exposure as the market continue to rise. Less exposure to equities, means less upside performance of the portfolio, or rather, “opportunity cost.” As I noted:

While the markets could certainly see a push higher in the short-term from the Fed’s ongoing liquidity injections, the gains for 2020 could very well be front-loaded for investors. Taking profits and reducing risks now may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades.”

However, the problem for the majority of investors is the inability to predict whether the next correction will be just a “correction” within an ongoing bull market advance or something materially worse. Unfortunately, by the time most investors figure it out – it is generally far too late to do anything meaningful about it. 

By reducing risk now it provides us three benefits for the future.

  1. Less equity risk, and higher cash levels, lowers the volatility of the portfolio which will allow us to navigate a correction process, and protect our investment capital.
  2. It gives us capital to reinvest back into positions we currently own at better prices; or,
  3. Buy new positions which have corrected in price.

While it is entirely true that “you can not time the market,” you can do some analysis and make deliberate changes to avoid problems.

As shown below, price deviations from the 50-week moving average have been important markers for the sustainability of an advance historically. Prices can only deviate so far from their underlying moving average before a reversion eventually occurs. (You can’t have an “average” unless price trades above and below the average during a given time frame.)

Notice that price deviations became much more augmented heading into 2000 as electronic trading came online, and Wall Street turned the markets into a “casino” for Main Street.

At each major deviation of price from the 50-week moving average, there has either been a significant correction or something materially worse. Currently, the deviation from the 50-week moving average is the second-highest level in history, next to the 1999 “dot.com” mania.

How bad could it be?

Measuring The Mean Reversion 

Given the current momentum of the market, combined with the Fed’s ongoing liquidity interventions, we only expect a correction of 5-10% to reset the overbought, optimistic, and deviated markets. Such a correction can be used to increase equity exposure and bring equity holdings back to target weights.

However, there is a risk of a larger mean reverting event, yet this is a possibility completely dismissed by the mainstream media under the guise of “this time is different.” 

With the market trading more than 3-standard deviations above the 50-week moving average, historical reversions have tended to be more brutal. I have laid out support levels below.

At this juncture, a correction back to the 2018 lows would entail a 25% decline. However, if a “bear market” growls, the 2015-16 highs become the target which is 34% lower. The lows of 2016 would require a 43% draft, with the 2008 highs posting a 52% “crash.” 

That can’t happen you say?

We had two 50% declines since the turn of the decade, and the next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of “stock buybacks,” which have accounted for almost 100% of net purchases since 2018.

Then there is also the other possibility as noted by technical analyst J. Brett Freeze, CFA:

“The Wave Principle suggests that the S&P 500 Index is completing a 60-year, five-wave motive structure. If this analysis is correct, it also suggests that a multi-year, three-wave corrective structure is immediately ahead. We do not make explicit price forecasts, but the Wave Principle proposes to us that, at a minimum, the lows of 2009 will be surpassed as the corrective structure completes.”

Anything is possible, and if he is right, such a decline will eclipse the 85% decline of the Dow following the 1929 peak when stocks last reached what seemed to be a “permanently high plateau.”

We Play The Probabilities

The probability is that we will see the 5-10% correction which will be used to increase our exposure.

Just don’t dismiss the possibilities.

“You play the probabilities; but prepare for the possibilities.”

No one knows with certainty what the future holds which is why we must manage portfolio risk accordingly and be prepared to react when conditions change.

While I am often tagged as “bearish” due to my analysis of economic and fundamental data for “what it is” rather than “what I hope it to be,” I am actually neither bullish or bearish. I follow a very simple set of rules which are the core of my portfolio management philosophy which focus on capital preservation and long-term “risk-adjusted” returns.

As such, let me remind you of the 15-Risk Management Rules I have learned over the last 30-years:

  1. Cut losers short and let winner’s run(Be a scale-up buyer into strength.)
  2. Set goals and be actionable. (Without specific goals, trades become arbitrary and increase overall portfolio risk.)
  3. Emotionally driven decisions void the investment process.  (Buy high/sell low)
  4. Follow the trend. (80% of portfolio performance is determined by the long-term, monthly, trend. While a “rising tide lifts all boats,” the opposite is also true.)
  5. Never let a “trading opportunity” turn into a long-term investment. (Refer to rule #1. All initial purchases are “trades,” until your investment thesis is proved correct.)
  6. An investment discipline does not work if it is not followed.
  7. “Losing money” is part of the investment process. (If you are not prepared to take losses when they occur, you should not be investing.)
  8. The odds of success improve greatly when the fundamental analysis is confirmed by the technical price action. (This applies to both bull and bear markets)
  9. Never, under any circumstances, add to a losing position. (As Paul Tudor Jones once quipped: “Only losers add to losers.”)
  10. Market are either “bullish” or “bearish.” During a “bull market” be only long or neutral. During a “bear market”be only neutral or short. (Bull and Bear markets are determined by their long-term trend as shown in the chart below.)
  11. When markets are trading at, or near, extremes do the opposite of the “herd.”
  12. Do more of what works and less of what doesn’t. (Traditional rebalancing takes money from winners and adds it to losers. Rebalance by reducing losers and adding to winners.)
  13. “Buy” and “Sell” signals are only useful if they are implemented. (Managing a portfolio without a “buy/sell” discipline is designed to fail.)
  14. Strive to be a .700 “at bat” player. (No strategy works 100% of the time. However, being consistent, controlling errors, and capitalizing on opportunity is what wins games.)
  15. Manage risk and volatility. (Controlling the variables that lead to investment mistakes is what generates returns as a byproduct.)

