Monthly Archives: January 2020

Relative Value Report 7/02/2020

Relative Value Report 7/2/2020

Due to the July 4th holiday, this week’s report uses data through Wednesday’s closes instead of Thursday.  Starting next week we resume the regular schedule.

The Relative Value Report provides guidance on which sectors, indexes, and bond classes are likely to outperform or underperform its appropriate benchmark.

Click on the Users Guide for details on the model’s relative value calculations as well as guidance on how to read the graphs. 

This report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary

  • Health care, Real Estate, and Utilities, representing more conservative sectors, improved over the week. Staples, the other conservative sector, did not follow. Real Estate is now the second most overbought sector, albeit not too overbought.
  • Energy has been underperforming the market, and it shows in this analysis as it is now the most oversold sector. It is not too oversold at -1.21 standard deviations, so we caution that it may become more oversold before improvement.
  • Discretionary is getting deeper into overbought territory. We are not overly surprised as high-flying AMZN is 24% of the ETF.  
  • Very little changed in the relative market analysis. The Dow Jones Industrial Average weakend versus the S&P, while the NASDAQ outperformed.
  • Value versus Growth remains the only oversold market sector.
  • Foreign Developed markets have cheapened back to fair value, but emerging markets remain decently overbought.
  • Mortgages became more oversold over the last week. As we noted last week, this is occurring despite the Fed’s large QE efforts.
  • The R-squared on the sigma/20 day excess return (Sectors) scatter plot is weak at .34.  The low correlation is likely the result of quick trading in and out of sectors. Typically rotations tend to last longer. With the R-squared this low, we urge caution overly relying on this week’s analysis.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

TPA Analytics: Introducing The TPA Marketscope

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

“In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”  – Benjamin Graham

WORLD SNAPSHOT – COMMENTS & CHARTS          Thursday, July 02, 2020

General comments first and macro tables at the bottom.  Links for Explanations of Technical terms at the bottom of the report.

 

INTRODUCING THE TPA MARKETSCOPE

 

TPA MARKETSCOPE EXPLAINED

Market timing is not a complete investment strategy in and of itself, but should be utilized as a tool for successful investing.  Knowing when stocks are at extremes can present investors with opportunities and help them to avoid pitfalls.  The TPA Marketscope uses a set of carefully watched indicators to assess if the market is at or near extremes.  When the market is oversold, risk-return favors buying and not selling and when the market is overbought, risk-return favors selling and not buying.

TPA MARKETSCOPE

The seven indicators below were developed after years of observation and the extreme limits used have historically been levels that mark short-term and medium-term inflection points.

Indicators explained:

  • Short term market score – is a daily analysis of the S&P500 relative to the normal distribution using the 2 standard deviation Bollinger Band. TPA then adjusts the score by the amount of overbought or oversold as measured by RSI.
  • Percent stocks above or below the 2 standard deviation Bollinger Band – Bollinger Bands identify ranges using standard deviations away from a moving average. They, therefore, measure volatility (the width of the band) and extremes (using normal statistical distributions). In a normal distribution, 2 standard deviations identifies 96% of all occurrences.  As a stock reaches the extreme of the 2 standard deviation Bollinger Band, it becomes more probable that the price will regress back to the mean.  TPA has found that historically market reversions are very likely when 40% of stocks are above or 60% of stocks are below the 2 standard deviation Bollinger Band.
  • Percent stocks above the 50DMA – when a large number of stocks (85%) are trading above their 50DMA, the market is at an overbought extreme. When a small number of stocks (15%) are trading above the 50DMA, the market is oversold.
  • Percent stocks RSI above 70 or below 30 – RSI is a measure of the speed and size of a recent move in a stock or index; the greater the price move and the quicker that move has taken place, the higher RSI. TPA has found that historically market extremes occur when 30% of stocks are trading above RSI 70 or when 55% of stocks are trading below RSI 30.
  • Percent stocks 50DMA>200DMA – This is a longer-term measure of extremes. An uptrend is defined when short term prices consistently trade above longer-term prices. An example of an uptrend is Last > 20DMA > 50DMA > 200DMA.  Technically, a long-term uptrend is defined by the 50DMA trading above the 200DMA.  TPA has found that historic oversold extremes occur when 22% or less stocks are trading 50DMA>200DMA.  The overbought extreme has become trickier since it has been declining since 2010 as a small number of TECH stocks have garnered an increasingly large percentage weighting in the S&P500.  Currently, the extreme is approximately 40% to 50% of stocks trading 50DMA > 200DMA.

TPA notes that not all of these indicators are equally consistent.  Clients should use the “Historical Importance” comments to determine the weight they will assign to each alert.

 

CLICK ON LINKS BELOW FOR TECHNICAL INDICATOR EXPLANATIONS:

ASCENDING – DESCENDING TRIANGLE

BASING-TOPPING-CONSOLIDATION

BREAKOUT (Breakdown)

CHANNEL & RANGE

DIRECTIONAL MOVEMENT INDEX (DMI)

DOUBLE BOTTOM or DOUBLE TOP

MACD-MOVING AVERAGE CONVERGENCE-DIVERGENCE

MOVING AVERAGES

RELATIVE STRENGTH & PEER STOCK PERFORMANCE

REPEATING PATTERNS

RSI-RELATIVE_STRENGTH

SUPPORT, RESISTANCE, BREAKOUT, BREAKDOWN

TREND

ALWAYS REMEMBER: No strategy exists in a vacuum – always evaluate the relevant sector & market.

Over 80% of portfolio performance is determined by sector and market forces (Ibbotson & Kaplan study – January/Febuary2000)

 

Turning Point Analytics Disclaimer

Turning Point Analytics (TPA) is only one of many tools that an investor should use to make a final investment decision.  TPA is an overlay on top of a client’s good fundamental or macro analysis.  TPA does not create or provide fundamental analysis. The information in this communication may include technical analysis.  Technical analysis is a discipline that studies the past trading history of a security while trying to forecast future price action.  Technical analysis does not consider the underlying fundamentals of the security in question and it does not provide information reasonably sufficient upon which to base an investment decision.  Investors should not rely on technical analysis alone while making an investment decision.  Before making an investment decision, investors should consider reviewing all publicly available information regarding the security in question, including, but not limited to, the underlying fundamentals of the security and other information which is available in filings with the Securities and Exchange Commission.  The information and analysis contained in reports provided by TPA are copyrighted and may not be duplicated or redistributed for any reason without the express written consent of TPA. The information in this communication is for institutional or sophisticated investors only.  By accepting this communication, the recipient agrees not to forward, and/or copy the information to any other person, except as permitted, or required by law. TPA does not guarantee accuracy or completeness. TPA is a publisher of technical research and has no investment banking or advisory relationship with any company mentioned in any report.  Reports are neither a solicitation to buy nor an offer to sell securities. Past performance is in no way indicative of future results. Opinions expressed are subject to change without notice.  TPA will provide, upon request, the details of any past recommendations. TPA’s analysis and recommendations should not be used as the sole reason to buy or sell any security. TPA may compensate brokers and intermediaries for sales and marketing services. You understand and acknowledge that there is a very high degree of risk involved in trading securities and/or currencies. The Company, the authors, the publisher, and all affiliates of Company assume no responsibility or liability for your trading and investment results.  It should not be assumed that the methods, techniques, or indicators presented will be profitable or that they will not result in losses. Statements, data, and analysis made by TPA or in its publications, are made as of the date stated and are subject to change without notice. TPA and/or its officers and employees may, from time to time acquire, hold, or sell a position in the securities mentioned herein. Upon request, TPA will furnish specific information in this regard. TPA will not be held liable for losses caused by conditions and/or events that are beyond TPA’s control, including, but not limited to, war, strikes, natural disasters, new government restrictions, market fluctuations, and communications disruptions.

S&P 500 Monthly Valuation & Analysis Review – 7-01-2020

S&P 500 Monthly Valuation & Analysis Review


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

Cartography Corner – July 2020

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

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

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

GTA Users Guide


June 2020 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESU0) during June 2020. In our June 2020 edition of The Cartography Corner, we wrote the following:

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

  • M4                 3706.25
  • M3                 3181.50
  • M1                 3166.0
  • M2                 3095.75
  • PMH             3065.50      
  • Close             3042.00
  • MTrend        2782.31
  • PML              2760.25      
  • M5               2555.50

If active traders do not agree with our rationale detailed above, they can use PMH: 3065.50 as the pivot, maintaining a long position above that level and a flat or short position below it.  If active traders do agree with our rationale detailed above, they can sell against each resistance level between 3065.50 and 3181.50 with tight stops until the market sustains a turn lower.   We provide the map; you drive the car.

Figure 1 below displays the daily price action for June 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The month of June began by continuing the latest swing to higher prices that began in earnest on May 14th, 2020.  The second and third trading sessions saw the market price exceed and settle above both May’s high at PMH: 3065.50 and M2: 3095.75.

The next three trading sessions saw the market price achieve and exceed our clustered-resistance levels at M1: 3166.00 and M3: 3181.50.  In May, we identified M3: 3181.50 as the upper limit to the range of prices at which we thought the market would turn lower.  We wrote, “Our rationale is as follows:

  1. Our anticipated two-period high in the monthly time-period will be satisfied with any tick above 3065.50.
  2. A market can retrace 80% of its prior move and still be corrective. Calculated using settlement prices, that level equates to 3142.00. (It can be calculated using intra-day highs and lows as well.)
  3. The March candle is the control candle. April and May’s trading activity are classified as inside-month ranges.  It will take a break of the March range to initiate the next substantial directional trend.  The high of the March candle is 3137.00.
  4. Resistance in June exists at M2: 3095.75 and M1: 3166.00 / M3: 3181.50.

OUR ANALYSIS SUGGESTS THAT THE BEST OPPORTUNITY FOR THE MARKET TO TURN LOWER IS BETWEEN 3065.75 AND 3181.50.”

The market price achieved both its high price (3226.95*) and high-settlement price (3223.20*) on June 8th, two trading sessions before the release of the FOMC statement after the Federal Reserve’s two-day meeting on June 9th and 10th.  Following the release of the FOMC statement, the market began to weaken. It settled the June 10th trading session at 3177.60*, back inside our clustered-resistance levels at M1: 3166.00 and M3: 3181.50.  Market participants did not get the “more” they were anticipating from the Fed… they did not get anything.

On June 11th, the market’s price-decline (as measured from June 8th) equaled (6.94%).  Two sessions later, at that morning’s low, the decline equaled (9.29%).  In a move indicative of panic? stupidity? desperation? micromanagement, the Federal Reserve announced “…updates to the Secondary Market Corporate Credit Facility (SMCCF), which will begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.”

On June 16th, the day after the Federal Reserve’s announcement, the market price rallied as much as 7.95% from the previous morning’s low.  The high of that session, 3156.25, capped the price action for the remainder of the month.

The final ten trading sessions of June were spent with the market price begrudgingly trading lower.  The market had distinct signs of the price levels associated with the Federal Reserve’s action being explicitly defended.  Quelle surprise.

Market participants following our analysis had the opportunity to realize profits, regardless of the initial strategy chosen.  However, we are disappointed in our accuracy for June.  The upper limit of our “sell-zone” missed its mark by 45 points (1.4%) and our timing was off by three trading sessions.  We will strive to improve (and pay closer attention to the FOMC meeting calendar).  

  * These prices reflect the rolling of our data from the June contract to the September contract.  We roll over five days, in 20% increments.  For example, on day 1 of the roll, the price reflects a weighting of (80% * June price) + (20% * September price).

Figure 1:

Natural Gas Futures

We continue with a review of Natural Gas Futures (NGQ0) during June 2020.  In our June 2020 edition of The Cartography Corner, we wrote the following:

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

  • M4         2.803
  • M1         2.224
  • PMH       2.162
  • M2         1.961
  • Close        1.849
  • MTrend   1.842
  • M3         1.749  
  • PML        1.741              
  • M5           1.382

Active traders can use 1.741 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for June 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first trading session of June saw the market price test our isolated pivot level at PML: 1.741.  That level held on its first test, with the market price settling above at 1.774.

The following eight trading sessions saw the market price ascend towards and surpass our first isolated resistance level at MTrend: 1.842.  The rally fell short of our next isolated resistance level at M2: 1.961 by 4.6 cents, peaking on June 11th at 1.915.

The following two trading sessions saw the market price make a quick descent back to our isolated pivot level at PML: 1.741.  On June 16th, the market price decisively broke, and settled, below PML: 1741.  The following four trading sessions were spent with the market price testing our resolve, as it rose back into clustered support at PML: 1.741 / M3: 1.749, now acting as resistance.

On June 23rd, the market price began a significant decline towards our isolated Downside Exhaustion Level at M5: 1.382.  The low price for the month was achieved on June 25th at 1.517.  The final three trading sessions were spent with the market rallying back to our isolated pivot level at PML: 1.741.

Market participants following our analysis had ~12.5% profit in the trade at the low price.  Trailing stops allowed them to monetize a portion of it.  “Un-administered” price discovery is both rare and refreshing.  

Figure 2:


July 2020 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESU0).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Current Settle         3090.25       
  • Weekly Trend         3056.27
  • Daily Trend             3042.58       
  • Monthly Trend        2933.44       
  • Quarterly Trend      2913.69

The relative positioning of the Trend Levels is bullish.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”, after having been “Trend Up” for four quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are in “Consolidation”, after having been “Trend Down” for three months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Down”, having settled for three weeks below Weekly Trend.

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  Recall, these two-period highs may occur at higher levels but can also occur from lower levels.  We now anticipate a two-period high in the quarterly time-period over the next three to five quarters.  If this were to be achieved in 3Q2020, a trade to a new all-time high is required.  The two-month high that we had been anticipating since March was achieved in June.

We continue to believe that the June high was a crucial inflection point, equivalent to the “Return to Normal” point on the classic bubble-and-burst graph.  The market’s reaction off that high to the June 15 low re-enforced our conviction.  Based upon its action, it re-enforced the Fed’s as well.

Support/Resistance:

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

  • M4                 3693.65
  • M1                 3388.40
  • PMH              3226.95
  • M3                 3138.50
  • Close            3090.25      
  • M2                3087.25
  • MTrend        2933.44
  • PML              2923.75      
  • M5               2782.00

Active traders can use M2: 3087.25 as the pivot, maintaining a long position above that level and a flat or short position below it.

Silver Futures

For July, we focus on Silver Futures.  We provide a monthly time-period analysis of SIU0.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Current Settle       18.637           
  • Daily Trend           18.189
  • Weekly Trend       17.931           
  • Monthly Trend      16.868           
  • Quarterly Trend    16.574

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross; the Trend Levels are higher as the time-periods decrease.  As can be seen in the quarterly chart below, Silver is in “Consolidation”.  Stepping down one time-period, the monthly chart shows that Silver is in “Consolidation”, after having been “Trend Down” for three months.  Stepping down to the weekly time-period, the chart shows that Silver is in “Consolidation”, after having been “Trend Up” for five weeks.

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  We now anticipate a two-period high in the quarterly time-period over the next three to five quarters, which requires a trade above 19.010 (19.690, if not including inside-range candles) to be achieved in 3Q2020.  The two-month high that we had been anticipating since March was achieved in June.

Support/Resistance:

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

  • M4         23.140
  • M2         19.610
  • M1         19.365
  • PMH       18.950
  • M3         18.775
  • Close       18.637
  • PML        17.185             
  • MTrend  16.868                         
  • M5           15.835

Active traders can use 18.950 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Summary

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


The Decade Long Path Ahead To Recovery- Part 1 Debt

The Decade Long Path Ahead To Recovery – Part 1 Debt

This article is the first of a four-part series on the vectors driving future economic growth. Forthcoming articles will tackle Depression, Demographics, and De-globalization.

The discussions about economic recovery and the path ahead are ongoing. The shape it will take will defy the simplistic “V”, “W”, and “L” expressions being used by forecasters. One thing, however, is certain. Every bazooka, tank, and A-bomb of stimulus is being used to combat the downturn.

The question, so few seem to ask, is at what cost?

“Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery,” 5/29/2020 Jerome Powell Peterson Institute of International Economics.

As we will explain, what is best for economic growth and prosperity is not what Powell’s Fed is doing. Power, influence, and intellectual elitism may be winning today’s battle, but they are losing the war. The evidence is compelling.

Yardeni et al.

In a recent Grant’s Current Yield podcast, guest Ed Yardeni, said: “I find too many investors…act like preachers. They judge the Fed, good or bad, a moralistic approach. My approach, as an investment strategist is bullish or bearish.”

Yardeni’s only concern appears to be whether Fed actions are good or bad for his portfolio. Specifically, good or bad for his career.

Like all investors, we also need to understand whether Fed actions are bullish or bearish. However, we have a conscience and care about what is best and right. Yardeni’s comments remind us of the Niemoller prose, “First they came…”.

Yardeni’s view represents the epitome of expedience over principle. His perspective is not a one-off, in fact, far from it. It is a consensus among financial and political insiders. It runs through the veins of Wall Street, Congress, and the White House. 

Planning Ahead

The United States is in the midst of an unprecedented third asset bubble in twenty years. The recent crisis is being blamed on COVID. We disagree, COVID is the pin that pricked the bubble.

To help visualize this, we quote from our article The COVID 19 Tripwire:

“There is a popular game called Jenga in which a tower of rectangular blocks is arranged to form a sturdy tower. The objective of the game is to take turns removing blocks without causing the tower to fall. At first, the task is as easy as the structure is stable. However, as more blocks are removed, the structure weakens. At some point, a key block is pulled, and the tower collapses. Yes, the collapse is a direct cause of the last block being removed, but piece by piece the structure became increasingly unstable. The last block was the catalyst, but the turns played leading up to that point had just as much to do with the collapse. It was bound to happen; the only question was, which block would cause the tower to give way?”

The real catalysts include the following:

  • Accumulated leverage
  • Poor use of cash for stock buybacks
  • Fragile financial infrastructure
  • Lack of productive investment
  • Overzealous speculation
  • Unfettered government spending
  • Preference for consumption over savings

In sum, capital has been grossly misallocated towards speculation and away from productive investment. These outcomes are, in large part, a result of prior and current Fed policy.