The current market advance both looks, and feels, like the last leg of a market “melt up” as we previously witnessed at the end of 1999. How long it can last is anyone’s guess. However, importantly, it should be remembered that all good things do come to an end. Sometimes, those endings can be very disastrous to long-term investing objectives.

This is why focusing on “risk controls” in the short-term, and avoiding subsequent major draw-downs, the long-term returns tend to take care of themselves.

Everyone approaches money management differently. This is just the way we do it.

Major Market Buy/Sell Review: 1-13-20

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

  • On Friday, the market had a small drop after we took profits in our portfolios. However, that drop did little to resolve any of the overbought conditions which currently exisit.
  • The S&P remains more than 2-standard deviations above the 200-dma (shaded blue area).
  • The “buy signal” (lower panel) is back to levels of extensions normally only seen with short-term tops and corrective actions, particularly when combined with extreme extensions and deviations from long-term means.
  • As noted we took profits in both the ETF and Equity Model (See Portfolio Commentary) and we still recommend taking profits and rebalancing risks in positions accordingly. We will likely have a much better entry point in the next couple of months to buy into.
  • Short-Term Positioning: Neutral Due To Extension
    • Last Week: Hold position
    • This Week: Take profits and rebalance to target weights.
    • Stop-loss moved up to $300
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • As goes the S&P 500, goes the DIA, especially when MSFT & AAPL are the two top holdings and drivers of the advance in both markets. (We reduced both of those holdings last week.)
  • The “buy” signal is extremely extended along with a very overbought condition.
  • Hold current positions and take profits, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral due to extensions
    • Last Week: Hold current positions
    • This Week: Take profits and rebalance risk.
    • Stop-loss moved up to $275
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Again, like SPY, the Nasdaq is just “crazy” extended currently. With QQQ now pushing the limits of 3-standard deviations, a correction is inevitable, it is just a function of time now.
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a correction to add exposure.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold position
    • This Week: Take profits and rebalance risks.
    • Stop-loss moved up to $195
  • Long-Term Positioning: Neutral due to valuations

S&P 600 Index (Small-Cap)

  • As noted above, small-caps have also pushed above 2-standard deviations of the 200-dma.
  • With the buy signal also extremely extended, and the index overbought, like all the other markets, a correction will provide a better entry point to add to our positions.
  • That correction has started and the current support level is being tested. A failure here and the previous breakout levels will be the next important support and our stop level.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop loss moved up to $69
  • Long-Term Positioning: Neutral

S&P 400 Index (Mid-Cap)

  • Like SLY, MDY is also extremely extended and deviated above the 200-dma, and it has started to correct a bit finally.
  • With MDY’s “buy” signal extremely extended, and very overbought, this is a prime setup for a correction. Hold off adding exposure until we see a better entry point.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bullish

Emerging Markets

  • EEM continues to underperform but did finally breakout above resistance. The next target will be the old highs.
  • With the “buy signal” extremely extended, the set up to add exposure is not present. Be patient for a correction that does not violate our stop.
  • EEM has tested, and held the 61.8% Fibonacci retracement level, so if it can break above the recent high, that will continue the bullish trend.
  • The Dollar (Last chart) is the key to our international positioning. The dollar looks to have confirmed a break lower which should support our thesis of adding back international exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $43
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA rallied out of its consolidation channel and broke out.
  • But, like EEM, the market is both EXTREMELY overbought and extended. Also, EFA is testing old highs which, as previously expected, is providing short-term resistance.
  • As with EEM, the key to our positioning is the US Dollar.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $67
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • Oil finally broke above the downtrend resistance line from the 2018 highs, which is bullish. However, the spurt from the “Iran spat,” shot oil prices to the 61.8% Fibonacci retracement level where it failed badly.
  • With oil prices falling back below $60/bbl, it is imperative that oil maintains the 200-dma support level.
  • As noted last week, with the short-term buy signal for oil is extended, the struggle we saw was not unexpected.
  • Add positions on weakness that doesn’t violate the 200-dma
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Hold positions
    • Stop-loss for any existing positions is $58.
  • Long-Term Positioning: Bearish

Gold

  • Gold found its mojo last week, as Iran sparked fear in the markets. However, it faded a bit as tensions quickly dissapated.
  • With gold now testing old highs, our positioning looks good particularly given that gold remains on a sell-signal currently. A reversal of the signal could suggest further highs to come.
  • We used the recent weakness to add to our GDX and IAU positions taking them back to full weightings.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position adjusted to $137
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • Bond prices rallied last week, again, and are testing downtrend resistance. For now bonds remain in a bearish channel, suggesting higher yields are still likely short-term.
  • I suspect we are going to get some economic turmoil sooner, rather than later, which will lead to a correction in the equity markets and an uptick in bond prices. The weak employment and wages report last Friday suggested such may be coming.
  • Use lower bounds of the downtrend, and the 200-dma, to add to holdings currently.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132
  • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously, we noted the dollar broke down below both the 200-dma and the bullish trend line. It then retested, and failed, at that previous support level which confirms a breakdown in the dollar from its previous bullish channel.
  • Last week, the dollar has rallied back to that all important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • As stated last time: “It may be too early for a sharper dollar decline currently, as the U.S. economy is still the “cleanest shirt in the dirty laundry.”
  • Be patient for now on commodity related exposures. Momentum still rules the market as a whole.
  • The “sell” signal remains intact currently suggesting there is further downside, if it begins to reverse that will be an important clue.

Comparison & The Role Your Advisor Should Play

A recent article on MarketWatch by Sanjib Saha caught my attention:

“After taking the Series 65 exam last February, I set a goal for 2019: Help 10 friends and family members with their finances. Instead of giving specific investment advice, I wanted to educate them on money matters. I knew that they would benefit from one-on-one discussions, well-regarded books, educational videos and credible websites.”

Think about that for a moment. Here is a young man, who grew up during the longest bull market in history, just took his exam last year, has no real investment experience to speak of, and is now giving advice to people with no investment knowledge.

What could possibly go wrong?

While the majority of the article is grossly misinformed and a regurgitation of the “bullish mantras,” there was one paragraph that jumped out with respect to investment success and failure over time. To wit:

“Many years ago, Aisha, received a windfall that she needed to invest. She interviewed a few financial advisers and went with someone who had an impressive job title, a long list of designations and a friendly demeanor. She regularly reviewed her portfolio with the adviser, but never considered there might be performance problems. After all, a paid professional ought to do better than the market, not worse—or so she thought.

As it turned out, her portfolio had more than doubled over 16½ years.Aisha was impressed, until she backtested an identical asset allocation—one with half U.S. stocks and half corporate bonds. A 50-50 allocation consisting of just two broadly diversified index funds would have quadrupled her money over the same holding period. She stared at the results in disbelief. The opportunity cost was huge.”

The Comparison Trap

This is one of the biggest tools used by financial advisors to get clients to switch their accounts over to a “better” program. Let me explain.

Comparison is the cause of more unhappiness in the world than anything else. Perhaps it is inevitable that human beings as social animals have an urge to compare themselves with one another. Maybe it is just because we are all terminally insecure in some cosmic sense. Social comparison comes in many different guises. “Keeping up with the Joneses,” is one well-known way.

Think about it this way.

If your boss gave you a Mercedes as a yearly bonus, you would be thrilled, right? However, what if you found out shortly afterward that everyone else in the office got two cars.

WTF? Now, you are ticked.

But really, are you deprived of getting a Mercedes? Shouldn’t that enough?

Comparison-created unhappiness and insecurity is pervasive, judging from the amount of spam touting everything from weight-loss to plastic surgery. The basic principle seems to be that whatever we have is enough, until we see someone else who has more. Whatever the reason, comparison in financial markets can lead to remarkably bad decisions.

It is this ongoing measurement against some random benchmark index which remains the key reason why investors have trouble patiently sitting on their hands, letting whatever process they are comfortable with, work for them. They get waylaid by some comparison along the way and lose their focus.

If you tell a client that they made 12% on their account, they are very pleased. If you subsequently inform them that “everyone else” made 14%, you’ve now made them upset. The whole financial services industry, as it is constructed now, is predicated on making people upset so they will move their money around in a frenzy.

Therein lies the dirty little secret. Money in motion creates revenue. The creation of more and more benchmarks, indexes, and style boxes is nothing more than the creation of more things to COMPARE to, allowing clients to stay in a perpetual state of outrage.

Aisha, for example, was completely happy with doubling her money over the last 16-years, until our young, inexperienced, newly minted financial advisor showed her “what she could have had.” Now she will make decisions which will potentially increase the amount of risk she is taking in the second most expensive bull market in history.

Our Worst Enemy

I have written about the psychological issues which impede investors returns over longer-term time frames in the past. The two biggest factors, according to Dalbar Research, which lead to chronic investor underperformance over time are:

  • Lack of capital to invest, and;
  • Psychological behaviors

Psychological factors account for fully 50% of investor shortfalls in the investing process. Of course, not having the capital to invest is equally important.

These factors, as shown by data from Dalbar, lead to the lag in performance between investors and the markets over all time periods.

Behavioral biases are an issue which remains little understood and accounted for when individuals begin their investing journey. There are (9) nine of these behavioral biases specifically which impact investors the most.

  • Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time.  Also known as “panic selling.”
  • Narrow Framing – Making decisions about on part of the portfolio without considering the effects on the total.
  • Anchoring – The process of remaining focused on what happened previously and not adapting to a changing market.
  • Mental Accounting – Separating performance of investments mentally to justify success and failure.
  • Lack of Diversification – Believing a portfolio is diversified when in fact it is a highly correlated pool of assets.
  • Herding– Following what everyone else is doing. Leads to “buy high/sell low.”
  • Regret – Not performing a necessary action due to the regret of a previous failure.
  • Media Response – The media has a bias to optimism to sell products from advertisers and attract view/readership.
  • Optimism – Overly optimistic assumptions tend to lead to rather dramatic reversions when met with reality.

These cognitive biases impair our ability to remain emotionally disconnected from our money. As a consequence, we are continually lured into making decisions which are inherently bad for our long-term outcomes.

The Advisor’s Role

These psychological and behavioral issues are exceedingly difficult to control and lead us regularly to making poor investment decisions over time. But this is where the role of an “experienced advisor” should be truly defined and valued.

While the performance chase, a by-product of the very behavioral issues we wish to control, leads everyone to seek out last years “hottest” performing manager or advisor, this is not really the advisor’s main role. The role of an advisor is NOT beating some random benchmark index or to promote a “buy and hold” strategy. (There is no sense in paying for a model you can do yourself.)

Jason Zweig summed it well:

“The only legitimate response of the investment advisory firm, in the face of these facts, is to ensure that it gets no blood on its hands. Asset managers must take a public stand when market valuations go to extremes — warning their clients against excessive enthusiasm at the top and patiently encouraging clients at the bottom.”