Like households and corporations, the government also reacts to the “signals” being sent through the market. When interest rates are manipulated, strange things happen and ripple throughout an economy. When that currency is the global reserve currency, the word “strange” takes on a new definition.

Past Experience

In the current set of circumstances, the economy and markets are experiencing a confluence of shocks that are both extreme and unique. Regardless, we can still reflect on past episodes that caused great turmoil and anxiety. Although the analysis does not provide explicit answers, the rigor offers insight and direction.

As James Grant once said, “My goal is to have everyone agree with me, later.”

Foresight with confidence offers early, cheap entry into opportunities that everyone else sees “tomorrow”.

A New Trajectory for U.S. Growth

The chart below offers a substantive context for what has transpired over the past 40 years. The colored lines show what economic activity would have been had the growth rate of the prior expansion held true in the following expansion.

As shown, after each successive bubble, the trajectory of growth, GDP shifts lower. Slow economic growth implies that the time to full recovery is elongated.

To predict a post-COVID growth trajectory we need only look at the ratio of Federal debt to GDP. As shown below, the trend lines of that ratio to trend economic growth are negatively correlated. Since 1990 the relationship has a very high r-square of .928. Simply, as the ratio of Federal debt to GDP rises, economic growth declines.

The next graph projects GDP based on the expected ratio of Federal Debt to GDP. For this exercise, we conservatively assume the ratio will be 115% when the economic recovery begins. That compares to 82% in 2009 and 55% in 2002. We also assume economic growth falls by 10% in the second quarter and 1% in the third quarter. GDP then grows at our projected growth rate of 1.07%.

Based on this analysis, the economy will not regain pre-COVID economic levels this decade. 

The Culprit

The new paradigm of weak recoveries is due to the Fed’s policy prescription for recessions; debt-fueled consumption. Through lower interest rates they incentivize people, corporations, and the government to borrow. The benefits are here and now as economic recovery ensues. The cost is paid tomorrow.

The debt is increasingly put to unproductive uses, and the obligations grow exponentially larger than income. As we discussed in Why the Recovery Will Fall Short of Forecasts, given the issues facing productivity and demography, this is a troubling outlook.

Recessions are a normal part of the economic cycle. They are a healthy reset that purges weak businesses and encourages productive capital investment for the future, not speculation.  The resumption of growth takes time in a recession left to its course. However, improved productivity and prudent use of resources sets the economy on a sustainable path to healthy growth.

The New Order

Modern-day Fed policy encourages speculation over productivity growth. The result is sustained unemployment and low wage growth. The longer people are out of work, the less likely they are to re-assimilate into the productive workforce. This means they require and expect more government assistance, which further raises the debt obligation on the dwindling taxpayer.

Revisiting one of our cornerstone concepts, economic growth hinges upon two key elements:

  1. Growth in the labor force
  2. Productivity gains

The regressive trajectory of GDP growth reflects that those factors of growth are diminishing.

A Fine Mess

Even after the surprisingly positive payroll report for May 2020, the chart below illustrates the magnitude of our predicament. It also reflects the mischaracterizations being used to discuss the post-COVID19 economic circumstance.

Note that the last four recessions required longer periods consecutively for jobs to recover fully.

The amount of non-productive debt used to combat downturns compounds the pre-existing debt problem. It ensures that the economy will continue to struggle for years to get back to pre-COVID levels of economic activity.

“Much higher public debt levels will become a permanent feature of our economies and will be accompanied by private debt cancellation.”  – Mario Draghi, March 2020, FT

At $6 trillion in December 2001, then $11.5 trillion in June 2009, U.S. government debt has now ballooned to $26 trillion. Tragically, debt continued to pile up over the last decade despite economic recovery. It, in fact, was the economic recovery. Without that expansion of debt, there would have been little to no economic growth.

To characterize it otherwise as Fed and government officials have done is intellectually dishonest. When the debt-to-GDP graph below updates next, the ratio will be close to 120%. The pattern since 1980 is clear.

The Fed is extraordinarily accommodative in both their interest rate posture and their willingness to fund massive federal deficits.

They deliberately encourage everyone to borrow. That occurs with lower rates and expansion of the Fed balance sheet (QE) as shown in the chart below. They have also promised near-zero rates and QE for the foreseeable future.  This is, indeed, a fine mess.

Evidence

Despite the information we present, the same talking points justify the same actions. The actions do not serve the best long-term interests of the public. The tools the Fed is employing destroys wealth for all but the top 1%.

The policies incite inflation, much of which is hidden by faulty government reporting. As detailed in a previous article, Two Percent for the One Percent, inflation erodes living standards for the broad population.

Even after years of botched policies that damage the organic economy, no one in Congress challenges the Fed’s counter-factual. Given the evidence from their inability to forecast even one or two quarters ahead, how do they know what they are doing works? How do they know the long-term implications of their policies will not be disastrous? The answer, of course, is they do not know.

Summary

As mentioned, based on this analysis using the trends of the past 40 years, the economy will not regain pre-COVID output levels until sometime in the 2030s. The implications of that scenario are weak GDP growth, poor labor market growth, and high market volatility, among many other unknowns. It might also imply continuing civil unrest and potentially war.

All of those in power appear to be complicit in advancing this agenda. Why not? They are rewarded handsomely for their compliance. That is how politicians and the corporate elite get wealthy from their positions of power.

Meanwhile, the rest of us watch and wait, hoping that someone will show up to represent the community in this injustice.

What the Fed is doing to save today will cause problems tomorrow. We have two choices; we can recognize the problem and force change by electing like-minded legislators. Or, we can stand aside. The latter, of course, only furthers behavior detrimental to our country.

Instead of cheering Fed actions today, consider what they are doing to the future.

If nothing changes, then the problem will eventually take care of itself. It will not be peaceful or pleasant, but it will come to a resolution. The outcome will not be favorable for investors or what was once the greatest economy in history.

10 Dividend Stocks We Like Now

In this issue of “10-dividend stocks we like now,” we scan our database for the ten companies with strong fundamentals to add income to portfolios.

I previously discussed in “GE – Bringing Investment Mistakes To Life,” the fundamental investor fallacy of “I bought it for the dividend.” However, the most critical point was what we are currently seeing, as the pandemic is crushing corporate revenue. To wit:

“While I completely agree that investors should own companies that pay dividendsit is also crucial to understand that companies will cut dividends during periods of financial stress. During the next major market reversion, we will see much of the same happen again.”

With a litany of companies that have cut, and even eliminated dividends, that risk has come to fruition.

COVID, Market Corrects As COVID Cases Surge 06-26-20

The Screen

However, this doesn’t mean dividends aren’t important. If you look at our portfolios, you will see we have a preference for high-quality names that pay dividends. We usually screen our database of over 8000 stocks for companies that fit several fundamental and value factors. Such ensures we are buying top-quality names and lowering bankruptcy risk.

For today’s purpose of a specific dividend focus, we are looking for companies that are members of the S&P 500 index. They must also have a history of growing dividends over the last 5-years and a declining payout ratio relative to their earnings. We are taking only the top 10 highest rated stocks.

The criteria for our Dividend screen are:

  • Market Capitalization > $1 Billion
  • Index Constituency: Must Be A Member of the S&P 500 Index
  • Dividend Yield > 1% 
  • 5-Year Dividend Growth Rate > 0
  • Change In Payout Ratio < 0
  • Zack’s Investment Ranking = Top 10

The table below are the 10-candidates that resulted from the latest screening.

The combination of these fundamental measures should yield an excess return over the market.

COVID, Market Corrects As COVID Cases Surge 06-26-20

The Results

The table below assumes that over the last 5-years you bought all 10-stocks and rebalanced them quarterly.

Over the 21-quarterly rebalancing periods, the portfolio had an annualized return of 11.4% versus the 10.8% for the market. This annual outperformance is likely better, however, since this is a quarterly rebalance, the data for Q2-2020 is not included as of yet.

The Need

With interest rates near historic lows, the price of money has been persistently lower in this economic cycle than in the past. This factor provides support for income-yielding stocks as a growing population of retirees, are seeking higher incomes.

The risk of this strategy is that valuations for many companies, including higher dividend payers, have expanded much more than usual. Such is reminiscent of the “Nifty-Fifty” period in the late 1970s.

While investing in dividend-yielding stocks certainly provides an additional return to portfolios, as “GE” reminds us, stocks are “not safe” investments. They can, and will lose value, and often much more than you can withstand.

For our “safe money” we continue to use rallies in interest rates to buy Treasury bonds. Bonds not only provide income, but safety of principal during a market sell-off.

COVID, Market Corrects As COVID Cases Surge 06-26-20

Conclusion

Valuation and safety continue to be a top concern for investors. Such is especially the case with markets signaling more troubling technical trends. We believe the best way for investors to generate income is to invest in quality businesses at a discount to their intrinsic value. We focus on names that still maintain a fair valuation, are growing, and are well-founded in their industries. We think these names are more likely to offer investors a reasonable return on their investment.


Disclaimer: Nothing in this post should be construed as an offer to buy or sell any securities. This content is for informational purposes only. Past performance is no guarantee of future results. Use at your own risk and peril.

RIAPro: 15-Investing Rules To Win The Long-Game

I wanted to share with you a post I wrote for our RIAPro subscribers (try risk-free for 30-days) on the 15-investing rules to win the long-game. The rather “Pavlovian” response to Central Bank interventions has led investors into a false sense of security with respect to the risk being undertaken.

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

However, to understand why the “rules” are important, one must first understand the definition of “risk” as it relates to investing. Howard Marks previously penned a great piece on this concept.

“If I ask you what’s the risk in investing, you would answer the risk of losing money.

But there actually are two risks in investing: One is to lose money, and the other is to miss an opportunity. You can eliminate either one, but you can’t eliminate both at the same time. So the question is how you’re going to position yourself versus these two risks: straight down the middle, more aggressive or more defensive.

I think of it like a comedy movie where a guy is considering some activity. On his right shoulder is sitting an angel in a white robe. He says: ‘No, don’t do it! It’s not prudent, it’s not a good idea, it’s not proper and you’ll get in trouble’.

On the other shoulder is the devil in a red robe with his pitchfork. He whispers: ‘Do it, you’ll get rich’. In the end, the devil usually wins.

Caution, maturity and doing the right thing are old-fashioned ideas. And when they do battle against the desire to get rich, other than in panic times, the desire to get rich usually wins. That’s why bubbles are created and frauds like Bernie Madoff get money. Unemotionalism

Unemotionalism

Howard goes on to discuss the importance of “unemotionalism” in managing a portfolio.

How do you avoid getting trapped by the devil?

I’ve been in this business for over forty-five years now, so I’ve had a lot of experience.  In addition, I am not a very emotional person. In fact, almost all the great investors I know are unemotional. If you’re emotional then you’ll buy at the top when everybody is euphoric and prices are high. Also, you’ll sell at the bottom when everybody is depressed and prices are low. You’ll be like everybody else and you will always do the wrong thing at the extremes.

Therefore, unemotionalism is one of the most important criteria for being a successful investor. And if you can’t be unemotional you should not invest your own money, period. Most great investors practice something called contrarianism. It consists of doing the right thing at the extremes which is the contrary of what everybody else is doing. So unemtionalism is one of the basic requirements for contrarianism.”

It is not surprising with markets surging off the March lows, the Fed flooding the system with liquidity, and the mainstream media trumpeting the news, individuals became swept up in the moment.

After all, it’s a “can’t lose proposition.” Right?

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

Greed & Fear

This is why being unemotional when it comes to your money is a very hard thing to do.

It is times, such as now, where logic states that we must participate in the current opportunity. However, emotions of “greed” and “fear” cause individual’s to take on too much exposure, or worry they have too much and a crash could come at any moment. These emotionally driven decisions tend to lead to worse outcomes over time.

As Howard Marks’ stated above, it is in times like these that individuals must remain unemotional and adhere to a strict investment discipline. It is from Marks’ view on risk management that I thought sharing the rules that drive our own investment discipline. 

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.” In reality, I am neither bullish or bearish. I follow a very simple set of rules which are the core of our portfolio management philosophy. We focus on capital preservation and long-term “risk-adjusted” returns.

Do I make mistakes? Absolutely.

Do emotions still seep into our decision making process? Of course.

We are humans, just like you, and suffer from the same frailties as everyone else. However, we try and mitigate those flaws through the fundamental, economic and price analysis which forms the foundation of overall risk exposure and asset allocation.

The following rules are the “control boundaries” under which we strive to operate.

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

The 15-Rules

  1. Cut losers short and let winner’s run. (Be a scale-up buyer.)
  2. Set goals and be actionable. (Without specific goals, trades become arbitrary.)
  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. (“Only losers add to losers.” – Paul Tudor Jones)
  10. Markets 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.)
  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 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. Be consistent, control errors, and capitalize on opportunity to win.)
  15. Manage risk and volatility. (Control the variables that lead to mistakes to generate returns as a byproduct.)

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

The Bull Trend Still Lives

Currently, the long-term bullish trend that began in 2009 remains intact. The correction in early 2016 was cut short by massive, and continuing, interventions of global Central Banks. The 2018 correction, reversed with the Fed returning to a more “dovish” posture and cutting rates. The 2020 crash reversed due to the most extreme monetary interventions the world has ever seen.

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

What is important to note is that it is taking increasingly larger amounts of interventions to keep the “bull trend” intact. The limits to the efficacy of monetary interventions are becoming evident.

A violation of the long-term bullish trend, and a failure to recover, will signal the beginning of the next “bear market” cycle. Such will then change portfolio allocations to be either “neutral or short.”  BUT, and most importantly, until that violation occurs, portfolios should remain either long or neutral.  

Conclusion

The current market advance against a backdrop of deteriorating economics and fundamentals is certainly worth worrying about. However, with Central Banks furiously flooding the system with liquidity, the “risk” of “fighting the Fed,” potentially outweighs the reward.

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, will allow the long-term returns to take care of themselves.

Everyone approaches money management differently. Our process isn’t perfect, but it works more often than not.

The important message is to have a process that can mitigate the risk of loss in your portfolio.

Does this mean you will never lose money? Of course, not.

The goal is not to lose so much money you can’t recover from it.

I hope you find something useful in it.

Sector Buy/Sell Review: 06-30-20

Each week we produce a “Sector Buy/Sell Review” 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 SECTOR BUY/SELL REVIEW CHARTS

There are three primary components to each chart:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. We are back to “stupid” overbought on many levels. Caution is advised.

Basic Materials

  • As noted last week, XLB held support at $54, but remains very overbought short-term.
  • Trading positions can be added with a tight stop at $54. 
  • The sector looks weak overall so caution is advised as we head into earnings season.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
  • Stop-Loss set at $54
  • Long-Term Positioning: Bearish

Communications

  • XLC has continued to correct its very overbought condition. We took some profits previously. 
  • We continue to like the more defensive quality of the sector. We have been looking for a pullback to $51 to add to our holdings. We are approaching that level.  
  • We moved our alert to $51 to revisit adding to our holdings.
    • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Neutral

Energy

  • The pullback in energy stocks has moved the sector back to oversold. We were a bit early adding to our holdings but we were close to the short-term bottom.
  • If support can hold here, our positions should play out.
  • We maintaining fairly close stops however.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Stop loss adjusted to $36.00
  • Long-Term Positioning: Bearish

Financials

  • Financials are back to underperforming and remain a sector to avoid currently.
  • Initial support was at $24, which was violated. Now that level of tested as “resistance.” 
  • We have an alert set at $22 to start evaluating holdings, but we aren’t excited about the sector currently.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • Industrials bounced of support at the 50% retracement level and triggered a buy signal. Sector performance has improved as well.
  • We are now looking for an opportunity to add exposure. The sector remains very overbought.short-term but we may get a good entry point here soon.
  • Short-Term Positioning: Bullish
    • Last week: No position.
    • This week: No position.
  • Long-Term Positioning: Bearish

Technology

  • Technology continues push higher and we continue to hold our exposure to the sector.
  • The rally had started to fade a bit, but money quickly rotated back into the sector.
  • As stated previously: “We added to our holdings for a rotation trade out of Materials, Financials, and Industrials back to liquidity and fundamental balance sheet strength.”  
  • We remain long the sector currently. We need a decent pullback to add more exposure.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Staples

  • XLP has corrected, and and after we added a bit more to our holdings for the defensive nature of the sector, the sector is close to triggering a buy signal.
  • XLP is not overbought after working off the previous extension, so there is “fuel” for a further rally on a rotation trade. Look for an offense to defense rotation to see a pickup in the sector. 
  • We are moving our stop-loss alert to $55 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
    • Long-Term Positioning: Bullish

Real Estate

  • Like XLP, XLRE is very close to triggering a buy signal.
  • The sector is not grossly overbought and a further defensive rotation in the market should see this sector rally. 
  • XLRE failed a second time at the 200-dma, however, if there is a risk-off rotation in the market we should see the sector gain some traction. 
  • We have $31 as our stop-loss level.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Utilities

  • XLU has been lagging but is working off its previous sell signal.
  • We previously added some exposure again to the sector in anticipation of the risk rotation into more defensive names. 
  • If there is further weakness in the market over the next few weeks, we will likely see a rotation in to XLU for defense and safety. 
  • We have an alert set at $54
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV has been consolidating over the last several weeks. With the previous sell signal heading higher, a defensive rotation in the market could push the sector higher.
  • The consolidation was needed following the massive rally from the lows.
  • The 200-dma is now important support and needs to hold, along with the previous tops going back to 2018. 
  • We have an alert set at $95 as a stop.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • AMZN is still driving this sector. The overall retail sector looks terrible and with earnings coming we are looking for weakness in the sector..
  • Hold current positions but maintain your stop levels.
  • Stop loss is set at $122.50
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • The rally in XTN is losing traction and failing at resistance.
  • The sector is performing weakly so caution is advised. 
  • XTN failed the 50% correction retracement level so there is mounting risk it will fail this support level.
  • Stop loss set at $50
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bearish

Major Market Buy/Sell Review: 06-29-20

HOW TO READ THE MAJOR MARKET BUY/SELL CHARTS FOR THE WEEK OF 06-22-20.