Given that individuals are emotional and subject to emotional swings caused by market volatility, the advisors role is not only to be a portfolio manager, but also a psychologist. Dalbar suggested four successful practices to reduce harmful behaviors:

  1. Set Expectations Below Market Indices: Change the threshold at which the fear of failure causes investors to abandon an investment strategy. Set reasonable expectations and do not permit expectations to be inferred from historical records, market indexes, personal experiences or media coverage. The average investor cannot be above average. Investors should understand this fact and not judge the performance of their portfolio based on broad market indices.
  2. Control Exposure to Risk: Include some form of portfolio protection that limits losses during market stresses. Explicit, reasonable expectations are best set by agreeing on a goal that consists of a predetermined level of risk and expected return. Keeping the focus on the goal and the probability of its success will divert attention away from frequent fluctuations that lead to imprudent actions
  3. Monitor Risk Tolerance: Periodically reevaluate investor’s tolerance for risk, recognizing that the tolerance depends on the prevailing circumstances and that these circumstances are subject to change. Even when presented as alternatives, investors intuitively seek both capital preservation and capital appreciation. Risk tolerance is the proper alignment of an investor’s need for preservation and desire for capital appreciation. Determination of risk tolerance is highly complex and is not rational, homogenous nor stable.
  4. Present Forecasts In Terms Of Probabilities: Simply stating that past performance is not predictive creates a reluctance to embark on an investment program. Provide credible information by specifying probabilities, or ranges, that create the necessary sense of caution without negative effects. Measuring progress based on a statistical probability enables the investor to make a rational choice among investments based on the probability of reward.

The challenge, of course, it understanding that the next major impact event, and market reversion, will NOT HAVE the identical characteristics of the previous events. This is why comparing today’s market to that of 2000 or 2007 is pointless. Only the outcome will be the same.

One thing that all the negative behaviors have in common is that they can lead investors to deviate from a sound investment strategy which was narrowly tailored towards their goals, risk tolerance, and time horizon.

The best way to ward off the aforementioned negative behaviors is to employ a strategy that focuses on one’s goals and is not reactive to short-term market conditions. The data shows that the average mutual fund investor has not stayed invested for a long enough period of time to reap the rewards that the market can offer more disciplined investors. The data also shows that when investors react, they generally make the wrong decision.

The reality is that the majority of advisors are ill-prepared for an impact event to occur. This is particularly the case in late-stage bull market cycles where complacency runs high.

When the impact event occurs, advisors who are prepared to handle responses, provide clear messaging, and an action plan for both conserving investment capital and eventual recovery will find success in obtaining new clients.

The “do-it-yourself” crowd will also come to learn the value of experience. When the impact event occurs, the losses in passive investments, “yield-chase” investments, and ETF’s will be substantially larger than individuals currently imagine. Those losses will permanently impair individuals ability to obtain their financial goals.

If you don’t believe me, then explain why, with 30 of the last 40 years in major bull market trends, is a large majority of the population woefully underfunded for retirement?

The reason is that investing is not simple. If it was, everyone would be rich. The reality is that whatever gains investors have garnered over the last decade will be largely wiped away by the next impact event.

Of course, this is the sad history of individual investors in the financial markets as they are always “told to buy” but never “when to sell.”

You can do better.

RIA PRO: This Is Nuts & Why We Reduced Risk On Friday


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Catch Up On What You Missed Last Week


Market Review & Update

When you sit down with your portfolio management team, and the first comment made is “this is nuts,” it’s probably time to think about your overall portfolio risk. On Friday, that was how the investment committee both started and ended – “this is nuts.” 

We have been discussing the overbought, extended, and complacent market over the last couple of weeks, but on Friday, I tweeted out a couple of charts that illustrated the excess. 

The first chart was comparing the Nasdaq to the S&P 500 index. Both are banded by 2-standard deviations bands of the 200-WEEK moving average. there are a couple of things which should jump out immediately:

  1. The near-vertical price acceleration in the markets has been a historical hallmark of late-stage cycle advances, also known as a “melt up” phase.
  2. When markets get more than 2-standard deviations above their long-term moving average, reversions to the mean have tended to follow shortly after that. 

Currently, both of those conditions exist in the chart above. However, if it were only price acceleration, we would just be mildly concerned. However, investor complacency has also reached more extreme levels with PUT/CALL ratio now hitting historically high levels. (The put/call ratio is the ratio of “put options” being bought on the S&P 500 (theoretically to hedge risk) versus the number of “call” options purchased to “lever up” risk.)

Lastly, all of our indicators from momentum to relative strength are all suggesting risk substantially outweighs reward currently. 

While none of this means the market will “crash,” it does suggest the risk/reward ratio is not in favor of the bulls short-term. 

However, we are mindful that in the short-term, the market is currently obsessed with the Fed’s monetary interventions (the topic of this week’s MacroView), which are supportive of the markets currently. However, as my friend and colleague Doug Kass summed noted this week:

“It is growing increasingly clear to me that global stock markets are in the process of making a speculative move (driven by global liquidity) that may even compare to the advances that culminated in the seminal market tops in the Fall of 1987 and in the Spring of 2000.

As today’s trading day comes to a close, it is apparent that, like the 1997 Long Boom paradigm expressed in a column in Wired Magazine during the dot.com bubble –– the current market is similarly viewed as in its own, new liquidity-based paradigm.

No longer is the market hostage to the real economy or sales and profit growth – stuff I have spent four decades analyzing. Instead, liquidity is seen as an overriding influence, actually it has become the sine quo non.

As such, historical valuations become increasingly irrelevant, and price momentum is the lodestar.

He is right. 

Currently, almost every single valuation metric is at historic extremes, yet investors continue to take on increasing levels of risk due to nothing more than “F.O.M.O – Fear Of Missing Out.” 

As Doug goes on to note:

“We live in unusual times – in which central bankers have adopted policy unlike any point in history. Near-zero interest rates around the world have become commonplace and are accepted with little thought given to the adverse consequences. Forgetting history, central bankers seem to have no idea that they have created another monster again – just as they did in 1999.

Meanwhile, corporate profits are lower (year over year), and the rate of global GDP growth remains below the historic trendline – as it takes more and more debt to deliver a unit of production.

The climb in stocks will likely end badly as it is not supported by the fundamental (social, economic, political and geopolitical) backdrop and, increasingly, classical valuation metrics have moved to the highest percentiles in history (enterprise value/EBIT, price to sales, market capitalizations to GDP, etc.)

Yes, “this is nuts,” which is why we took profits out of portfolios on Friday.



Portfolio Positioning

On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels. 

In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now. 

The Dynamic Portfolio was allocated to a market neutral position by shorting the S&P index itself.

Let me state clearly, we did not “sell everything” and go to cash. We simply reduced our holdings to raise cash, and capture some of the gains we made in 2019. When the market corrects we will use our cash holdings to either add back to our current positions, or add new ones.

One of the areas we have been discussing recently is the opportunity that may be presenting itself in the Energy sector. With oil prices rising, and valuations better than other areas of the market, there are some trading opportunities starting to appear.

While our portfolios are designed to have longer-term holding periods, we understand that things do not always go as planned. This is why we enter positions on a trading basis only, which are short-term until both the position, and the overall thesis, starts to mature.

Last week, we presented some technical analysis on three major energy ETF’s and seven individual companies which may be presenting a trading opportunity in the near future. You can view all of our portfolio models, which are live accounts, at RIA PRO. (Try the service for 30-days RISK FREE)

But from a broad perspective, the Energy sector is showing some signs of life. The break above the 200-dma, as well as the downtrend from previous highs, gives the sector a much more bullish tone currently. However, there are still many issues that overhang the energy market in the longer-term from cash flows, to leverage, to economic demand, which will likely keep energy markets fairly range-bound through 2020 and beyond.

The complete analysis we presented to RIAPRO clients last week is presented here.

3300 To 3500, And Back Again

In July of 2019, we laid out our prognostication the S&P 500 could reach 3300 amid a market melt-up though the end of the year. On Friday, the market touched 3280, which, as they say, is “close enough for Jazz.”

However, with the Federal Reserve having “turned on the liquidity taps,” it is entirely possible the markets could continue their upward momentum towards 3500.

The potential “fly in the ointment” is if the economic, employment, and profit data fail to recover as anticipated. With 2020 earnings estimates already cut markedly heading into the year, further downward revisions will likely begin to weigh on investor sentiment. 

Friday’s employment report was weak and exposed the anomaly caused by the autoworkers strike in the blockbuster November report. CEO and CFO confidence remain very suppressed currently, and if their views don’t start to improve markedly in the short-term we are likely to start seeing much weaker employment reports. 

While the markets could certainly see a push higher in the short-term from the Fed’s ongoing liquidity injections, the gains for 2020 could very well be front-loaded for investors. 

Taking profits and reducing risks now may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades.



The Macro View

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

See You Next Week

By Lance Roberts, CIO


Financial Planning Corner

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Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Energy (XLE), Communications (XLC)

The improvement in Energy stalled this past week as the Iran hostilities came and went literally in a matter of hours. While the sector has cleared the downtrend channel and the 200-dma it remains overbought short-term, but is beginning to correct that condition. We are looking for an entry point near the 200-dma if it holds.

As recommended last week, we reduced our weighting in XLC slightly on Friday just to take in some profits. Our thesis of a push in the sector due to the holiday shopping season came to fruition, but now the entire sector is just extremely extended.  

Current Positions: 1/2 weight AMLP, Underweight XLC

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

We noted previously that Financials have been running hard on Fed rate cuts and more QE and that the sector was extremely overbought and due for a correction. That correction/consolidation started last week and continued this week. We recommended taking profits previously, and that remains good advice again this week with the sector still very overbought.

We also recommended last week to take profits in Technology and Healthcare, which have not only been leading the market but have gotten extremely overbought. On Friday, we took profits in both sectors and reduced our weights back to target portfolio weight.

Current Positions:  Reduced from overweight to target weight XLK, XLV

Weakening – Industrials (XLI)

Industrials, which perform better when the Fed is active with QE, has broken out to new highs, but is still consolidating at a high level and has begin to underperform on a relative basis to the S&P 500. Given the sector is extremely overbought, we will wait for this correction to play out  before adding to our current position.

Current Position: 1/2 weight XLI

Lagging – Real Estate (XLRE), Staples (XLP), Discretionary (XLY), Materials (XLB), and Utilities (XLU)

After a run to new highs, Staples continues to consolidate and hold above its 50-dma. Since taking profits previously, we are just maintaining our stop loss on the sector currently. 

Discretionary, after finally breaking out to new highs, has gotten very extended in the short-term. We reduced our position slightly to take in profits. We remain optimistic on the sector for now. However, the sector is extremely overbought so a correction is needed that doesn’t violate support at the 50-dma to add back to our exposure.

XLRE has been weak as of late as interest rates have been on the rise. We remain weighted in the sector for now but may increasing sizing opportunistically if we see weakness begin to form in the leading sectors of the market.

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

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps broke out of the previous ranges as the rotation to risk occurred, but over the last couple of weeks, the relative performance has fallen flat as the focus has returned to chasing the largest of large-cap names. As noted two weeks ago, we added to our small-cap holdings with a small-cap value ETF, and the pullback we expected is in progress. We are holding that position for now, but are tightening up our stops.

Current Position: KGGIX, SLYV

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

Emerging and International Markets, rallied recently on news of a “trade deal” and finally clearly broke above important resistance. However, like small and mid-caps above, international stocks relative performance has also stalled. As discussed two weeks ago, we added positions in both emerging market and international value  positions, however, we are tightening up our stops to protect our capital investment. 