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

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

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

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

Market Buy/Sell 06-22-20

NOTE: I have added relative performance information to each Major Market buy/sell review graph. Most every Major Market buy/sell review graph also shows relative performance to the S&P 500 index except for the S&P 500 itself, which compares value to growth, and oil to the energy sector.

2 and 3-standard deviations from the 50-dma to show where extreme extensions currently exist.

S&P 500 Index

  • Previously we noted: “With the SPY pushing into 3-standard deviation territory, profit taking is suggested. We will likely see a short-term reversal to provide a better entry point to add further exposure.”
  • That correction happened over the last two weeks with the SPY bouncing off support at the 200-dma and retesting it again on Friday. It is critical the market holds support into next week. 
  • Some of the overbought condition has been corrected, but not all of it, so there could be more selling pressure in the short-term, particularly with the rise of virus cases again. 
  • A trading position can still be put on with a stop at the 200-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No core position
    • This Week: No core position
    • Stop-loss set at $295 for trading positions.
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • As with SPY, DIA had also pushed well into 3-standard deviation territory and suggested a short-term corrective pullback was likely to relieve some of that extension.
  • DIA continues to lag both the S&P and the Nasdaq, and DIA failed to hold the 200-dma but is holding support at the 61.8% retracement from the low. DIA needs to hold that level next week.
  • We added a 5% trading position in the Dow for a catchup trade, but we violated the stop on Friday. As always, by the time a stop is triggered, markets are short-term oversold. We will look for bounce to clear the position. 
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss violated, will sell on a bounce.
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • QQQ’s outperformance of SPY continues. 
  • The QQQ’s continue to digest after breaking out to all-time highs.
  • The QQQ’s are overbought and the buy signal is extended so consolidation or a correction is still possible so maintain stops accordingly and take profits and rebalance as needed.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss moved up to $225
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • As stated previously, SLY is pushing limits of a 3-standard deviation extension, so if you are long small-caps take profits on Monday and rebalance risk. We will likely see a correction soon.”
  • That correction was swift and sharp with small-caps failing at the 200-dma resistance and failing support at the 50% retracement of the March correction.
  • The previous stop-loss at $58 was violated.
  • We still have an “avoid small-caps” stance at the moment due to earnings risk and underperformance
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $56
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. MDY also failed its breakout above the 200-dma resistance. 
  • We suggested previously, as with Small-Caps “We will likely see a correction sooner than later, so take profits and rebalance risk accordingly.” 
  • The $320 stop-loss was violated. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $310
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets performed much better on a relative basis this past week. However, I suspect it will be short-lived as the virus resurfaces globally. 
  • There is dollar risk to international markets so pay attention to it for clues as to when to leave the emerging markets trade.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $38 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Overall, like EEM, EFA is holding up better this past week. 
  • As with EEM, EFA is dollar sensitive, so watch it for clues as to when to exit positions.
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss reset at $60
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Oil prices are struggling to hold the 50% retracement level again this week but remain grossly overbought. 
  • We suggested last: “Look for a correction to reverse some of the extreme overbought.” That hasn’t occurred yet, but is still likely. Energy stocks are underperforming oil prices currently which suggests more trouble in the sector. 
  • Oil should hold support between $30 and $35 and we will look to increase our holdings on pullbacks.
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long our current position in IAU. 
  • This past week Gold rallied and broke out to new highs. However, the position is extremely overbought.
  • We are looking to potentially take some profits for now and look for a pullback to increase our sizing. We noted previously that gold would likely rise with a correction is stocks. That occurred this past week. 
  • We believe downside risk is fairly limited, but as always maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss remains at $155
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Two weeks ago we noted: “Bonds have now corrected and got back to oversold while holding support. Such sets us up for two events – a rally in bonds, as the stock market corrects.”
  • That correction in stocks came hard this past week, and the “risk off ” trade has picked up pushing TLT higher.
  • With TLT clearing the 50-dma, there is room for the holding to rise further particularly if we get further corrective action in stocks next week. 
  • We noted that we had added to both TLT in our portfolios to hedge against our increases in equity risk. We have also swapped IEF and SHY for MBB and AGG to increase duration and yield.
  • That hedge worked well this past week during the stock market correction as bonds rallied. There is still more upside potential in rates if volatility continues this week.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously we stated, “While the dollar has sold off, and helped fuel a rather torrid stock and commodity rally, we are likely closer to a bottom. With the USD extremely oversold, and well into 3-standard deviations below the 50-dma, the rally this past week was likely.”
  • The dollar is struggling to move higher but remains oversold. Trading positions can be added to hedge portfolios but there is not a huge move available currently given the current market dynamics. 
  • Stop-loss adjusted to $95

The Theory Of MMT Falls Flat When Faced With Reality (Part I)

If you haven’t heard of Modern Monetary Theory, or “MMT,” you will soon. If you recently lost your job due to the economic shut down, and received a stimulus check, you are already a beneficiary. As we will discuss in Part-1 of this two-part series, MMT’s theory falls flat when faced with reality.

With economic growth sluggish, unemployment high, and the wealth gap widening, politicians will be increasing pressure to delve deeper into MMT to cure our economic woes. However, to understand more about the premise of MMT, economist Stephanie Kelton, recently produced a video explaining the concept.

The Government Isn’t A Household

“MMT starts with a simple observation, and that is that the US dollar is a simple public monopoly. In other words, the United States currency comes from the United States government; it can’t come from anywhere else. So, what that means is that the federal government is nothing like a household.

For households or private businesses to be able to spend they’ve got to come up with the money, right? And the federal government can never run out of money. It cannot face a solvency problem with bills coming due that it can’t afford to pay. It never has to worry about finding the money to be able to spend.”

There is nothing untrue about that statement. While the Government can indeed “print money to meet all obligations,” it does NOT mean there are not consequences. The chart below really tells you all you need to know.

In reality, just like households, debt matters. When debt is used for “non-productive” purposes, the debt diverts dollars from productive purposes into servicing of the debt. The concept of “productive investments” is critically important to understanding why MMT fails the “litmus” test.

American Gridlock

Dr. Woody Brock, in American Gridlock, explained the importance of the productive use of debt. To wit:

“The word ‘deficit’ has no real meaning. 

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

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

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

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

MMT’s Root Problem

For MMT, the problem is government spending has shifted away from productive investments. Instead of things like the Hoover Dam, which creates jobs (infrastructure and development), spending shifted to social welfare, defense, and debt service, which have a negative rate of return.

According to the Center On Budget & Policy Prioritiesnearly 75% of every tax dollar goes to non-productive spending. 

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

To clarify, in 2019, the Federal Government spent $4.8 Trillion, which was equivalent to 22% of the nation’s entire nominal GDP. Of that total spending, ONLY $3.6 Trillion came from Federal revenues, the remaining$1.1 trillion came from debt.

If 75% of all expenditures go to social welfare and interest on the debt, those payments required $3.6 Trillion, or roughly 99% of the total revenue coming in. 

Measuring With The Wrong Yardstick

“So, the deficit definitely matters; it’s just that it matters in ways that we’re not normally taught to understand. Normally I think people tend to hear deficit and think it’s something that we should strive to eliminate; that we shouldn’t be running budget deficits; that there is evidence of fiscal irresponsibility. And the truth is the deficit can be too big. Evidence of a deficit that’s too big would be inflation.” – Kelton

Yes, Ms. Kelton does acknowledge the deficit can be too big, and the consequence would be inflation.

There are two problems with her argument. The first is that if the Government was running a massive deficit funding productive investments, then “inflation” would indeed be a problem. However, increasing deficits for non-productive purposes slows economic growth and is deflationary. Even a cursory glance at GDP, the deficit, and inflation show the error in MMT’s premise.

The second, and more important problem is the measure of inflation.

How Should MMT Measure Inflation?

Prior to 1998, inflation was measured on a basket of goods. However, during the Clinton Administration, the Boskin Commission was brought in to recalculate how inflation was measured. Their objective was simple – lower the rate of inflation to reduce the amount of money being paid out in Social Security.

Since then, inflation measures have been tortured, mangled, and abused to the point where it scarcely equates to the inflation that consumers deal with. For example, home prices were substituted for “homeowners equivalent rent,” which was falling at the time, and lowered inflationary pressures, despite rising house prices.

Since 1998, homeowners equivalent rent has risen 72% while house prices, as measured by the Shiller U.S. National Home Price Index has almost doubled the rate at 136%. House prices which currently comprise almost 25% of CPI has been grossly under-accounted for. In fact, since 1998, CPI has been under-reported by .40% a year on average. Considering that official CPI has run at a 2.20% annual rate since 1998, .40% is a big misrepresentation.

Innovation, technology, and the exportation of labor has lowered stated inflation rates. The chart below compares inflation today measured with both the 1990 computations and current ones.

Whether you agree with the calculations, weightings, and hedonics, the measure of inflation MUST be defined if it is the governor of economic policy.

It currently isn’t.

Deficits Are Others Surpluses

In other words their deficits become our surpluses and so when we talk about the government having all this red ink, we have to remind ourselves that their red ink becomes our black ink and their deficits are our surpluses and the question is then should you expand fiscal policy? Should you run bigger budget deficits in order to boost growth?” – Kelton

In theory, the concept is correct; in economic reality, it hasn’t functioned that way.

If used for productive investments, debt can be a solution to stimulating economic growth in the short-term and providing a long-term benefit. The current surge in deficit spending only succeeds in giving a temporary illusion of economic growth by “pulling forward” future consumption, leaving a void to fill continually.

Jerome Powell previously stated the economy should grow faster than the debt. Yet, each year, the debt continues to grow faster than the economy.

, Powell&#8217;s Fantasy: The Economy Should Grow Faster Than Debt

Economy Can’t Grow Faster Than Debt

The relevance of debt growth versus economic growth is all too evident, as shown below. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the growth in debt must continue to maintain current economic growth.

, Powell&#8217;s Fantasy: The Economy Should Grow Faster Than Debt

However, merely looking at Federal debt levels is misleading.

It is the total debt that weighs on the economy.

, Powell&#8217;s Fantasy: The Economy Should Grow Faster Than Debt

It now requires nearly $3.00 of debt to create $1 of economic growth.

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

, Powell&#8217;s Fantasy: The Economy Should Grow Faster Than Debt

The economic deficit has never been more enormous. For the 30 years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. With the economy expected to grow below 2% over the long-term, the economic deficit has never been greater.

Such is why MMT will ultimately fails. 

Interest rates and inflation MUST remain low, and debt MUST grow faster than the economy, just to keep the economy from stalling out.

The current environment is the very essence of a “liquidity trap.”

Productivity Loss

“So, what is the objective, what is the proper policy goal, and I think the right policy goal is to maintain a balanced economy where you’re at full employment. You’re guarding against an acceleration and inflation risk. And economists tend to understand that the kinds of things that you can do to boost longer term growth are investments in things like education, infrastructure, R&D. Those are the sorts of things that tend to accelerate productivity growth so that longer term real GDP growth can be higher.

So, there are ways in which the government can make investments today that increase deficits today that produce higher growth tomorrow and build in the extra capacity to absorb those higher deficits.” Kelton

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

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

The graph below plots a simple index we created based on total factor productivity (TFP) versus the ten-year average growth rate of TFP. The TFP index line is separated into green and red segments to highlight the change in the trend of productivity growth rate that occurred in the early 1970’s. The green dotted line extrapolates the trend of the pre-1972 era forward.”

, MMT Sounds Great In Theory&#8230;But

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

, MMT Sounds Great In Theory&#8230;But

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

Ill-conceived policies, like MMT, which impose an over-reliance on debt and demographics, have mostly run their course and failed.

Let’s Be Like Japan

“So, it’s impossible really to put a number on it. Nobody can know how much debt is too much debt. If you look at Japan today you see a country where the debt to GDP ratio is something like 240%, orders of magnitude above where the US is today or even where the US is forecast to be in the future. And so the question is how is Japan able to sustain a debt of that size.

Wouldn’t it have an inflation problem? Would it lead to rising interest rates? Wouldn’t this be destructive in some way? The answer to all those questions as Japan has demonstrated now for years is simply, no. Japan’s debt is close to 240% of GDP, almost a quadrillion. That’s a very big number. Again, long term interest rates are very close to zero. There’s no inflation problem and so despite the size of the debt there are no negative consequences as a result. I think Japan teaches us a really import lesson.” – Kelton

Ms. Kelton is correct. Japan does indeed teach us that running massive debts and deficits have not fostered stronger economic growth, beneficial inflation, or prosperity.

Should We Worry About Government Debt? Probably., Should Worry About Government Debt? Probably.

There Is More To The Story

Japan has been running a massive “quantitative easing” program starting in 2008, which is more than 3-times the size of that in the U.S. While stock markets did rise with ongoing Central Bank interventions, long-term performance has remained muted.

Should We Worry About Government Debt? Probably., Should Worry About Government Debt? Probably.

More importantly, economic prosperity is only slightly higher than it was before the turn of the century.

Should We Worry About Government Debt? Probably., Should Worry About Government Debt? Probably.

Despite the Bank of Japan consuming 80% of the ETF market and a sizable chunk of the corporate and government debt market, Japan has been plagued by rolling recessions, low inflation, and low-interest rates. (Japan’s 10-year Treasury rate fell into negative territory for the second time in recent years.)

Should We Worry About Government Debt? Probably., Should Worry About Government Debt? Probably.

Clearly, Ms. Kelton has not studied the impacts of MMT on Japan. The consequences for its citizens has been less than beneficial.

Japan Is A Template

Should we worry about the debt? If Japan is indeed a template of what we will eventually face, the simple answer is “yes.”

Should We Worry About Government Debt? Probably., Should Worry About Government Debt? Probably.

As global growth continues to slow, the negative impact of debt expands economic instability and wealth inequality. Likewise, the hope Central Bank’s monetary ammunition can foster economic growth, or inflation has been misplaced.

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

Japan is a microcosm of what the U.S. will face in the coming years as the “3-D’s” of debt, deflation, and the inevitability of demographics continue to widen the wealth gap. What Japan has shown us is that financial engineering doesn’t create prosperity, and over the medium to longer-term, it has negative consequences.

Such is a key point.

What is missed by those promoting the use of more debt, is the underlying flawed logic of using debt to solve a debt problem.

At some point, you simply have to stop digging.

Market Corrects As COVID Cases Surge


In this issue of “Market Corrects As COVID Cases Surge.”

  • Market Holds Bullish Support
  • From Bubble, To Bust, To Bubble
  • The Problem With 2-Year Forecasts
  • A Bearish Pattern Remains
  • Portfolio Positioning
  • MacroView: Rationalizing High Valuations Won’t Improve Outcomes
  • Sector & Market Analysis
  • 401k Plan Manager

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


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July 25th from 8-9 am

Send in your questions, and Rich and Danny will answer them live.


Catch Up On What You Missed Last Week


Note:

I am on vacation next week, so while I will post a newsletter next weekend, it will only be a short market update as I will not have access to all of my usual data. However, I assure you everything will return to normal on my return.

If you have any questions, I will continue to answer every question, every day. That is between sleeping on the beach, fishing, skiing, or eating. 

Market Corrects As COVID Cases Surge

Three overriding catalysts were driving the correction this past week:

  1. The market had gotten a good bit ahead of fundamentals.
  2. The surge in COVID cases is undermining the V-Shaped recovery narrative.
  3. End of the quarter portfolio rebalancing, which managers postponed in March.

We will go through each of these in more detail. However, let’s start with where we left off last week and update our risk/reward ranges.

Currently, the risk/reward dynamics have become slightly less favorable. The good news is that the 50-dma and 200-dma are so close there is strong support short-term. Such should give the bulls a bit of optimism. However, a breakdown below that level and things will get ugly quickly.

  • -2.2% to consolidation highs vs. +3.1% to the top of the current downtrend. (Positive)
  • -8.9% to previous consolidation lows vs. +7.7% to previous rally peak (Negative)
  • -13.1% to March bounce peak vs. +12% to all-time highs. (Negative)
  • -18.4% to April 5th lows vs. +12% to all-time highs. (Negative)

As shown, with the sell-off on Friday, the short-term oversold condition, a reflexive rally next week would not be surprising. Given that COVID concerns are escalating, it may be wise to use any rally to reduce risk further and increase hedges.

The Market Is Well Ahead Of Fundamentals

Part of the correction over the last two weeks is coming partially from the realignment of stocks back to reality. We specifically mentioned some of the more visible issues last week, but it was interesting to watch the “Daytraders Favorites” crash back to Earth (No pun intended.)

As we addressed on Tuesday, it is hard to justify paying current valuations.

“Furthermore, given the depth of the economic crisis, 49-million unemployed, collapsing wages and incomes, and a resurgence in the number of COVID-19 cases, estimates are still too high. During previous economic downturns, earnings collapsed between 50% and 85%. It is highly optimistic, given the current backdrop, that earnings will only decline by 20%.”

fully invested bears, Technically Speaking: Unicorns, Rainbows, &#038; Fully Invested Bears

6-Downside Risks

With States now beginning to back off of reopening plans, it is highly likely current earnings estimates will need to be guided lower over the next couple of months.

The most significant risk to investors currently is a “reliance on certainty” about future outcomes, when, in reality, there is no certainty at all. As Mike Shedlock pointed out just recently, there are numerous risks still present.

Six Downside Risks 

  1. The future progression of the pandemic remains highly uncertain.
  2. The collapse in demand may ultimately bankrupt many businesses.
  3. Unlike past recessions, services activity has dropped more sharply than manufacturing—with restrictions on movement severely curtailing expenditures on travel, tourism, restaurants, and recreation and social-distancing requirements and attitudes may further weigh on the recovery in these sectors. 
  4. Disruptions to global trade may result in a costly reconfiguration of global supply chains. 
  5. Persistently weak consumer and firm demand may push medium- and longer-term inflation expectations well below central bank targets.
  6. Additional expansionary fiscal policies— possibly in response to future large-scale outbreaks of COVID-19—could significantly increase government debt and add to sovereign risk.”

Again, the market is trading well ahead of underlying fundamentals. While the “Fed Put” may indeed put a “floor” below stocks, that doesn’t mean they can’t correct to realign with economic and fundamental realities.