Current Position: EFV, DEM

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

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

Current Position: RSP, VYM, IVV

Gold (GLD) – As noted two weeks ago, Gold was holding support at the $140 level and registered a buy signal. GDX has also held support and turned higher with a triggered buy signal. Over the last two weeks, gold has broken out to highs, however, miners have turned lower as the “value” rotation shifted back to momentum. We previously took our holdings back to full-weights after taking profits earlier this year. However, we are tightening up our stop levels.

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

Bonds (TLT) – 

Bonds rallied back above the 50-dma on Friday as money rotated into bonds for “safety” as the market weakened on Friday. There is a consolidation with rising bottoms occurring currently, which suggests we may see further weakness in the market with a “risk off” rotation into bonds.

Add to bonds here with a stop at $136 for TLT as a benchmark. 

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:

Next week, Michael Lebowitz is coming to town, and we are hosting very small group events to discuss our portfolio and investing outlook for 2020. We are recording the presentation, and will share it with you next week in this newsletter as our MacroView.

Over the last several months, we have discussed adding “value” to the portfolio, increased our “gold” holdings, and continue to run shorter-duration in our bond portfolios. One of the big macro-themes we are studying is a weaker U.S. Dollar relative to the rest of the world, which could significantly shift our focus from “stocks” to commodities and other assets that benefit from a weaker currency. 

Please read our previous “MacroView” which discussed our view in this regard.

As noted in the main missive this week, the market is extremely extended, overbought, and complacent. As such, market corrections occur regular in this type of environment regardless of the underlying bullish thesis.

As such, on Friday, we took actions to slightly reduce portfolio risk, and raise cash. While this may lead to some short-term underperformance in portfolios, you will appreciate the reduced volatility if a correction occurs over the next 3-4 weeks as expected. 

Therefore, here are our portfolio actions we have taken:

  • New clients: We are holding off onboarding new client assets until we see some corrective action or consolidation in the market.
  • Dynamic Model:  We previously started building the “core equity” of the portfolio. We have now taken the model to “market neutral” by adding an equal weight of a short S&P 500 index.
  • Equity Model: We reduced our holdings in AAPL, MSFT, AGNC, CVS, HCA, JNJ, MU, and UNH. We remain long these positions, but they were extremely overbought so we reduced our position slightly to take in profits.
  • ETF Model: We reduced our holdings in REM, XLC, XLK, XLV, and XLY. Again, these sectors were overweight their target weightings in the model so we have reduced those holdings back to target weight to capture gains and reduce portfolio risk.

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.


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

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

See below for an example of a comparative model.


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

401k Plan Manager Live Model

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

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MacroView: Has The Fed Trapped Itself?

“Don’t fight the Fed”

That’s how I started out last week’s “Macroview.”

“That is the current mantra of the market as we begin 2020, and it certainly seems to be the right call. Over the last few months, the Federal Reserve has continued its ‘QE-Not QE’ operations, which has dramatically expanded its balance sheet. Many argue, rightly, the current monetary interventions by the Fed are technically ‘Not QE’ because they are purchasing Treasury Bills rather than longer-term Treasury Notes.

However, ‘Mr. Market’ doesn’t see it that way. As the old saying goes, ‘if it looks, walks, and quacks like a duck…it’s a duck.'” 

As we discussed, there is something “broken” in the financial system when it requires massive injections of capital to maintain sufficient liquidity. This was a point noted by Curvature Securities’ Scott Skyrm in his daily “Repo Market Commentary” via Zerohedge:

“Indeed, something appears amiss, because the total overnight and term Fed RP operations on Friday were greater than on year end! On year-end, the Fed had pumped a total of $255.95 billion into the market verses $258.9 billion on Friday.”

When these excessive “Repurchase Operations” initially began in late September, we were told they were to meet corporate tax payments. The issue with that excuse is that corporate tax payments come due every quarter and are easy to forecast weeks in advance. Why was last October’s payment period so different? But, following October 15th, the “repo” operations should have been no longer needed, however, the funding not only continued, but grew.

As the end of the year approached, we were told liquidity was needed to meet “the turn,” as 2019 ended, and 2020 began. Once again, this excuse falls short as, without exception, every year ends on December 31st. So, after nearly a decade of NO “repo” operations, as shown below, what is really going on?

What is clear, is the Fed may be trapped in their own process, a point made by Mark Cabana of BofAML:

“It seems implausible to me that the Fed will be able to stop their repo operations by the end of January.”

The Fed’s New Liquidity Trap

We previously discussed the “liquidity trap” the Fed has gotten themselves into, along with Japan, which will plague economic growth in the future. To wit:

“The signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.

Our “economic composite” indicator is comprised of 10-year rates, inflation (CPI), wages, and the dollar index. Importantly, downturns in the composite index leads GDP.

The Fed’s problem is not only are they caught in an “economic liquidity trap,” where monetary policy has become ineffective in stimulating economic growth, but are also captive to a “market liquidity trap.”

As Mr. Skrym noted:

“The problem with the broken repo market, and the Fed’s respective Repo operations, is similar to the problem observed with QE, and the Fed’s balance sheet in general, over the past decade. The market has gotten addicted to the easy Fed liquidity.” 

This can be seen in the chart below.

Whenever the Fed, or other Global Central Banks, have engaged in “accommodative monetary policy,” such as QE and rate cuts, asset prices have risen. However, as denoted by the “red” shaded areas, when those activities are not present, asset prices have declined.

In short, the market has become addicted to QE, and like any drug addict, when the drug was taken away in 2018, as the Fed hiked rates and reduced their balance sheet in an attempt to normalize policy, the market dropped by nearly 20%.

To understand why this is important we have to go back to what Ben Bernanke said in 2010 as he launched the second round of QE:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

I highlight the last sentence because it is the most important. Consumer spending makes up roughly 70% of GDP, therefore increased consumer confidence is critical to keeping consumers in action. The problem is the economy is no longer a “productive” economy, but rather a “financial” one. A point made by Ellen Brown recently:

“The financialized economy – including stocks, corporate bonds and real estate – is now booming. Meanwhile, the bulk of the population struggles to meet daily expenses. The world’s 500 richest people got $12 trillion richer in 2019, while 45% of Americans have no savings, and nearly 70% could not come up with $1,000 in an emergency without borrowing.

Central bank policies intended to boost the real economy have had the effect only of boosting the financial economy. The policies’ stated purpose is to increase spending by increasing lending by banks, which are supposed to be the vehicles for liquidity to flow from the financial to the real economy. But this transmission mechanism isn’t working, because consumers are tapped out.”

If consumption retrenches, so does the economy.

When this happens debt defaults rise, the financial system reverts, and bad things happen economically.

For this reason the Federal Reserve has been engaged in an ongoing campaign to “avoid the pain” experienced during the financial crisis. This was a question asked of Janet Yellen during her semi-annual Humphrey-Hawkins testimony by Rep. Edward Royce. I am going to break this down for clarity.

“ROYCE: I’m worried that the Federal Reserve has created a third pillar of monetary policy, that of a stable and rising stock market. And I say that because then-Chairman Bernanke, when he appeared here, stated repeatedly that, ‘the goal of QE was to increase asset prices like the stock market to create a wealth effect.’”

As stated, Ben Bernanke clearly states the goal of Q.E. was to increase asset prices. As Royce continues he clearly identifies the Fed’s “new liquidity trap:”

“ROYCE: That seems as though that was goal. It would stand to reason then that in deciding to raise rates and reduce the Fed’s QE balance sheet standing at a still record $4.5 trillion, one would have to be prepared to accept the opposite result, a declining stock market, and a slight deflation of the asset bubble that QE created.

Yet, every time in the past three years when there has been a hint of raising rates and the stock market has declined accordingly, the Fed has cited stock market volatility as one of the reasons to stay the course and hold rates at zero.

Read the last paragraph again.

Royce understands that in order to normalize monetary policy, and return markets to a more normal state of operation, some pain would have to be expected.

So, what was Yellen’s response.

YELLEN: It is not a third pillar of monetary policy. We DO NOT target the level of stock prices. That is not an appropriate thing for us to do.”

Yes, the Fed absolutely targets the financial markets with their policies. However, as Royce notes above, it will require a level of pain to wean the markets off of ongoing liquidity. In 2018, the Fed learned their lesson of what would happen as the small adjustment to monetary policy they did make resulted in a market decline of nearly 20%, yield curves inverted, and threats of a recession rose.

They aren’t willing to make that mistake again. The subsequent policy reversal pushed the markets to new record highs, which has been a function of  valuation expansion due to the lack of improvement in underlying fundamentals and earnings.

The Inextricable Problem

The problem is that stopping the current “repo” operations is that it could well spark another “repo market crisis,” especially with $259 billion in liquidity pumped currently. Notably, that is even more than what was at year end to fulfill “the turn.”

The BIS recently explained why these operations lift asset prices.

Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly. Thus, any sustained disruption in this market, with daily turnover in the U.S. market of about $1 trillion, could quickly ripple through the financial system. The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

You really have to ask what is going on here. Wall Street veteran Caitlin Long provided a clue.

U.S. Treasuries are the most rehypothecated asset in financial markets, and the big banks know this. [They] are the core asset used by every financial institution to satisfy its capital and liquidity requirements, which means that no one really knows how big the hole is at a system-wide level.

This is the real reason why the repo market periodically seizes up. It’s akin to musical chairs – no one knows how many players will be without a chair until the music stops.

As ZeroHedge noted, this isn’t just a bank issue.

Hedge funds are the most heavily leveraged multi-strategy funds in the world, taking something like $20 billion to $30 billion in net assets under management and levering it up to $200 billion. As noted by The Financial Times:

“Some hedge funds take the Treasury security they have just bought and use it to secure cash loans in the repo market. They then use this fresh cash to increase the size of the trade, repeating the process over and over and ratcheting up the potential returns.”

So….it’s a hedge fund problem, right?

Probably.

“The repo-funded [arbitrage] was (ab)used by most multi-strat funds, and the Federal Reserve was suddenly facing multiple LTCM (Long-Term Capital Management) blow-ups which could have started an avalanche. Such would have resulted in trillions of assets being forcefully liquidated as a tsunami of margin calls hit the hedge funds world.”

Think “Lehman crisis” multiplied by a factor of four.

The Fed’s position is they must continue inflating a valuation bubble despite the inherent, and understood, risks of doing so. However, with no alternative to “emergency measures,” the Fed is trapped in their own process. The longer they continue their monetary interventions, the more impossible it becomes for the Fed to extricate itself without causing the crash they want to avoid.

Stated simply, the longer the Fed avoids normalizing monetary policy, and weaning the “crack addicted” markets off of their “liquidity drug,” the bigger the “reversion” will be “when,” not “if,” it occurs.

The only question is how much longer can Jerome Powell continue “pushing on a string.”

FPC: All The Numbers You Need To Know For 2020

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Hopefully you’ve had some time to reflect and grade yourself on your financial progress for 2019 and you’re ready to take 2020 by the horns. The new year brings new numbers to be aware of to ensure you’re taking advantage of all you can. There are many contribution limits, income limits and a vast array of numbers used in financial planning, but here are a few more common ones to make sure you’re staying on track.

Retirement Plans:

For employees:

401(k), 403(b), most 457 plans and the federal governments Thrift Savings Plan employee contributions have increased from $19,000 to $19,500. The maximum amount employees + employers can contribute has also gone up to $57,000.