COVID Makes A Second Appearance

As we discussed previously, the market rallied from the March lows based on 4-underlying premises:

  1. There would be no second-wave of the virus.
  2. There would be a vaccine available by year-end. 
  3. The economy would fully recover back to pre-pandemic levels.
  4. And, of course, “The Fed.”

While the bullish fantasy indeed prevailed over the last couple of months, suddenly, the world has shifted. The hope was that cases in the U.S. would slow into the fall before the potential onset of a “second wave” during a more traditional “flu season.” Unfortunately, the spike in cases in the still ongoing “first wave” will delay economic recovery longer.

In Texas, where I live, the Governor has shut-down bars again, is keeping businesses at reduced capacity, and potentially will reverse more if needed.

My wife went to the doctor recently for a test, and she received the “ole’ swap up the nose.” While the test came back negative. The doctor told my wife that COVID lives in the lungs and not the nasal cavity. Therefore, while her test was negative, it could be a false negative. If the doctor is correct, the real numbers of infected could be 10x higher. Such confirms a recent Reuters article:

“Government experts believe more than 20 million Americans could have contracted the coronavirus, 10-times more than official counts, indicating many people without symptoms have or have had the disease, senior administration officials said.

The estimate, from the Centers for Disease Control and Prevention, is based on serology testing used to determine the presence of antibodies that show whether an individual has had the disease, the officials said.”

If true, the ramifications could substantially impair the bullish thesis.

Timing Couldn’t Be Worse

Without a bill to extend more Federal Aid via Payroll Protection Programs and increased unemployment benefits, the ongoing restriction on trade will likely lead to a further surge in bankruptcies and layoffs.

“According to Bloomberg data, no less than 13 U.S. companies sought bankruptcy protection last week, matching the global financial crisis’s peak. The filings, led by the perennially weak consumer and energy sectors, were the most for any week since May 2009.”

There is a virtual spiral between job losses and bankruptcies. As more individuals lose their jobs, they have less to spend. Since consumption is what drives earnings for businesses, they have to lay off workers to stay in business. Pay attention to the “continuing claims,” which will tell the story of the economic recovery. (That doesn’t look like a “V”)

End Of The Quarter Rebalancing

There was one other factor which has weighed on stocks this past week, which was noted recently by Zerohedge:

“When adding all the other possible sources of the month- and quarter-end forced rebalancing, the total amount ‘for sale’ soars to an unprecedented $170 billion according to calculations by JPMorgan.

In the latest Flows and Liquidity report from JPM’s Nikolas Panagirtzoglou, writes that after correctly pointing out at the market lows on March 23rd that there is a massive $1.1 trillion in rebalancing flow into equities, all of that has since balanced out, and three months later, we are looking at a substantial outflow of about $170BN before month-end, resulting in a ‘small correction.'”

This rebalancing of portfolios was postponed by pension and mutual funds in March as they did not want to sell at market lows. That decision worked out well then, but now they need to rebalance portfolios by selling equities and buying bonds. We can see this action by looking at the performance between the S&P 500 index and Treasury Bonds over the last two weeks.

This rotation is either likely close to completion, or will complete early next week. As we stated previously, this is why we hedge our equity portfolios with fixed income. The risk offset reduces downside volatility and allows the portfolio to weather tough patches in the market.

With the market very oversold short-term, it would not be surprising to see a reasonably decent reflexive rally into the start of July. However, that rally will likely be an excellent opportunity to rebalance risk and rethink exposures accordingly.

Portfolio Positioning Update

As stated last week, with our portfolios almost entirely allocated towards equity risk in the short-term, we remain incredibly uncomfortable.

Our positioning in fixed income and gold has hedged the portfolio against the latest decline in the very short-term. Still, with the market getting very oversold short-term, as shown below, we expect a reflexive rally off of current support next week.

Most likely, we will use any counter-trend bounce to reduce equity risk a bit, rebalance exposures, and focus our attention on capital preservation for the next couple of months. With the virus resurfacing, the potential risk of disappointment to the earnings and economic recovery story has risen.

While it is easy for the mainstream media to write articles and post comments about the markets, it is an entirely different matter when you manage money. Currently, there is a battle raging between the fundamental and “hope” driven narratives.

On the one hand, it’s easy to see the fundamental problems in the market and the economy, which argues for much less risk exposure. However, on the other, you have the Fed and a Government, ready to throw money at, and “jawbone,” the markets at a moment’s notice.

Trying to navigate the two is like trying to thread a needle, in a moving car, on a bumpy road, with your eyes closed. Given we aren’t prescient, we will have to resign ourselves to doing the best job we can for our clients with the information we have available.

That is a fancy way of saying, “we are going to give it our best guess.”

The goal remains the same as always, protect our client’s capital, reduce risk, and try to come out on the other side in one piece.

Sometimes, however, it just gets messy.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


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 – Financials (XLF), Industrials (XLI), and Energy (XLE)

Last week, Financials moved into the improving quadrant of the rotation model, but will likely be short-lived. Recent moves by the Fed to cap buybacks and dividends may add to selling pressure. Materials and Industrial performance overall remains inadequate with a failure at the 200-dma. Energy is deeply oversold and is cheap on a value basis; we may look to add to our exposure again.

Current Positions: XLE

Outperforming – Materials (XLB), Technology (XLK), Discretionary (XLY), and Communications (XLC)

Discretionary, which had gotten very extended, and has corrected this past week. The sector has worked off some of the overbought conditions, so after discussing last week, a “correction” was possible, it has occurred. After suggesting profit-taking the previous week, the same for Communications, both sectors have had a sizable correction are now moving back to oversold. We may have a trading setup by next week. Technology did not correct much this past week and remains short-term overbought. The opportunity may be to reduce Technology and add to Communications and Discretionary.

Current Positions: XLC, XLK, XLC

Weakening – Healthcare (XLV)

Previously, we added to our core defensive positions Healthcare. We continue to hold Healthcare on a longer-term basis as it tends to outperform in tougher markets and hedges risk. Healthcare is now sitting on support and is getting decently oversold. We may see a counter-trend rally next week to rebalance.

Current Position: XLV

Lagging – Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Our defensive positioning in Staples, Real Estate, and Utilities has lagged but remains part of the “risk-off” rotation trade. We see early signs of improvement, suggesting it is the right place to be. If it turns up meaningfully, we will add to our current holdings.

Current Position: XLRE, XLU, & XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Two weeks ago, both of these markets were extremely overbought and susceptible to a pullback. Even with the pullback, neither market is oversold. Both markets are sitting on the last line of support. We maintain no holdings currently.

Current Position: None

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

Emerging and International Markets have performed better recently, and have not declined as much as the market. However, with the virus on the rise, there is a risk in these markets. Both of the markets are very overbought, so take profits and rebalance if needed. Pay attention to the dollar for your cue as to what to do next.

Current Position: None

S&P 500 Index (Core Holding)Given the broad market’s overall uncertainty, we previously closed out our long-term core holdings. We are currently using DIA as a “Rental Trade” to pick up some bulk exposure for trading purposes. We tripped our stop on Friday so we will sell the position on any rally next week.

Current Position: None

Gold (GLD) – We currently remain comfortable with our exposure through IAU.  Gold is a bit overbought short-term, so we are looking to potentially take some profits and look for a pullback to rebuild exposures.

Current Position: IAU, UUP

Bonds (TLT) –

As we have been increasing our “equity” exposure in portfolios, we have added more to our holding in TLT to improve our “risk” hedge. However, with yields so low, and with the Fed supporting the mortgage-back and corporate bond markets, we swapped our near zero-yielding short-term Treasury funds for Mortgage-Backed and Broad Market bond funds with 2.5% yields.  No change this week.

Current Positions: TLT, MBB, & AGG

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. Such is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)

Portfolio / Client Update

Let me reiterate what I wrote in the main body of this week’s newsletter as it specifically applies to you, our clients.

Most likely, we will use any counter-trend bounce to reduce equity risk a bit, rebalance exposures, and focus our attention on capital preservation for the next couple of months. With the virus resurfacing, the potential risk of disappointment to the earnings and economic recovery story has risen.

While it is easy for the mainstream media to write articles and post comments about the markets, it is an entirely different matter when you manage money. Currently, there is a battle raging between the fundamental and “hope” driven narratives.

On the one hand, it’s easy to see the fundamental problems in the market and the economy, which argues for much less risk exposure. However, on the other, you have the Fed and a Government, ready to throw money at, and “jawbone,” the markets at a moment’s notice.

Trying to navigate the two is like trying to thread a needle, in a moving car, on a bumpy road, with your eyes closed. Given we aren’t prescient, we will have to resign ourselves to doing the best job we can for our clients with the information we have available.

That is a fancy way of saying, “we are going to give it our best guess.”

The goal remains the same as always, protect our client’s capital, reduce risk, and try to come out on the other side in one piece.

Sometimes, however, it just gets messy.

Changes

We were a little early in both the ETF and EQUITY portfolios, adding back to our energy holdings after taking some gains at the recent peak. After rebalancing our bond holdings previously, TLT performed well in hedging risk this past week, as intended. 

With States now starting to reverse reopening procedures, we suspect we will hear something from the Fed next week about more liquidity, or increased interventions. Also, it will not be surprising to see a push by Congress to pass more stimulus very quickly, after all, an “election is a-comin'”

In the short-term, the markets are very oversold, so we will look for a counter-trend bounce to reduce some risk. We have a few positions such as RTX, NSC, and DIA, which violated our stop-levels on Friday, so we will use a bounce to reduce those positions specifically if needed.

In the meantime, we are doing our best to maintain some risk controls to avoid being forced to sell emotionally. In the meantime, please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only and should not be relied on 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 plan manager.

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

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

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

#MacroView: The Fed Has Inflated Another Asset Bubble

It didn’t take long. Over the last several years, we have discussed the risk of excessive monetary policy inflating a bubble in a variety of assets from debt, to real estate, to stocks. In March, it appeared as if the bubble had finally popped. However, the Fed’s quick response and massive monetary interventions ceased the asset bubble’s deflation and reinflated it.

Another Bubble

The idea of another bubble was put forth recently by Jeremy Grantham of GMO fame:

“At GMO, we dealt with three major events before this crisis, and rightly or wrongly, we felt ‘nearly certain’ that we would be right sooner or later. We exited Japan 100% in 1987 at 45x and watched it go to 65x (for a second, more significant than the U.S.) before a downward readjustment of 30 years and counting. In early 1998 we fought the Tech bubble from 21x (equal to the previous record high in 1929) to 35x before a 50% decline. Through 2007 we led our clients relatively painlessly through the housing bust. 

In all three, we felt we were nearly sure to be right. Japan, the Tech bubbles, and 1929, which sadly I missed, were not new types of events. They were merely extreme cases akin to South Sea Bubble investor euphoria and madness. The 2008 event was also easier if you focused on the U.S. housing euphoria, a 3-sigma, 100-year event, or, simply, unique. We calculated that a return trip to the old price trend and a typical overrun in those extreme house prices would remove $10 trillion of perceived wealth from U.S. consumers and guarantee the worst recession for decades. All these events echoed historical precedents. And from these precedents, we drew confidence.

But this event is unlike all those. It is new, and there can be no near certainties, merely strong possibilities. Such is why Ben Inker, our Head of Asset Allocation, is nervous. and this is why you are worried or should be.”

Don’t Blame The Pandemic

While much of the media points to the pandemic as the “cause” of the economic problems,  it isn’t.

COVID-19 was merely the “pin the pricked the bubble.” If the pre-pandemic economy were as strong as previously reported, it would have weathered the blow better. However, the 5-year average growth of wages, productivity, and real economic growth tells the story.

Consequently, the surge in the stock market over the last decade gave an “illusion” of prosperity, that “prosperity” was relegated to a relatively small portion of the broader economy. As noted recentlythe Fed’s policies are responsible for the “wealth gap.” 

“This isn’t surprising. A recent research report by BCA confirms one of the causes of the rising wealth gap in the U.S. The top-10% of income earners own 88% of the stock market, while the bottom-90% owns just 12%.”

George Floyd, Riots Across America Are About More Than George Floyd

, Fed Trying To Inflate A 4th Bubble To Fix The Third

Reliance On Debt To Solve A Debt Problem

The reliance on debt, or what the Austrians refer to as a “credit induced boom,” has reached its inevitable conclusion. The unsustainable credit-sourced boom, which led to artificially stimulated borrowing, created diminished investment opportunities. Those diminished investment opportunities lead to widespread malinvestments, which we saw play out “real-time” in subprime mortgages in 2008 and excessive “share buybacks” over the last few years.

Now companies are struggling to take on more debt just to survive the economic downturn. Even as balance sheets are levering up, stock buybacks, a main support of the stock market over the last decade, are dropping sharply.

The Problem Of Debt

Unfortunately, given the Fed stopped the “debt reversion process” with the latest rounds of monetary interventions, nearly $4.00 of debt are required to create $1 of economic growth. This all but guarantees that future economic growth will be further retarded.

Such is a point made previously:

“Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.”

“The ‘COVID-19’ crisis led to a debt surge to new highs. Such will result in a retardation of economic growth to 1.5% or less. While the stock market may rise due to the Fed, only the 10% of the population owning 88% of the market will benefit. Going forward, the economic bifurcation will deepen to the point where 5% of the population owns virtually all of it.

That is not economic prosperity. It is a distortion of economics.

, Fed Trying To Inflate A 4th Bubble To Fix The Third

Bubbles, Bubbles, Bubbles

Jerome Powell clearly understands this risk. After a decade of monetary infusions and low interest rates, the Fed has created the largest asset bubble in history. However, trapped by their own policies, any reversal leads to almost immediate catastrophe as seen in 2018, and again in 2020.

As previously stated:

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s.”

, Fed Trying To Inflate A 4th Bubble To Fix The Third

Not surprisingly, after the market correction in March, the immediate response stopped the correction from becoming a full-fledged bear market. However, this only forestalled the inevitable as we have seen a sharp rise in “speculative fervor” ever since. Investors, and the financial media, continue to assume there is investment risk due to the Fed. To quote Dr. Irving Fisher:

“Stocks have reached a permanently high plateau.”

Instability

It is imperative for the Fed that market participants, and consumers, “believe” in their actions. With the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” remains the most significant risk.

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

The Fed had hoped they would have time, after a decade of the most unprecedented monetary policy program in U.S. history, to navigate the risks built up in the system. Unfortunately, they ran out of time, and the markets stopped “acting rationally.”

By not letting the system correct, letting weak fail, and allowing valuations to revert, the Fed has trapped itself into an even bigger bubble. One way to view this problem is by looking at the Nasdaq 100 versus the S&P 500 index. That ratio is now at the highest level ever.

Furthermore, that rise was not a function of a broad number of companies participating due to stronger economic growth and profits, but rather just 5-companies driving the surge.

If you don’t think this is important, I suggest you re-read Bob Farrell’s Rule #7:

Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”

, Fed Trying To Inflate A 4th Bubble To Fix The Third

Bubbles Aren’t About Price

“Market bubbles have NOTHING to do with valuations or fundamentals.”

As we discussed last week, the market is now trading nearly 90% above multiple long-term valuation measures.

“One thing I had hoped for in 2018-2019 is a correction large enough to revert some of the excessive valuation levels which existed. Such would provide higher future returns over the next decade. Such would allow investors to reach their investment goals.

Instead, the Fed’s actions halted the correction. Subsequently, the ‘clearing process’ was not allowed to occur. The outcome has been increased levels of corporate leverage, and valuations remain grossly elevated on many different levels.”

fully invested bears, Technically Speaking: Unicorns, Rainbows, &#038; Fully Invested Bears

Since stock market “bubbles” are a reflection of speculation, greed, emotional biases, valuations are only a reflection of those emotions.

It’s Elementary

Bubbles can exist even at times when valuations and fundamentals might argue otherwise. Let’s look at an elementary example. The chart below is the long-term valuation of the S&P 500 going back to 1871.

, Market Bubbles: It&#8217;s Not The Price, It&#8217;s The Mentality.

Notice that except for 1929, 2000, and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently. 

Secondly, market crashes have been the result of things unrelated to valuation levels. Such as liquidity issues, government actions, monetary policy mistakes, recessions, and inflationary spike, or even a “pandemic.” Those events were the catalyst, or trigger, which started the “reversion in sentiment” by investors.

Market crashes are an “emotionally” driven imbalance in supply and demand. Such has nothing to do with fundamentals. It is strictly an emotional panic, which is ultimately reflected by a sharp devaluation in market fundamentals.

That is what started in March.

The Fed’s actions have only temporarily halted its inevitable completion.

, Fed Trying To Inflate A 4th Bubble To Fix The Third

The 4th-Bubble

Our previous prediction:

“The current belief is the Fed will implement QE at the first hint of a more protracted downturn in the market. However, as suggested by the Fed, QE will likely only be employed when rate reductions aren’t enough.”

Credit markets’ implosion made rate reductions completely ineffective and has pushed the Fed into the most extreme monetary policy bailout in the history of the world.

So far, the Fed was able to inflate another asset bubble to restore consumer confidence and stabilize the credit market’s functioning. The problem is that since the Fed never unwound their previous policies, current policies are likely to have a more muted long-term effect.

However, with 50+ million unemployed, wage growth declining, bankruptcies on the rise, and banks tightening lending standards, the Fed’s attempt to inflate another bubble to offset the damage from the deflation of the last bubble, will likely not work.

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade. There is little evidence that growth will recover following this crisis to the degree many anticipate.

Problems QE Can’t Fix

There are numerous problems which the Fed’s current policies can not fix:

  • A decline in savings rates
  • Aging demographics
  • Heavily indebted economy
  • Decline in exports
  • Slowing domestic economic growth rates.
  • Underemployed younger demographic.
  • Inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases

The lynchpin in the U.S., remains demographics, and interest rates. As the aging population grows, they are becoming a net drag on “savings,” the dependency on the “social welfare net” will explode as employment and economic stability plummets, and the “pension problem” has yet to be realized.

While the current surge in QE has been successful in inflating another bubble, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. There are only so many autos, houses, etc., that consumers can purchase within a given cycle. 

Unfortunately, extremely high levels of unemployment, lack of incomes, and a slow economic recovery will likely undermine those hopes.

One thing is for certain. The Federal Reserve will never be able to raise rates or reduce monetary policy ever again.

The only question is, what will the Fed do if “all the king’s men can’t put Humpty Dumpty back together again?”

#WhatYouMissed On RIA This Week: 06-26-20

What You Missed On RIA This Week.

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

Here is this week’s rundown of what you missed. A collection of our best thoughts on investing, retirement, markets, and your money.

Webinar: Candid Coffee

After our recent “Great Reset” webinar there were so many questions, we couldn’t get to them all. Candid Coffee is an upcoming series of events specifically designed to answer YOUR questions.

Got a question you want us to answer? CLICK HERE

Join Us: Saturday, June 27th from 8-9 am.

The Week In Blogs

Each week, the entire team at RIA publishes the research and thoughts which drive the portfolio management strategy for our clients. The important focus are the risks which may negatively impact our client’s capital. If you missed our blogs last week, these are the risks we are focusing on now.

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Our Latest Newsletter

Each week, our newsletter covers important topics, events, and how the market finished up the week. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how to trade it.

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What You Missed: RIA Pro On Investing

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

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The Best Of “The Real Investment Show”

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

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What You Missed: Video Of The Week

Interview With Jim Mosquera

Jim and I dig deep into the economy, potential outcomes from excessive monetary policy, and the issue of “Escaping Oz.”

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What You Missed: Our Best Tweets

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. Here are a few from this past week that we thought you would enjoy. Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Relative Value Report 6/25/2020

Relative Value Report 6/25/2020

This week’s report uses data through Wednesday’s closes instead of Thursday. 

The Relative Value Report provides guidance on which sectors, indexes, and bond classes are likely to outperform or underperform its appropriate benchmark.

Click on the Users Guide for details on the model’s relative value calculations as well as guidance on how to read the model’s graphs. 

This report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary

  • Most sectors continue to sit around fair value versus the S&P. The outliers are Healthcare, which remains the most oversold sector, and Discretionary and Tech, which moved to overbought this past week.
  • Emerging Markets are now well into overbought territory and joined to a lesser degree by Foreign Developed markets and the NASDAQ.
  • Value versus Growth is the only oversold market sector.
  • Mortgages are the only oversold fixed income sector. Despite the Fed’s massive QE efforts, the spread of MBS to U.S. Treasuries has been widening. We included a graph below to provide context for the spread.
  • The other fixed-income sectors, including TLT, are close to fair value versus their appropriate benchmark.
  • The R-squared on the sigma/20 day excess return (Sectors) scatter plot improved to .7779.  The high correlation represents a sharp improvement versus the prior few weeks.
Image

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

Seth Levine: Emergencies May Cause Strange Market Behavior

Emergencies may cause strange market behavior. 2020 is certainly not shaping up to be the year I had hoped for. Like many, I was optimistic at the start. I underwent some major surgery late last year and 2020 was going to be “my year.” Boy did those plans derail quickly. In the blink of an eye, the coronavirus (COVID) escalated from a mystery-meat sideshow to a full-blown economic crisis. Suddenly, we investors faced the realities of investing during an emergency. However, you’d hardly know it by the look of today’s markets. Was COVID just a blip or could they be reflective of investing during an emergency?

Emergencies are Abnormal

Emergencies are not normal situations. They are discreet intervals of time characterized by extreme living conditions, distinct from “normal.” Survival is the singular focus. Escape danger. Nothing else matters. As a result, emergencies compress time horizons to the immediate future. There is no concern for the long term; that must wait.

It is important to differentiate between the rules of conduct in an emergency situation and the rules of conduct in the normal conditions of human existence. This does not mean a double standard of morality: the standard and the basic principles remain the same, but their application to either case requires precise definitions.

An emergency is an unchosen, unexpected event, limited in time, that creates conditions under which human survival is impossible—such as a flood, an earthquake, a fire, a shipwreck. In an emergency situation, men’s primary goal is to combat the disaster, escape the danger and restore normal conditions (to reach dry land, to put out the fire, etc.). … By its nature, an emergency situation is temporary; if it were to last, men would perish.

Ayn Rand, The Ethics of Emergencies

As a consequence, emergencies necessitate behavior that would be strange under normal circumstances. For instance, you actually might run into a burning building to save your trapped child; sheer insanity otherwise. Perhaps emergencies create similarly strange investment behavior.

The COVID Emergency

COVID quickly escalated into an emergency. Rightly or wrongly so, governments forcefully reacted to the virus’s spread. By decree, entire economies throughout the world were locked down. It’s truly an unprecedented event.

As a result, investment markets burst into panic: VIX, rates, credit, stocks, loans, high yield, the dollar, you name it. The message was loud and clear to anyone with half a pulse: An economic crisis arrived. Dutifully, the Federal Reserve and other central banks sprang into action. They introduced even more “creative” emergency measures, the magnitudes of which make Quantitative Easing look like a capitalist utopia.

The US stock and high yield credit markets fell sharply in March (S&P 500 and HYG, respectively) as VIX exploded.
Source: TradingView.com

The COVID Crazies

The selloff’s size, speed, and intensity were unlike anything I’ve experienced in my career, which spans the Great Financial Crisis. However, as of this writing, most markets retraced their initial declines. What gives? I thought risk assets fell during economic turmoils. Is the commercial environment not in shambles?

The S&P 500, HYG (US high yield ETF), and VIX retraced much of their March declines
Source: TradingView.com

Maybe markets simply overreacted to the emergency. After all, investors only care about the short term, right (some sarcasm for those playing at home)? Or perhaps they’re playing long ball and pricing in the next bull run? Ah, the central bankers saved us again, right? What if we’ve simply all gone mad?!

The Two Phases of COVID

The contrast between market and economic performance could not be more stark. To me, though, this is a clue. Perhaps my beliefs of how stocks relate to the economy require updating. The market simply is (a “metaphysically given”). Since contradictions don’t exist, I must question their occurrences in order to dispassionately assess if the trend will continue or reverse … as hard as it may be.

My working assumption is that we’re in a two-phased environment. Phase 1 is the COVID lockdown. It is an emergency. Phase 2 is life after COVID; when the emergency ends and we start to assess the structural changes that COVID will effect and accelerate. In my view, the longer Phase 1, the deeper the changes in Phase 2.

A Literal Relief Rally

Separating the current events into two distinct phases brought me some clarity. It allowed me to think about both the short and long term impacts of COIVD. Characterizing the former as an emergency helps contextualize the markets. Obviously, emergency situations are incredibly bad. Thus, their ends are decisively positive. Might this be a literal relief rally as the the emergency phase draws to an end?

The Path Forward

If this framework is correct (a big if), it raises the question: What’s next? If the recent market rallies reflect the end of the COVID emergency, then their next moves should depend upon Phase 2. Thus, the trajectory of the economic and capital markets recoveries should now come into focus. Are they shaped like an L, W, V, U, X, Y, Z, etc.? Is the stock market a reflection of the economy or are bonds telling us something? What about capital flows; to where will they go? Will passive investing’s dominance continue?

These are the questions I’m asking myself. Unfortunately for the reader, I offer no answers. This website is devoted to frameworks, not trade ideas. That said, my hope is that separating the market moves into discrete phases will help me (well, us) think through the possible trajectories.

Is Emergency Investing Abnormal?

We do strange things in emergencies because our priorities change. Time horizons compress to the immediate future. Long term thinking is simply not possible in emergencies.

What holds for emergencies in “real life” might also hold for investing. Goals may be simplified to capital preservation, cutting poor risks from portfolios, or even doing nothing (i.e. sheltering in place). It is only when the emergency ends when normal investing behavior can resume.

Is this framework merely a rationalization; confirmation bias? Or does it have some explanatory power? It’s impossible to know now or to test in a blog post; strong views held loosely, always. However, one thing is certain: We’ll know more when the emergency’s over.

Robertson: Is It Time To Retire The 60/40 Portfolio?

Is it time to retire the 60/40 portfolio?

If ever there was a mantra in the investment world, it is that you have to diversify. Everyone knows that combining uncorrelated assets into a portfolio reduces the risk of destructive drawdowns. For several decades now, the iconic way to realize diversification in investment portfolios has been through a balance of 60% stocks and 40% bonds (60/40).

This approach has worked brilliantly and has allowed countless investors to sit back and watch their retirement dreams come true comfortably. Unfortunately, those halcyon days are coming to a close. It is time for investors to start considering alternative ways to balance their portfolios.

The 60/40 Model Worked

There is no doubt that the 60/40 model has worked. Phil Lynch of Russell Investments, for example, shows that between 1926 and 2019, “a balanced 60/40 global stock/bond portfolio has provided competitive returns …” According to investment bank Goldman Sachs, the Financial Times adds: “A US 60-40 portfolio in the decade to 2020 produced its highest volatility-adjusted returns in over a century.”

There is a caveat, however, and it is one that many providers of investment services use to make a point. Those attractive returns have only been “for investors who stay invested during turbulent markets.” The message is that if you even so much as think about getting out of the market, you risk forfeiting handsome returns.

It is not good to jump out of the market at just any little hint of turbulence. But nor is it a good idea to assume that the landscape never changes and that risk and reward are static. Indeed, a great deal of evidence is accruing that now is precisely the time investors and advisors should be carefully re-assessing the strengths and weaknesses of the 60/40 strategy.

For starters, the historical performance of the 60/40 portfolio is considerably less robust than it first appears. Chris Cole from Artemis Capital Management points this out in a terrific piece of research entitled The Allegory of the Hawk and Serpent (h/t Grants Interest Rate Observer). He highlights: 

“A remarkable 91% of the price appreciation for a Classic Equity and Bond Portfolio (60/40) over the past 90 years comes from just 22 years between 1984 and 2007.” 

In other words, the performance for other periods was much less impressive.

The Cracks Appear

Also, further cracks in the case for the 60/40 appeared earlier this year. According to the FT“the 60-40 strategy suffered one of its worst performances since the 1960s, as the bond rally proved insufficient to offset the tumble in stocks.” 

While instances of bad performance happen, and stocks were undoubtedly part of the problem, it was especially unsettling that bonds did not do their job this time.

The monetary policy response to Covid-19 in the first quarter also exacerbated challenges. The FT added: 

“Covid-19 has brought us to a historic turning point in financial markets. A fundamental investment strategy that has protected institutional and retail investors alike for decades — balancing equity risk by holding high-quality government bonds — has finally run its course. When the Fed lowered short-term rates to zero in response to the pandemic, the last shoe dropped.”

In retrospect, it is easy to see why bonds provided such a powerful combination with stocks. Not only did investors receive insurance in the form of diversification benefits, but they also got paid for having that insurance by receiving coupons. It was one of the scarce instances in which investors got to have their cake and eat it too.

That blissful situation has changed, however, and the FT goes on to describe how:

“Now that double benefit has turned into double jeopardy. As main central banks have lowered interest rates towards zero over the past decade, the yield component of the return on a portfolio of government bonds has evaporated. That leaves capital appreciation as the sole source of future returns. But the room for prices to rise has arguably all but disappeared too.”

Investors must now face the music. Their beloved and productive 60/40 strategy can no longer accomplish what it has achieved for so long. It will be missed.

“For investors who hold the classic 60/40 portfolio, this is a disaster. They have lost a reliable source of return, and their diversification strategy is broken.”

The Quandary

This difficulty is raising questions by investors of all types. Rusty Guinn from Epsilon Theory reports, “What is fascinating to me is that within a week, a professional market research shop, a personal finance writer and a financial markets journalist all took on the question of ‘the role of bonds’.”

“But I can observe that enough people are thinking about it – and enough people know that other people are thinking about it – that common knowledge is forming around the question.”

In other words, the issue of the role of bonds is becoming a thing. It is undoubtedly a thing among fund managers as the FT notes:

“Investors are now grappling with the implications. In Bank of America’s investor survey in March, 52 percent of fund managers said that US government bonds were the best hedge against turmoil. That share dropped to 22 percent in April.”

The Role Of Bonds

The fact the industry is discussing the role of bonds is good news in the sense that the industry is adapting. However, it also means that if you are not working through these things yourself, you fall behind the curve.

More is needed than just discussion though. Identifying specific alternatives to take the place of the diversifying role of bonds. The FT offers some suggestions, some of which are simple and some of which are a lot more complicated:

“In seeking new sources of ballast for balanced portfolios, asset allocators will have to think about alternatives to bonds, including cash, gold, cryptocurrencies, and explicit volatility strategies — such as put options directly hedging equities — with which they may be less familiar. There are pros and cons to each selection, but the key point is that, with the diversifying power of bonds gone, there is no longer any natural choice.”

These ideas are extremely helpful in framing out possible replacements for bonds in balanced portfolios. Managing expectations is important. These replacements are unlikely to provide the same types of returns that bonds have, but they are less likely to offer the same diversifying effect as bonds have. On top of all that, some of these options are unfamiliar and uncomfortable for some investors. 

The Days Are Numbered

While the days of the 60/40 strategy are numbered, the more general lesson to keep in mind is that things always change. Therefore, it is important to remain flexible and open-minded to deal productively with those changes. As John Hussman explains, these traits are likely to be extremely important in dealing with investment challenges ahead:

“That ability to respond to changing market conditions in a disciplined way is the one thing that passive buy-and-hold investors don’t have. I strongly believe that it’s the primary factor that will determine investment success over the coming decade. Lacking a flexible discipline, my view is that passive investors are doomed to go nowhere in an interesting way over the coming 10-12 year horizon.”

So, it’s never easy to replace something that has worked well for a long time. In this sense, replacing the 60/40 strategy is like bidding farewell to a retiring star athlete. We can all remember and respect the terrific accomplishments of the past and recognize that younger players are now more capable of competing at the highest level. Overly sentimental attachments will prevent progress; it is best to make the change and move forward.

As Yields Approach The Zero Bound – There Is Nowhere To Hide

Years of monetary policy which has consistently driven yields lower, along with economic growth, have now left investors nowhere to hide from risk.

The graph above shows how many basis points benchmark U.S. Treasury securities are from their record lows. The table below the chart provides possible return scenarios if those bonds fall back to those records.

As you can see, the potential upside in most Treasury bonds is marginal at best.

Do portfolio managers understand the repercussions of such a return outlook? Simply, there is nowhere to hide.

Traditional Portfolio Management

Many individual and institutional portfolios have allocations to stocks and bonds. For some investors, the ratio of stocks to bonds is static. For others, it vacillates based on risk preferences and market conditions. In any case, investment advisors, pension funds, and endowments, a required allocation to bonds is both an intuitive response and a matter of legal requirement.

Ballast

Bonds play an important role in portfolio management because they provide ballast to the risk exposure of equity markets. In the prior two bear markets, diversification using bonds proved very useful. In Greater Fool Bonds we wrote the following:

“Going back to what we described above as a balanced portfolio, investors benefited greatly during bear markets from the allocation to bonds in a simple 60/40 strategy (S&P/UST). For purposes of simplicity, we assume the full 40% allocation of bonds was in 10-year U.S. Treasuries. In most cases, investors would use other high quality fixed income categories such as mortgages and investment-grade corporates as well as a range of various maturities such as 2-year, 5-year, and 10-years.

The following analysis shows how allocations to bonds helped limit downside in the last two equity bear markets.

  • From September 2007 through March 2009, a simple 60/40 (S&P 500/7-10 Yr. UST) portfolio returned -23.92%. An all-stock portfolio returned -45.76%. The 40% allocation to bonds reduced losses by 21.84%.
  • From January 2000 through September 2002, a simple 60/40 (S&P 500/7-10 Yr. UST) portfolio returned –16.41%. An all-stock portfolio would have returned -42.46%. The 40% allocation to bonds reduced losses by 26.05%.

Heading into the two bear markets mentioned above, the 12-month average yield on ten-year U.S. Treasury bonds was 6.66% in 2000 and 4.52% in late 2007. At their lows, the yields fell to 3.87% and 2.43% for 2002 and 2008, respectively.”

A cursory glance at current yields highlights that those benefits are no longer available.

Floored Yields

Back to our lead graph. Holding U.S. Treasuries maturing in ten years or less is likely to provide no price appreciation if yields fall to their record lows. If that’s the case, and given such low yields, those bonds are essentially cash surrogates with outsized risks.

The question for those bondholders is, why hold such bonds? Given the yields are not much above cash yields, they must believe rates can drop to new records. If they did not think that, why not just hold cash?

There are likely two factors that would lead to lower rates for the full maturity spectrum of Treasury yields.

  1. Deflation kicks in, boosting real yields, which entices investors to buy bonds.
  2. The Fed shows intent to reduce Fed Funds into negative territory.

Deflation?

Currently, inflation expectations are reduced from prior-year levels but are ticking up gradually and still well above zero. It is reasonable expectations fall if the recovery proves elusive.

Contrary, the Fed seems more than willing to push unlimited amounts of monetary stimulus until inflation is running hot. That potentially raises other problems. As the saying goes, “you can’t put a saddle on a mustang.”

Negative Rates?

Most Fed speakers, including Jerome Powell, have come out against negative rates. They seem to have noticed that such policy has damaged European and Japanese banks. The banks own the Fed, and therefore it’s reasonable to assume they will not repeat the mistakes by the other central banks.

“There’s no clear finding that it (negative rates) actually does support economic activity on net, and it introduces distortions into the financial system, which I think offset that,” Powell said. “There’re plenty of people who think negative interest rates are a good policy. But we don’t really think so at the Federal Reserve.” -Jerome Powell on 60 Minutes 5/18/2020

We certainly do not rule out negative rates but believe QE is the Fed’s preferred option.

Hedging with Bonds

While the inflation outlook and the Fed’s perspective can change, it appears yields may be at a floor. Based on the table, 30-year Treasury bonds can provide a 10% return if they decline to record low yields. Every other maturity, assuming the floor holds, will deliver cash-like returns in a best-case scenario.

Whether they know it or not, balanced portfolio managers are in quite a quandary. Will they consider Treasury notes with meager yields and little upside an equity hedge? Are they willing to hold higher duration price-sensitive bonds with limited upside as a hedge?