For those of you over 50 the catch up provision has increased from $6,000 to $6,500.

Please, please don’t overlook the Roth option if you have it within your plan.

For Small Business Owners:

SIMPLE IRA plan contribution limits have been increased from $13,000 to $13,500. There is also a catch up provision of $3,000 for individuals over 50.

SEP IRA contribution limits have also increased from $56,000 to $57,000 or 25% of income whichever is lower.

IRA’s

While the maximum contribution limits for IRA’s of $6,000 and a catch up provision of $1,000 for those over 50 remained unchanged. The income limits for deductibility in the case of the Traditional IRA and the ability to contribute to a Roth IRA did change a bit.

Traditional IRA

You can always make a contribution to a Traditional IRA with no income limitations, but your contribution may not be deductible for income tax purposes. For those of you who would like to make a tax deductible contribution which I assume is most of you, the numbers have changed slightly. There is such a thing as a “phase out limit”. This applies if you make over a certain amount of income you can still contribute and deduct, but the amount will be reduced that you can deduct.

Then there are those who can’t make tax deductible contributions at all.

If you and your spouse are not covered by an employer sponsored plan then regardless of income you can make a deductible contribution.

If you are covered by an employer sponsored plan here is what you need to know about those phase out limits. If you’re single or Head of Household the income limit starts at $65,000 and ends at $75,000. Meaning that if you make between $65,000 and $75,000 your deductible contribution will be reduced, but if you make over $75,000 you can’t deduct your contribution for income tax purposes. If you file Married Filing Jointly that number is $104,000 to $124,000.

Now if only one of you is covered by an employer sponsored plan the income limit for tax deductible contributions goes up to $196,000-206,000.

Roth IRA

Roth IRA’s are a little trickier than their older brethren the Traditional IRA. You can either contribute or you can’t. In the case of the Roth the benefit isn’t a tax deduction, but paying taxes now, funding the Roth with after tax funds and enjoying tax free growth and distributions should you meet a couple of small stipulations.  Roth contributions can be withdrawn at any time without a 10% penalty, but the earnings could be subject to taxes and the 10% early withdrawal penalty if you don’t meet the following:

  • Withdrawals must be taken after 59 ½
  • Withdrawals must be taken after a five year holding period

There are also a few qualifying events that may preclude you from having to pay taxes and/or 10% penalty, but we’ll save those for another post.

Here are the numbers you need to know to determine if you can or can’t contribute to a Roth IRA.

If you’re single or Head of Household and make under $124,000 you can make a full Roth contribution of $6,000 if you’re over 50 you can also make the additional $1,000 catch up contribution. If you make over $124,000, but less than $139,000 then you will be able to make a partial contribution. Over $139,000 you’re out of luck on a Roth IRA.

Married Filing Jointly income numbers for eligibility to contribute to a Roth increase a bit as well increasing from $193,000-$203,000 to $196,000- $206,000.

Saving for Health Care

There are two main types of accounts designed to help pay for medical expenses. If you can utilize them both that’s great, most don’t have that choice, but if you have to choose I really like the Health Savings Account.

Health Savings Accounts (HSA)

If you have access to a Health Savings Account max it out and if you can pay medical expenses out of pocket don’t use these funds.

This is the only account in the world which will give you a triple tax benefit-funds go in pre-tax, grow tax free and come out tax free if used for qualified medical expenses. Fidelity did a study last year that estimated the average 65 year old couple will spend $280,000 in health care expenses. You must be in a high deductible health insurance plan to utilize a HSA, but we are seeing more and more employers offering these types of plans.

This year if you are single you can contribute $3,550 and families can contribute $7,100 to an HSA. There is also an additional catch up provision of $1,000 for those 55 and older.

Flexible Spending Accounts (FSA)

FSA’s which are typically use it or lose it now have an annual contribution limit of $2,750 up from $2,700 in 2019.

Social Security and Medicare

We spend a lot of time discussing Social Security and Medicare and for good reason. According to our workshop attendance in 2019 there is a thirst for knowledge in these areas. I understand, they both can be confusing and this is an area that contains “stealth taxes.”

Social Security

Social Security had a couple of increases in 2020, for instance the estimated maximum monthly benefit if turning full retirement age (66) in 2020 is now $3,011.

OASDI which is an acronym for Old-Age, Survivors, Disability Insurance (Social Security Trust) taxes income up to $137,700 this is an increase from $132,900 in 2019. The current tax is 6.20% on earnings up to the applicable taxable maximum amount of $137,000. The Medicare portion is 1.45% on all earnings.

The retirement earnings test exempt amounts have also increased. In layman’s terms, if you take social security prior to full retirement age you will have $1 in benefits withheld for every $2 over $18,240/yr.

The year an individual reaches full retirement age that number increases to $48,600/yr, but only applies to earning for months prior to attaining full retirement age. In this instance $1 in benefits will be withheld for every $3 in earning above the limit.

Medicare

Medicare Part B premiums have also increased from $135.50 to $144.60. The first threshold for premium increases or surcharges has also increased for single filers to $87,000 to $109,000 and $174,000 up to $218,000 for joint filers. If you’re above those first numbers your monthly premium goes up to $202. 40 and it only goes up incrementally from there.

These are some of the more common numbers we watch for to either try to keep more money in your pocket or make sure you’re maximizing all funding sources. Now is a great time to check to ensure you’ve updated any systematic contributions to reflect the new numbers. After all, I know you’re paying yourselves first.

#WhatYouMissed On RIA: Week Of 01-06-20

This past week was our annual family ski trip, which is why our postings have been lighter than normal this week. We will return next week back with our full schedule.

In the meantime, 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

Michael Lebowitz & I discussing the Fed Repo operations and the trap they have gotten themselves into.

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!