The benefits of hedging with bonds have certainly changed from years past. It seems unlikely that a 40% allocation of bonds can provide 20-25% downside protection, as was the case in the prior two recessions.

Other Bond Asset Classes

Investment-grade corporate bonds and mortgage-backed securities may also offset equity exposure. The benefit versus Treasuries is they provide a little more yield. The cost for the higher yield are additional risks. Credit spreads on such instruments have a habit of rising at the most inopportune times.

The Fed is actively buying those sectors and not allowing risk to be priced correctly. Accordingly, those risks are minimal for now. We caution, however, the risk is higher for individual securities versus funds and ETFs representing those sectors.

Corporate and mortgage bonds offer some additional upside if their respective spreads return to their record lows. For reasons described above, that incremental benefit is limited though.  

Seeking Balance

If “balanced” portfolios are no longer balanced, what is a manager to do?

For starters, they can look for alternative securities such as commodities, precious metals, preferred stocks, and convertible bonds. Those assets and a host of others are not as common or liquid but offer diversification benefits.

Second, and equally difficult for most money managers, they can hedge equities with equities. This strategy may include options, short positions, and volatility strategies.

They may also tactically position equities by reducing or adding equity exposure to manage risks.

Further, managers can actively rotate between companies and sectors to navigate their exposure. 

The bottom line is the market is not providing the balance it used to, and investors will have to compensate in other ways. The sooner they figure this out, the better prepared they will be.

Summary

The new rate environment poses significant problems for passive balanced investors.  Gone are the days when these portfolios self-balance during drawdowns and perform admirably in upturns.

They need to adopt new tools and change in ways to which they are not accustomed.

The traditional balance portfolio management box is broken, so investors better quickly start thinking outside of it.

The biggest concern is that most managers, so accustomed to the ease of 60-40 investing, do not recognize the emergence of this problem.

TPA Analytics: The Resilience Of Stocks Explained

THE RESILIENCE OF STOCKS EXPLAINED

Like many market strategists, TPA has been puzzled as to how stocks are managing to maintain their rally, while unemployment stays high, the economy slips into a recession, businesses (public and private, large and small) continue to lose money, and Covid-19 new cases continue to climb. The first chart below shows how the U.S. has not managed the Pandemic nearly as well as the EU, yet it continues to outperform most other stock markets.

The table that follows from RealInvestmentAdvice shows how the S&P500 benchmark index is now trading at historical valuations. Finally, a chart of the percentage of non-earning companies in the Russell 2000 shows that we are at levels previously associated with real pain in stocks

Read more about these charts here.

TPA believes that divergence between the state of things and the stock market can be explained by looking at the people who own stocks and the people who have been most affected by the current crisis.

In 2018, the New York Times stated,

“A whopping 84 percent of all stocks owned by Americans belong to the wealthiest 10 percent of households. And that includes everyone’s stakes in pension plans, 401(k)’s and individual retirement accounts, as well as trust funds, mutual funds and college savings programs like 529 plans.”

Charting the U.S. stock market versus the U.S. economy over the long-term reveals that eventually the equity markets follow the economy, but in the short term stocks will not fall if the holder of stocks do not sell.

So, the question is “Why haven’t investors sold stocks?”

The question can be answered by examing a recent STUDY by written about in Planet Money entitled “Rich People, Please Spend Your Money Again”.

The article is based on a recent ground-breaking STUDY by economists led by Harvard’s Raj Chetty. The study shows that the poor have been disproportionately affected by the crisis since they work in service jobs, live in urban areas, and are less likely to work from home. On the other hand, the wealthy are more likely to work from home, live in less dense areas, and be less affected by Covid-19.

  1. Covid-19 affected the poor and urban areas to a far greater extent than the rich and people in less dense areas. The poor experienced the lion share of the layoffs
  2. The government’s rescue measures did not have a lasting positive effect on small businesses. Again, this hurts the poor.
  3. Speeding up reopening also did not improve the economic conditions of the less wealthy.

This recession has been driven by a decline in service where face-to-face contact is required and these spending declines were far greater in rich neighborhoods.

“First up, consumer spending. Typically, Chetty said, recessions are driven by a drop in spending on durable goods, like refrigerators, automobiles, and computers. This recession is different. It’s driven primarily by a decline in spending at restaurants, hotels, bars, and other service establishments that require in-person contact. We kinda already knew that. But what their data shows is this decline in spending is mostly in rich zip codes, whose businesses saw a 70% drop off in their revenue. That compares to a 30% drop in revenue for businesses in poorer zip codes.”

The layoffs in rich neighborhoods has been far greater than the pain felt in poorer neighborhoods.

“Second, jobs. This 70% fall in revenue at businesses in rich zip codes led them to lay off nearly 70% of their employees. These are mostly low-wage workers. Businesses in poorer zip codes laid off about 30% of their employees. The bottom line, Chetty said in his presentation, is that “reductions in spending by the rich have led to loss in jobs mostly for low-income individuals working in affluent areas.”

The government rescue effort did not improve the fortunes of small businesses.

“Third, the government rescue effort. They find it’s mostly failed. The $500 billion Payroll Protection Program, which has given forgivable loans to businesses with fewer than 500 employees, doesn’t appear to have done much to save jobs. When the researchers compare the employment trends of businesses with fewer than 500 employees to those with more, the smaller businesses eligible for PPP don’t see a relative boost after the program went into effect.

It looks like the program didn’t do its job of saving jobs. Meanwhile, the stimulus checks, while increasing spending, did not have much stimulative effect because the spending mostly flowed to big companies like Amazon and Walmart. The money didn’t flow to the rich zip code, in-person service businesses most affected by the downturn. Overall, the federal rescue package, they find, has failed to rescue the businesses and jobs getting hammered most by the pandemic.”

State ordered reopenings did not increase economic activity.

“Finally, there’s state-ordered reopenings: they don’t seem to boost the economy either. They compare, for example, Minnesota and Wisconsin. Minnesota ordered “reopening” weeks before Wisconsin, but if you look at spending patterns in both two states, Minnesota did not see any boost compared to Wisconsin after it reopened. “The fundamental reason that people seem to be spending less is not because of state-imposed restrictions,” Chetty said. “It’s because high-income folks are able to work remotely, are choosing to self isolate, and are being cautious given health concerns. And unless you fundamentally address that concern, I think there’s limited capacity to restart the economy.”

TPA provides and briefly discusses some of the charts from the STUDY below:

Spending on high ticket items like pools and landscaping has barely budged during the Pandemic, while industries like restaurants, airlines, and barber shops have been decimated.

Unemployment for low wage earners has been much worse than for the population as a whole.

Change in business revenue directly correlates to the wealth and the density of neighborhoods.

Lower-income people were far more likely to be forced to venture from their homes.

The spending changes for durables, non-durables, and services show a stark difference between 2008 and 2020. Although spending for durables and non-durables took a big hit in 2008, services have borne the brunt of the pain due to Covid-19.

The real pain of Covid-19 has so far been felt by average and poor citizens. On average, wealthier people, who are the owners of stocks, have been able to work from home and have continued to spend on things that did not require putting themselves at risk. Until the pain is felt by a broader and richer part of the population, the markets can continue to hang on; possibly ignoring the obvious fundamental issues.


Oil Gas E&P, TPA Analytics: It&#8217;s Time To Sell Oil &#038; Gas E&#038;P Stocks

We Are In The Winter of Household Finances.

We are in the winter of household finances. The “Fourth Turning” is upon us, as we explore how to navigate an uncertain future and maintain financial stability.

To everything there is a season and a time to every purpose under the heaven. – Ecclesiastes 3.

William Strauss’ and Neil Howe’s seminal tome – The Fourth Turning: An American Prophecy – What the Cycles of History Tell Us About America’s Next Rendezvous with Destiny – is a popular read among the RIA Advisor team. We reference it often, especially as the premise of The Fourth Turning grows increasingly prevalent.

As there are seasons to life, there are periods of heat and freeze to a culture – eras of discovery, turmoil, tranquility, war. Winter is the powderkeg. The cold front began in 2007. At grassroots levels, we must prepare for the coldest of seasons to follow that will last through 2030.

Households must gain a renewed level of resolve and prepare financially for a harsh cycle. The wheels of cultures turn from ‘Crisis’ to ‘Awakening’ and back again to ‘Crisis,’ with astounding regularity.  A new round of time doesn’t fade into the good night. On the contrary: Sharp breaks or razors of transition are common as cultures traverse seasons of time.

Although the penning of this book was in 1997, it eerily predicts the events we witness today. The current turmoil isn’t unusual. Over the last five centuries, Anglo-American society has entered a new era or turning approximately every two decades. At the start of each turn, people change how they feel about everything – themselves, the future, the very foundation of the nation.

The Fourth Turning

Each turn spans eighty to one hundred years and represents a seasonal rhythm of growth, maturation, entropy, and destruction. The Fourth Turning is Crisis, an era of secular upheaval where the old civic order replaces the new. Winter is history’s greatest break between one season and another. 

Previous estimates suggested winter would start around 2005 when remnants of the old social order would disintegrate, political and economic trust would implode. Severe distress would ignite questions of class, race, nation and empire. Americans would share a regret about recent mistakes and correct them, although harshly. I believe winter began with the Great Recession in 2007. The authors’ estimation is not far off.

The survival of the nation will feel at stake. Per the book, before the year 2025, America will pass through a great historical gate commensurate with the American Revolution, Civil War, and twin emergencies of the Great Depression and World War II.  

In ‘Crisis,’ the risk of catastrophe is high. A nation in ‘Crisis’ can ignite into insurrection or civil violence, break apart geographically or succumb to authoritarian rule. If  war arises, it will be total and all consuming. It will ratchet up the willingness to use greater technologies of destruction. 

Winter Of Finances

Winter has formed.  The great wealth and income inequalities are fueled by Central Bank policies coupled with structural publicly-traded corporate actions of malinvestment. These initiatives placed employee wage and career growth on the backburner for decades. 

In 2009, I was extremely worried how unrest would grow strong if nothing changed. Many of the issues that concern me began as early as the late 1980s. They accelerated post-Great Recession. Close to 50% of households have never recovered financially.

Chart courtesy of the Niskanen Center. 

The Great Divide

I’ve been impressed with overall analysis by the Niskanen Center. Their recent commentary – How Fragility of Household Wealth Threatens the Economic Recovery, is worth a read. Lance Roberts has written of this topic, extensively. 

Keep in mind, the stock market isn’t the economy. Per Federal Reserve analysis, the wealthiest 10% of U.S. households own close to 90% of all stocks and mutual funds. Less than 50% of families who lost a job due to the pandemic, can raise $400 bucks in an emergency. 

I want to make sure your family’s finances survive. Many advisors will remain complacent. Not our style. The design of the next war plan will require hours spent at dining room tables where revolutionary ideas are forged and followed.  

I am certain the majority of readers of RIA have already considered additional, even unconventional, household finance austerity measures. If so, please communicate your habits, share the following ideas with loved ones and friends who may not be as disciplined:

A Revolution & Revitalization Of Household Finances

So, have you scheduled your colonoscopy? How’s the diet going? How much weight have you lost? How many hours of sleep do you get a night? Welcome to client/advisor conversations of the future. And the future is now.

It’s easy to comprehend how unhealthy people accumulate less wealth, may be forced to retire sooner and suffer shorter life expectancies. If anything, being unhealthy in retirement even if one has the finances, makes for an emotionally challenging existence.

Based on COVID, we have yet to estimate the long-term costs to Medicare and Medicaid as workers retire sooner which portends to continued above-average inflation, possibly close to 7% for Medicare Part B premiums, Medigap supplemental coverage and Medicare Advantage. As advisors, our group is increasingly vigilant when it comes to monitoring of information that requires us to alter our inflation estimates for financial plans.

The Financial Cost Of Being Unhealthy

According to De Nardi, Pashchenko and Porapakkarm authors of NBER Working Paper 23963 The Lifetime Costs of Bad Health, unhealthy people accumulate substantially less wealth than healthy people. Among 65-year-old males with a high-school degree, the median wealth of healthy individuals is almost twice that of those who are unhealthy – $230,000 vs. $120,000 in 2015 dollars.

Per Fidelity Investments, the average couple will spend a total $280,000 in today’s dollars for medical expenses throughout retirement not including long-term care. In retirement, I’ve witnessed unhealthy couples spend close to half of their annual income on healthcare costs which includes Medicare premiums plus out-of-pocket costs. I’ve seen their annual inflation rates hit close to 6% and the quality of their retirements deteriorate.

For me, it was a wake-up call to make dramatic improvements to my health habits over three years ago. I don’t want a retirement, especially if I need to continue to work saddled by poor health. Nor do I want to witness clients go through a lifetime of hard work just to face a poor-quality retirement. 

Start With The Basics

You can make dramatic improvements to battle the top 3-most common health issues we face in America: Lack of physical activity, being overweight or obese, and tobacco usage. Improvements in these areas are squarely in your control. Like a financial discipline to pay yourself first, small, steady improvements over the years can lead to big results.

When people come to me to help analyze their spending habits and create a budget, I make sure to discuss the importance of additional spending on high-quality, unprocessed foods. Many seek to cut the gym expense. I outline the importance of continuing the membership. I look for ways for people to invest in a personal trainer and possibly a nutritionist to hold them accountable.

A Mental Trick

 I created a mental trick that helps keep my long-term financial and physical health on the right track and at the forefront of my thoughts. Before I indulge in an activity, I mentally increase or reduce my retirement savings by $100. For example, if I trade out a burger and fries for a salad, I add $100. If I’m about ready to indulge in something unhealthy or miss a workout, I subtract $100. All this mental ruse compels me to halt, consider what I’m about to do, and operate less on impulse.

At the end of the week, I review my additions and subtractions. The goal is to finish the net positive. Some weeks, I’m 100% positive and reward myself with a treat. It’s at the point where this mental accounting exercise is on auto-pilot and has been highly useful to keep me on a healthy path.

One of the positive trends emerging from the COVID crisis is the focus of families on physical activity. Bike sales are through the roof; Peleton’s revenues are higher. Kids are outside instead of cooped up with electronics. All good!

People lament that it’s expensive to eat healthy. I may have found a solution. I purchase fresh produce and other foodstuffs from www.imperfectfoods.com. Listen, this is the misshapen apple, the dented eggplant, grocery, and farm overstock. I customize my basket and timing of delivery. Upfront, I chose the grocery plan that fit my lifestyle, selected the groceries, and their service delivers to my door. They provide suggestions; I adjust, add or reduce items weekly as needed. Overall, very affordable and convenient. Check it out!

Household Debt-To-Income Ratios Are Dangerous

Touted mortgage and financial industry ratios are ridiculous. They’re designed to extend the latitude of consumerism and ultimately place households into more debt. They’re not designed to fortify fiscal health.  You must ignore them and redefine the financial boundaries of your household.

The standard rule is a house payment shouldn’t exceed 28% of pre-tax income. It’s a horrible rule. It’s designed to push the boundaries on cash flow and sell you more house than necessary. Throw it out if you desire financial flexibility, cash to cover emergencies and save for a prosperous financial future. Dave Ramsey suggests 25% of after-tax income. Not bad. However, you can do better.

Our rule at RIA is a total mortgage payment should not exceed 15% of after-tax income.

A Personal Example

I didn’t extract this percentage out of thin air. I’ve watched how households over the last two decades who utilized this rule continue to increase their wealth by thinking of a primary residence as a place to live, not an investment. In other words, an intimidating mortgage obligation was just too painful for couples who employed  long-term consideration of other important goals they sought to fund. I isolate my mortgage, HOA, and homeowner’s insurance payments and divide the sum by my  ‘take-home’ monthly income.  Currently, my ratio is 7.6%.

I then consider my household’s variable and specific fixed expenses – entertainment, groceries, clothing. I also examine costs for utilities, car insurance (not cheap with a college-bound daughter driving). The general rule is 30% of after-tax income for ‘wants.’ Obviously, auto insurance is a need, not a want. However, with the ability to shop around for better rates or utilize insurance company ‘drive-pay’ programs which reward responsible drivers, I place auto insurance into the variable category.

Currently, my variable expenses are 10% of monthly after-tax household income. I understand I no longer have a household with young children where variable expenses are greater. However, that doesn’t mean as a growing family, you shouldn’t create your own rules which still allow financial ‘breathing room.’

At RIA, we believe variable monthly expenses shouldn’t exceed 20% of after-tax income.

It’s time to do simple math and manage household debt-to-income ratios with ongoing vigilance.

Get Educated About Social Security

According to a working paper by Andrew G. Biggs, ‘How the Coronavirus Could Permanently Cut Near-Retirees’ Social Security Benefits,’ for the Wharton Pension Research Council, some groups of near-retirees are likely to suffer substantial permanent reductions to their Social Security Retirement benefits.

Those born in 1960 or later could see annual benefits in retirement reduced by around 13% with losses over their retirement period by close to $70,000. The basis of the assumption was a 15% decline in the Social Security Administrations measure of economy-wide average wages in 2020.

The Social Security benefits formula examines an individual’s highest 35-years of earnings and the National Average Wage Index (AWI) to calculate a worker’s PIA or Primary Insurance Amount. ‘Bend points’ in the formula are usually increased along with average wages in the economy. For the 1960 birth cohort, the bend point values used to calculate benefits will be equal to those in 2020, adjusted by the growth of the Average Wage Index between 2018-2020. For 2018, the most recent year for data available, the AWI was $52,146. The projection for 2020 in the Social Security Trustees’ Report was to be $56,396 – 8% higher!

The 2020 Impact

A significant decrease in the 2020 projection would reduce Social Security benefits for future recipients age 60 or younger. Those age 62 or older and current benefit recipients are not affected by changes to the AWI. I believe the author is too conservative when it comes to the negative long-term effects of the pandemic on the Average Wage Index. I foresee a challenge with wage growth over the next five years, which means the AWI estimates may decrease again. The possibility of this event requires close monitoring for financial planning purposes.

Also, retirees and their financial partners need to remain aware of the overall state of Social Security, which is funded primarily by payroll taxes. Payroll taxes may be cut for a period by Congress and the Executive Branch or simply by less of the population working and paying in over an extended period. Per Alicia H. Munnell, Director at the Center for Retirement Research at Boston College, the sudden collapse in payroll taxes due to COVID-19 may accelerate the depletion of the trust fund by two years – 2033 – which means benefits could be reduced by 25% at that time.

It’s crucial for financial professionals to keep abreast of the pandemic’s economic aftermath and to determine whether financial plans maintain an adequate level of guaranteed income to compensate for future changes.

Household Cash Flow Will Remain Uncertain

The priority is to start a Financial Vulnerability Cushion for as long as it takes to accomplish the task.  As a general rule,  we consider a year’s worth of living expenses in cash, an adequate goal. Why? We believe chronic underemployment will be an ongoing concern as business trends change and companies seek to radically reduce the cost of labor due to lessons learned during the pandemic.

Currently, investors are allowed to distribute from retirement accounts without penalty to survive the pandemic’s financial destruction. Prospective first-time homebuyers are permitted to raid retirement accounts for down payments. My view? If you need to reduce retirement funds to buy a house, you can’t afford it.

The financial services industry has always aggressively peddled investors fund contributions to pre-tax accounts above all else. Such leaves households with very little liquid savings to tap in case of emergencies or even worse, financial vulnerabilities. Our rule at RIA – Households require 3-6 months of living expenses in cash, to cover unexpected events – car repairs, etc. You get it.

However, our team over the last six months has communicated over the radio and in meetings, the importance of an additional six months of savings to cover the serious stuff – job loss, major illness. This rule is more important than ever in the face of ongoing  uncertainty.

I implore readers to consider this initiative before funding retirement accounts. In case of longer-term household cash flow disruption, retirement accounts can remain intact for the stated goal – RETIREMENT. Naturally, if an employer match is offered (matches have been placed on hold at many organizations), fund a retirement plan enough to capture it. Direct the rest of your savings into a FVC. Investigate online, FDIC-insured savings accounts with higher yields such as www.marcusbank.com and www.synchronybank.com. 

Be Increasingly Sensitive To Spending 

I love westerns, especially “The Big Valley.” Rich story lines and robust acting by Barbara Stanwyck as the matriarch of the Barkleys, along with Lee Majors and Richard Long as members of a California ranching family, have captivated me for years.

Your spending in retirement is mostly a big valley. I’ll explain:

Several of the Certified Financial Planners at RIA partner with clients who have been in retirement-income distribution mode for over a decade.  In other words, these clients are re-creating paychecks through systematic portfolio withdrawals and Social Security/pension retirement benefits. Although we formally plan for an annual cost-of-living increase in withdrawals, rarely if at all does this group contact us every year to increase their distributions!

There’s a time series in retirement where active-year activities, big adventures conclude, and retirees enter the big valley of level consumption. I call it the “been there done that,” stage where a retiree has moved on; the overseas trips have been fulfilled and enrichment thrives a bit closer to home.

Retirees move from grandiose bucket list spending to a long period or valley of even-toned, creative, mindful endeavors. It’s a sweet spot, an extended time of good health; so, healthcare is not so much an inflationary or heavy spending concern. The big valley stage is just a deeper, relaxed groove of a retirement lifetime.

Inflation Is Real

I often refer to a thorough analysis, as it reflects the reality I witness through clients, conducted by David Blanchett, CFA, CFP®, and Head of Retirement Research for Morningstar. The research paper, “Estimating the True Cost of Retirement,” is 25 pages and should be mandatory reading for pre-retirees and those already in retirement (along with financial professionals).

David concludes:

“While research on retirement spending commonly assumes consumption increases annually by inflation (implying a real change of 0%), we do not witness this relationship within our dataset. We note that there appears to be a “retirement spending smile” whereby the expenditures actually decrease in real terms for retirees throughout retirement and then increase toward the end. Overall, however, the real change in annual spending through retirement is negative.”

David eloquently defines spending as the “retirement spending smile.” As a fan of westerns, I envision the period as a valley bracketed by the spending peaks of great adventures on one side and healthcare expenditures. Hey, I live in Texas. This analogy works better for me.

In comprehensive financial planning, it’s prudent to incorporate an inflation rate to each spending need.

Medical costs affect retirees differently. Unfortunately, it’s tough as we age to avoid healthcare costs and the onerous inflation attached to them. Thankfully, proper Medicare planning is a measurable financial plan expense as most retirees’ healthcare costs will are covered by Medicare and Medigap or supplemental coverage.

Retirees Aren’t Prepared Financially

Unfortunately, many retirees are ill-prepared for long-term care expenditures which are erroneously believed to be covered by Medicare. Generally, long-term care is assistance with activities of daily living like eating and bathing. At RIA, we use an annual inflation factor of 4.8% for additional medical expenses (depending on current health of the client), and the cost of long-term care.

David suggests an alternative inflation proxy for older workers. The Experimental Consumer Price Index for Americans 62 Years of Age and Older or the CPI-E, reflects contrast of category weightings when compared to CPI-U or CPI-W, the CPI for urban consumers and urban wage earners, respectively.

Unfortunately, don’t expect CPI-E to gain traction as it would result in robust COLA or cost-of-living adjustments to Social Security benefits. Intuitively, it makes sense that greater relative importance is placed on medical care for seniors. However, based on the burden of social programs on the federal budget, don’t expect CPI-E to be employed anytime in the foreseeable future.

An Important Caveat

Inflation is indeed the omnipotent boogeyman in the room and must be addressed. Due to globalization, technological advancement, increased competition and decreased domestic energy dependence, inflation overall has progressively trended lower for decades (thankfully).

An important caveat – Although the overall landscape is deflationary, there are cold, inflationary winds stirring. First, there’s the possible impact of COVID on future healthcare premiums. Second, the costs of sanitary measures will pass on to consumers. Last, the cry for domestic production grows stronger daily. All this has the potential to impact inflation in a way we have rarely witnessed. The situation warrants monitoring.

Those with life expectancies that exceed the mortality tables need to take extra care to ensure against the risk of possibly higher living expenses through the use of reverse mortgages and long-term care insurance options.

Per the book, the outlook isn’t all dire. Every cycle creates a Phoenix from the ashes: Innovation, opportunity. 

We all just need to survive a hard winter.

I hope I’ve provided protection tips to weather your families through the imminent storm. 

Sector Buy/Sell Review: 06-23-20

Each week we produce a “Sector Buy/Sell Review” 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 SECTOR BUY/SELL REVIEW CHARTS

There are three primary components to each chart:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. We are back to “stupid” overbought on many levels. Caution is advised.

Basic Materials

  • As noted last week, XLB held support at $54, but remains very overbought short-term.
  • Trading positions can be added with a tight stop at $54.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
  • Stop-Loss set at $54
  • Long-Term Positioning: Bearish

Communications

  • Even with the correction last week, XLC remains very overbought. We took some profits previously. 
  • We continue to like the more defensive quality of the sector, so we continue to look for a pullback to add back to our holdings. We haven’t had enough of a correction to generate an entry point.
  • We moved our alert to $51 to revisit adding to our holdings.
    • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Neutral

Energy

  • As noted last week, the pullback in energy stocks came last week, and after taking profits we are looking for a buyable entry point to add back into our current holdings. 
  • If support can hold here, we can add to our current holdings.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Stop loss adjusted to $37.50
  • Long-Term Positioning: Bearish

Financials

  • The surge in XLF came and went. Now financials are back to underperforming
  • Initial support was at $24, which was violated. Now that level of tested as “resistance.” 
  • We have an alert set at $23 to start evaluating holdings, but we aren’t excited about the sector currently.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • Last week we noted that “XLI is playing catch-up with the market, and the move last week is a gross extension. It will correct and likely sharply.” 
  • The suggestion to take profits and rebalance holdings accordingly worked out well. Now, we can look for an opportunity to add exposure. The sector remains very overbought.
  • However, if we get a bit more consolidation, trading positions can be added with a stop at $66.
  • Short-Term Positioning: Bullish
    • Last week: No position.
    • This week: No position.
  • Long-Term Positioning: Bearish

Technology

  • Technology continues push higher and we continue to hold our exposure to the sector.
  • The rally had started to fade a bit, but money quickly rotated back into the sector. 
  • As stated last week: “We added to our holdings for a rotation trade out of Materials, Financials, and Industrials back to liquidity and fundamental balance sheet strength.”  
  • That was precisely what occurred.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Staples

  • Last week, we noted that XLP corrected, and that we added a bit more to our holdings for the defensive nature of the sector. 
  • XLP is not overbought after working off the previous extension, so there is “fuel” for a further rally on a rotation trade. Look for an offense to defense rotation to see a pickup in the sector. 
  • We are moving our stop-loss alert to $55 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
    • Long-Term Positioning: Bullish

Real Estate

  • XLRE broke out above the 200-dma but failed last week with the broad market selloff.
  • The sector is not grossly overbought and a further defensive rotation in the market should see this sector rally. 
  • XLRE failed a second time at the 200-dma, however, if there is a risk-off rotation in the market we should see the sector gain some traction. 
  • We have $31 as our stop-loss level.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Utilities

  • XLU held support on Monday and rallied slightly off the 50% correction retracement.
  • We previously added some exposure again to the sector in anticipation of the risk rotation into more defensive names. 
  • If there is further weakness in the market over the next few weeks, we will likely see a rotation in to XLU for defense and safety. 
  • We have an alert set at $54
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • We noted previously that XLV was “not extremely overbought, and we added to our holdings for a rotation trade out of the sectors that have gotten over-extended over the last two weeks.”
  • XLV continues to consolidate in a fairly tight range, and rallied on Monday. 
  • We are still looking for XLV to pick up with a defensive rotation in the market. The consolidation was needed following the massive rally from the lows.
  • The 200-dma is now important support and needs to hold, along with the previous tops going back to 2018. 
  • We have an alert set at $95 as a stop.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • As noted last week: “The pullback occurred, and support held at the 2019 peaks. The fundamentals aren’t great for the sector overall, but the pullback does provide an entry point for trading positions. 
  • Buy at current levels with a stop at $122.50
  • Stop loss is set at $122.50
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • The rally in XTN is coming to a conclusion after a previous sharp advance.
  • There is a trading opportunity for transports, but the sector is performing weakly so caution is advised. 
  • XTN is holding the 50% correction retracement level so far, but there is mounting risk it will fail this support level.
  • Stop loss set at $50
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bearish

Technically Speaking: Unicorns, Rainbows, & Fully Invested Bears

In this week’s “Technically Speaking,” I want to review the bull case, which is seeming built on “Unicorns” and “Rainbows,” as opposed to the more bearish fundamental backdrop. We are uncomfortably “long equities” in this momentum-driven market, essentially making us “fully invested bears.”

Let’s review the “Bull” and “Bear” case from last week:

The Bull’s Case

The bullish case for the market is pretty thin.

  1. Hopes are high for a full reopening of the economy. (Rainbow)
  2. A vaccine. (Rainbow)
  3. A rapid return to economic normalcy. (Rainbow)
  4.  2022 earnings will be sufficiently high enough to justify “current” prices. (Let that sink in – that’s two years of ZERO price growth.) (Rainbow)
  5. The Fed. (Unicorn)

In actuality, the first four points are rationalizations. It is the Fed’s liquidity driving the market.

The Bear’s Case

The bear’s built their case on more solid fundamental views.

  1. The potential for a second wave of the virus
  2. A slower than expected economic recovery
  3. A second wave of the virus erodes consumer confidence slowing employment
  4. High unemployment weighs on personal consumption
  5. Debt defaults and bankruptcies rise more sharply than expected.
  6. All of which translates into the sharply reduced earnings and corporate profitability. 

Ultimately, corporate profits and earnings always matter, as discussed previously. (Historically, earnings never catch up with price.)

“Throughout history, earnings are very predictable. Using the analysis above, we can “guesstimate” the decline in earnings, and the potential decline in stock prices to align valuations. The chart below is the long-term log trend of earnings versus its exponential growth trend.”

Fully Invested Bears

The problem in discussing “investment risk” is that such commentary is summarily dismissed as being “bearish,” By extension, I am either sitting in cash or short the market. In either event, I have “missed out” on the previous advance. However, now, the discussion of “risk” is even more futile due to the Fed’s massive interventions. 

Such reminds me of something famed Morgan Stanley strategist Gerard Minack said once:

The funny thing is there is a disconnect between what investors are saying and what they are doing. No one thinks all the problems the global financial crisis revealed have been healed. But, when you have an equity rally as you’ve seen for the past four or five years, everybody has had to participate.

What you’ve had are fully invested bears.”

While the mainstream media continues to skew individual’s expectations by chastising them for “not beating the market,” which is impossible to dothe job of a portfolio manager is to participate in the markets with a bias toward capital preservation. It is the destruction of capital during market declines that have the greatest impact on long-term portfolio performance.

From that view, as a portfolio manager, the idea of “fully invested bears” defines the reality of the markets we live with today. Despite the understanding that the markets are overly bullish, extended, and valued, portfolio managers must stay invested or suffer potential “career risk” for underperformance. 

Are Unicorns Real?

What the Federal Reserve’s ongoing interventions have done, and continue to do,  is push portfolio managers to chase performance despite concerns of potential capital loss. We have all become “fully invested bears” as we are all quite aware that this will end badly, but no one is willing to take the risk of being grossly underexposed to Central Bank interventions.

As noted yesterday, retail investors have come to believe in “Unicorns.” As we saw in 1999 and 2007, inexperienced investors are flocking to the market to speculate under the delusion there is no downside risk.

Such is evident when you look at the massive outperformance of just a handful of stocks in the S&P 500 versus the rest of the index. This is not investing. This is purely a function of performance chasing.

Therefore, as “full invested bears,” we must watch the markets carefully for signs of a market turn. Here are the things we are currently watching. These issues do NOT mean the market will crash tomorrow. However, they do always coincide with lower returns and higher volatility.

Valuations

One of the consistent drivers behind the bull market over the last few years has been the idea of the “Fed Put.” As long as the Federal Reserve was there to “bail out” the markets if something went wrong, there was no reason not to invest in equities. In turn, this has pushed investors to “chase yield,” due to artificially suppressed interest rates, It has also pushed valuations on stocks back to levels only seen before the turn of the century.

Furthermore, given the depth of the economic crisis, 49-million unemployed, collapsing wages and incomes, and a resurgence in the number of COVID-19 cases, estimates are still too high. During previous economic downturns, earnings collapsed between 50% and 85%. It is highly optimistic, given the current backdrop, that earnings will only decline by 20%.

As noted this past weekend, valuations on just about every metric are at the top-end of the range.

“One thing I had hoped for in 2018-2019 is that we would get a correction large enough to revert some of the excessive valuation levels which existed. Such would provide higher future rates of return over the next decade, allowing investors to reach their investment goals.

Instead, through the Fed’s actions, the correction was halted, and the “clearing process” was not allowed to occur. The outcome has been even higher levels of corporate leverage, and valuations remain grossly elevated on many different levels.”

Market, Market Holds 200-DMA, Bulls Remain In Control&#8230;For Now 06-19-20

As noted, these valuation extensions are occurring against a backdrop of deteriorating economic growth. The combination, shown in the chart above, has not worked out well for investors in the past.

Under-Estimating Earnings Decline

As noted above, during economic recessions, GAAP earnings tend to decline between 50% and 85% of their previous highs. Given that earnings are a function of revenue, which happens at the top line of the income statement, there is a direct correlation between economic growth, wages, consumption, and corporate earnings.

Currently, estimates have only been reduced by 34% of their previous peak. Such comes at a time where economic growth is weaker, job loss is higher, and consumption will drop lower than any previous point except during the “Great Depression.”

We are watching the chart closely as our expectations are that earnings will eventually drop closer to $60/share to align with historical norms. As such, stock prices will have to correct to align with those earnings.

While Fed liquidity can boost stock prices higher in the short-term, balance sheet expansions do not increase wages, employment, economic growth, or revenue. More importantly, with companies now having to issue stock to raise capital, the biggest support for EPS previously has been removed – stock buybacks.

Deviation

I have written many times in the past that the financial markets are not immune to the laws of physics. What goes up, must and will eventually come down. The example I use most often is the resemblance to “stretching a rubber-band.” Stock prices connect to their long-term trend, which acts as a gravitational pull. When prices deviate too far from this trend, they will eventually “revert to the mean.”

See Bob Farrell’s Rule #1

Currently, that deviation from the long-term log trend-line is at one of the highest points in history. Does this mean that the current bull market will crash tomorrow? No. However, it does suggest that “risk” is currently skewed to the downside. It will only take some exogenous, unexpected event, to cause a reversion. As such, some consideration to direct market exposure should be given.

Sentiment

Lastly, is investor sentiment. When sentiment is heavily skewed toward those willing to “buy,” prices can rise rapidly and seemingly “climb a wall of worry.”

Our Greed/Fear indicator is a little different than most. It is based on actual positioning in markets by both amateur and professional investors, plus indicators of positioning sentiment. Rather than it being a “sentiment” gauge, it is a “positioning” gauge.

In March, this indicator plunged to the lowest level seen since the “Financial Crisis.” Just a couple of months later, the indicator is back to “Greed” levels due to the Fed’s monetary interventions. Reading above 80, are typically seen at or near market peaks, corrections, and bear markets.

See Bob Farrell’s Rule #6

With sentiment currently at very high levels, combined with low volatility,  and a high degree of investor complacency, all the ingredients necessary for a market reversal are currently present. Am I sounding an “alarm bell” and calling for a massive correction? No.

I am suggesting that remaining heavily invested in the financial markets without a thorough understanding of your “risk exposure” will not have the desirable end result you have been promised.

As stated above, my job is to participate in the markets while keeping a measured approach to capital preservation. Since it is “bearish” to point out potential “risks,” then you can call me a “bear.”

Just make sure you understand that I am currently a “fully-invested bear.”

However, that positioning can, and will, rapidly change as needed.

Major Market Buy/Sell Review: 06-22-20

HOW TO READ THE MAJOR MARKET BUY/SELL CHARTS FOR THE WEEK OF 06-22-20.

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

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

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

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

Market Buy/Sell 06-22-20

NOTE: I have added relative performance information to each Major Market buy/sell review graph. Most every Major Market buy/sell review graph also shows relative performance to the S&P 500 index except for the S&P 500 itself, which compares value to growth, and oil to the energy sector.

This week I have added 2 and 3-standard deviations from the 50-dma to show where extreme extensions currently exist.

S&P 500 Index

  • Previoulsy we noted: “Currently the market is back to extremely overbought and the advance has been near vertical. With the SPY pushing into 3-standard deviation territory, profit taking is suggested. We will likely see a short-term reversal to provide a better entry point to add further exposure.”
  • That correction happened over the last two weeks with the SPY bouncing off support at the 200-dma.
  • Some of the overbought condition has been corrected, but not all of it, so there could be more selling pressure in the short-term. 
  • A trading position can be put on with a stop at the 200-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No core position
    • This Week: No core position
    • Stop-loss set at $300 for trading positions.
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • As with SPY, DIA had “also pushed well into 3-standard deviation territory which doesn’t happen often. It suggests a short-term corrective pullback to relieve some of that extension.” 
  • DIA continues to lag both the S&P and the Nasdaq, and DIA is trying to hold the 200-dma. 
  • We added a 5% trading position in the Dow for a catchup trade.
  • Support must hold at the 61.8% retracement of the March sell-off.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss reset at $255
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • QQQ’s outperformance of SPY returned last week with the correction as money fled the momentum chase back into liquidity. (We discussed our move to defense previously)
  • The QQQ’s tested and held its previous breakout level, so now a breakout to all-time highs will be very bullish.
  • The QQQ’s are overbought and the buy signal is extended so consolidation or a correction is still possible so maintain stops accordingly and take profits and rebalance as needed.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss moved up to $225
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • As stated two weeks ago, SLY is pushing limits of a 3-standard deviation extension, so if you are long small-caps take profits on Monday and rebalance risk. We will likely see a correction soon.”
  • That correction was swift and sharp with small-caps failing at the 200-dma resistance and failing support at the 50% retracement of the March correction.
  • The previous stop-loss at $58 was violated.
  • We still have an “avoid small-caps” stance at the moment due to earnings risk and underperformance
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $58
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. MDY also failed its breakout above the 200-dma resistance. 
  • We suggested last time that “We will likely see a correction sooner than later, so take profits and rebalance risk accordingly.” 
  • The $320 stop-loss was violated, but MDY recovered it. We are now moving stops up to that level on any outstanding trading positions. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $320
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging continue to underperform the S&P 500 and Nasdaq. Maintain domestic exposure for now. 
  • We stated previously the sharp surge in EEM on a “catch up” rotation would likely fade quickly. We previously suggested taking profits and rebalancing risk. 
  • There is dollar risk to international markets so pay attention to it.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $38 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Overall, like EEM, EFA is grossly underperforming the domestic markets. 
  • As with EEM, EFA had a big spurt of a “catch up” trade but that ended at the 200-dma.
  • EFA failed at the 200-dma resistance, and is trying to hold the 61.8% retracement support.
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss reset at $60
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Oil prices are struggling at the 50% retracement level again this week but remain grossly overbought. 
  • We suggested last: “Look for a correction to reverse some of the extreme overbought.” That hasn’t occurred yet, but is still likely. Energy stocks are underperforming oil prices currently which suggests more trouble in the sector. 
  • Oil should hold support between $30 and $35 and we will look to increase our holdings on pullbacks.
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long our current position in IAU. 
  • This past week Gold rallied with the pickup in volatility in the market. It continues to consolidate its recent advance and if support can hold a move higher would be expected. (Such would likely coincide with a bigger correction in stocks.)
  • We believe downside risk is fairly limited, but as always maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss remains at $155
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • As noted last week: “Bonds have now corrected and got back to oversold while holding support. Such sets us up for two events – a rally in bonds, as the stock market corrects.”
  • That correction in stocks has started and the “risk off ” trade has picked up pushing TLT higher.
  • We noted that we had added to both TLT in our portfolios to hedge against our increases in equity risk. We have also swapped IEF and SHY for MBB and AGG to increase duration and yield.
  • That hedge worked well this past week during the stock market correction as bonds rallied. There is still more upside potential in rates if volatility continues this week.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Last week: “While the dollar has sold off, and helped fuel a rather torrid stock and commodity rally, we are likely closer to a bottom.” 
  • With the USD extremely oversold, and well into 3-standard deviations below the 50-dma, the rally this past week was likely. This is still likely a good entry point to add to dollar holdings. 
  • The deep underperformance of UUP versus SPY has a habit of reversing sharply. We could be setting up for one of those reversals now. 
  • Stop-loss adjusted to $95

Is It 1999 or 2007? Retail Investors Flood The Market.

Is it 1999 or 2007? Retail investors flood the market as speculation grows rampant with a palpable exuberance and belief of no downside risk. What could go wrong?

Do you remember this commercial?

The Etrade commercial aired during Super Bowl XLI in 2007. The following year, the financial crisis set in, markets plunged, and investors lost 50%, or more, of their wealth.

However, this wasn’t the first time it happened.

The same thing happened in late 1999. This commercial was aired 2-months shy of the beginning of the “Dot.com” bust as investors once again believed “investing was as easy as 1-2-3.”

Why this trip down memory lane? (Other than the fact the commercials are hilarious to watch.) Because this is typical of the exuberance seen at the peaks of bull market cycles.

So, what are the signs we are seeing today.

  • Retail investors are chasing bankrupt companies like Hertz and Chesapeake Energy
  • Hertz, a company in bankruptcy, is issuing stock with a disclaimer the shares are likely worthless.
  • Investors chasing companies with extremely poor fundamentals.
  • Investing tips coming from individuals with no experience.

Investing is simple. Just pick some letters out of a Srabble bag, buy it, and it goes up.

Its so easy a “baby can do it.”

Or in this case, it like “stealing from the rich to give to the poor.” 

Retail Investors Go Robinhood

As Barron’s recently noted:

“Free trading app Robinhood has added more than three million retail accounts in 2020, and now has over 13 million. The median age of its retail customer is 31. The Covid-19 lockdowns and the plunge in markets in March persuaded millions of new investors to open accounts. Some of the action appears to be from people who would otherwise be gambling or betting on sports—both of which were shut down.”

Just like we saw in 1999 and 2008, “day trading” has had a resurgence from “message boards” on AOL to live blogs and video feeds on social media.

“The new generation tends to convene on social media. Beyond TikTok, retail investors chat on forums like Reddit and Twitter, sharing internet memes and jokes about stocks, and even posting self-deprecating charts showing their worst losses. 

A former Goldman Sachs partner, Joseph Mauro, joked on Twitter that his son’s friends are never free anymore to play videogames during the day because they’re too busy trading stocks. “He is 10,” Mauro added.”

The irony is that Robinhood really isn’t “stealing from the rich.” In reality, they are “getting rich by stealing from the poor.” As is always the case, there is no “free lunch,” as Robinhood bundles orders and then“sells” the flows to major hedge funds for profit. Those hedge funds then “front run” the “Robinhooders” taking advantage of their trading. (If this wasn’t massively profitable for hedge funds they wouldn’t pay millions for the data.)

Retail Discovers A New “Toy”

These “newbie” retail investors are not trading based on fundamentals, earnings, estimates, products or market values, but rather talking up stocks driven by pure momentum. Robinhood makes the “research” even easier by posting the top holdings of its users.

They are then leveraging what cash they have through option contracts and margin debt to boost their buying power.

The problem with options is that when you are wrong, you can lose 100% of your investment.

The problem with margin is that when you are wrong, you can lose more than 100% of your investment.

However, given the current belief by “daytraders”  that there is no downside risk, then why not leverage up and “get rich quick?”

After all, in this “new paradigm” of “no risk” investing there are only two rules:

But this is the nature of what happens in a late-stage bull market cycle.

Still In A Bull Market

“But we had a 35% selloff in March, how can we be in a late stage bull market?”

This was a point I discussed in “Was March A Bear Market?”

“Such brings up an interesting question. After a decade-long bull market, which stretched prices to extremes above long-term trends, is the 20% measure still valid?

To answer that question, let’s clarify the premise.

  • A bull market is when the price of the market is trending higher over a long-term period.
  • A bear market is when the previous advance breaks, and prices begin to trend lower.

Fed Liquidity, Technically Speaking: Too Fast, Too Furious As Fed Liquidity Slows

This distinction is important.

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

Given the trend was never broken, valuations were never reversed, and “speculative greed” wasn’t extinguished, the “bull market” remains intact.

Topping Process

The markets quick recovery from the March lows further bolstered the “speculative greed” in the market which has now manifested itself in current behaviors.

The risk, however, is the economic recession which will impair the fundamentals of the markets over the next several quarters making it harder to justify current valuations. As I noted in the chart above, the current rally could be part of a bigger “topping” process which may take young traders by surprise.

I have noted the market may be in the process of a topping pattern. The 2018 and 2020 peaks are currently forming the “left shoulder” and “head” of the topping process. Such would also suggest the “neckline” is the running bull trend from the 2009 lows. 

A market peak without setting a new high that violates the bull trend line would define a “bear market.”

What Could Cause The Market To Break?

As noted by Mish Shedlock recently, the Federal Reserve itself has noted six downside risks to the markets and the economy.

“In its semiannual monetary report to the Senate Finance Committee the Fed warns of six downside risks. The risks are not spread evenly. Low wage earners and small businesses are particularly vulnerable.

Please consider the Fed’s Monetary Policy Report to the Senate Committee on Banking, Housing, and Urban Affairs and to the House Committee on Financial Services. The report is 66 pages long and is full of interesting charts and comments. 

Let’s start with Powell’s statement on risk: ‘Despite aggressive fiscal and monetary policy actions, risks abroad are skewed to the downside.’

Six Downside Risks 

  1. The future progression of the pandemic remains highly uncertain.
  2. The collapse in demand may ultimately bankrupt many businesses.
  3. Unlike past recessions, services activity has dropped more sharply than manufacturing—with restrictions on movement severely curtailing expenditures on travel, tourism, restaurants, and recreation and social-distancing requirements and attitudes may further weigh on the recovery in these sectors. 
  4. Disruptions to global trade may result in a costly reconfiguration of global supply chains. 
  5. Persistently weak consumer and firm demand may push medium- and longer-term inflation expectations well below central bank targets.
  6. Additional expansionary fiscal policies— possibly in response to future large-scale outbreaks of COVID-19—could significantly increase government debt and add to sovereign risk.”

The biggest risk, is the 6th point where massive increases in debts and deficits retard long-term economic growth.

“Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.”

stocks economy, #MacroView: The Great Divide Between Stocks &#038; The Economy

 Retail “Investor” Or “Speculator?”

In today’s market the majority of investors are simply chasing performance.

But, this isn’t “investing,” it’s “speculation.”

Think about it this way.

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

Of course, not.

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

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

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

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

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

Graham & Dodd

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

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

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

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

Surviving The Game

Regardless of whether you believe fundamentals will ever matter again is largely irrelevant. What is important is that periods of excess speculation always end the same way.

For now, Dave Portnoy has garnered a legion of followers. However, Dave’s financial future is quite secure after he sold his company to Penn National for $450 million. So, when things go wrong in the market, he will be just fine financially. However, for the host of inexperienced, over-confident, millennials who follow him, many have the financial livelihoods on the line.

I get it. If you are one of our younger readers, who have never been through an actual “bear market,” I wouldn’t believe what I am telling you either.

However, after living through the Crash of ’87, managing money through 2000 and 2008, and navigating the “Great Crash of 2020,” I can tell you the signs are all there.

A real bear market will happen. When? I don’t have a clue. But it will be an unexpected, exogenous event that triggers the selling.

It always appears easiest at the top.

More importantly, at bottoms, retail investors will not be wanting to buy stocks.

Markowski: Why Recent High Will Prove To Be The Post-Crash Peak

The SCPA algorithm (Statistical Crash Probability Analyses), indicates the probability is 100% that the markets for 13 of the world’s largest GDP ranked countries, including the US, reached their post-crash highs from Friday June 5, 2020 to Monday June 8, 2020.

These markets will not exceed their post-crash highs for many years.  These markets have started their journey to their 2022 bottoms in the final fourth quarter of that year.

The Forecast

The SCPA, developed as a result of empirical data research on prior market crashes, has been accurate at forecasting both the 2020 pre-crash event and 2020 post-crash events.

My April 1, 2020 article, “Markets now at tipping point; roller coaster ride will be epic!”, contained the SCPA’s forecasts for the events that would occur after the markets of the 13 countries reached their relief rally highs.  Below are the SCPA’s forecasts from the article for two events:

  • Post-crash high before the journey begins to final Q 4 2022 bottom will occur as early as June 24, 2020 and as late as September 18, 2020.
  • Post-crash highs to get market to within 17% of 2020 highs.

The Highs Are In

Given that the markets for all 13 countries reached their post-crash highs from June 5th to June 8th the probability is high that the first forecast above will prove to be accurate.  The one thing that has been for certain in 2020 is that all 13 of these markets have been acting in concert.   All of these markets:

  • Commenced their crashes on February 20, 2020
  • Made new lows and declined by a minimum of 34% on March 23, 2020:

As of June 19, 2020; the markets for 8 of the 13 countries had climbed back to within 17% of their 2020 highs.  My suspicion is that the markets of the five countries which have not climbed to within 17% of their 2020 highs won’t. While the five have failed to perform as forecasted, they are great additions to my ongoing research of market crashes.

The empirical data from these countries’ crashes will improve the accuracy for the forecasting of future crashes. Finally, due to their lack of buoyancy, the markets for the five will probably have the worst percentage declines when compared to the other markets at their final Q4 of 2022 bottoms.

Based on my ongoing empirical research of the Dow 1929-32 and the NASDAQ 2000-02 market crashes which have the same genealogy as the 13 countries whose markets crashed in 2020, the forecasts for each of the 13 countries can become specific.  To that end, these 13 countries have been broken up into two groups:

  1. Those whose markets have climbed to within a single-digit percentage below their 2020 highs 
  2. Those whose markets have climbed to within a double-digit percentage below their 2020 highs

It’s A Global Issue

Japan, South Korea, Germany and the US comprise the four who are in the single digit group.  Based on my preliminary analysis the markets of the four countries, they will not have declined by 79% when they reach their final bottoms in Q4 of 2022.  The percentage decline forecasts for the markets of the US and the other three countries will be made available soon.

The remaining nine countries constitute the second group, all of whom are now members of the SCPA Global Crash Index.  The table below contains the countries and their post-crash percentage climbs to within 2020 highs.

The 1929 Analogy

The chart below depicts the performance of the SCPA Global Crash index from its 2020 high through June 19, 2020.

The fact that the index climbed back to a post-crash high of within 17% of its 2020 high further validates the SCPA’s efficacy. The charts for 1929 and 2000 crashes depicted below confirm that the 2020 crashes for the markets of the US and a dozen other countries have the same genealogy.

Some argue that the US stock market is insulated from the rest of the world.   The chart patterns for the Dow and S&P 500 indicate otherwise.  The charts depict that both of the US indices are behaving similarly to the SCPA Global Crash index as well as to the prior historical market crashes.

Based on the patterns in the above charts, the two US indices will go to lows in 2021 which will be lower than 2020.  The lows for 2022 will be lower than 2021.

The history books will depict that the post-crash rally of 2020 was the “Granddaddy” of all Bear Market rallies.  If you are still in the market, get out before it’s too late.


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

Market Holds 200-DMA, Bulls Remain In Control…For Now


In this issue of “Market Holds 200-DMA, Bulls Remain In Control.”

  • Market Holds Bullish Support
  • From Bubble, To Bust, To Bubble
  • The Problem With 2-Year Forecasts
  • A Bearish Pattern Remains
  • Portfolio Positioning
  • MacroView: Rationalizing High Valuations Won’t Improve Outcomes
  • Sector & Market Analysis
  • 401k Plan Manager

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Upcoming Event  – CANDID COFFEE

Sign up now for this virtual “Financial Q&A” GoTo Meeting

June 27th from 8-9 am

Send in your questions, and Rich and Danny will answer them live.


Catch Up On What You Missed Last Week


Market Holds Bullish Support

Last week, I updated the analysis on the break above the 200-dma, which changed the market’s complexion.

“If the markets can break above the 200-dma, and maintain that level, it would suggest the bull market is back in play.”

Then, in our Tuesday follow up, we discussed how the markets had pushed to more extreme overbought conditions and the importance of the market to hold the 200-dma on a subsequent correction.

“That correction came swiftly on Thursday. The surge in COVID-19 cases in the U.S. undermined the “V-Shaped” economic recovery meme. As we noted, the market had rallied into overhead resistance, and the correction found support at the 200-dma.”

As we saw in April and May after the initial surge off the March 23rd lows, the market has once again begun to consolidate its gains to work off the short-term overbought extension. With Friday’s sell-off, we can update our risk/reward range, which has turned more positive in the short-term.

  • -2.9% to the 200-dma vs. +4.9% to recent highs. Positive 
  • -5.7% to the 50-dma vs. +9.1%% to all-time highs. Positive
  • -11.2% to previous consolidation lows vs. +9.1% to all-time highs. Negative
  • -15.2% to March bounce peak vs. +9.1% to all-time highs. Negative 

However, the market reversal on Friday from a strong opening to a weak close, is a good reminder of just how volatile markets can be. Despite the technical backdrop becoming more bullish short-term, we hedge our portfolios against just this type of risk.

From Bubble, To Bust, To Bubble

In January and February of this year, we wrote articles discussing why we were taking profits from our portfolios and reducing overall portfolio risk. In “This Is Nuts,” we stated:

“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 discussed the overbought, extended, and complacent market over the last couple of weeks. Still, on Friday, I tweeted out a couple of charts that illustrated the excess.”

That was on January 6th.

Yesterday, I tweeted out some interesting charts:

This Is Nuts

Our portfolio management meeting Friday morning started with “This is nuts.”

Importantly, I want to direct your attention to the Nasdaq, which is where portfolio managers have been stuffing cash.

There are several things to note about the chart above:

  1. Every time, and it is only a function of time, the Nasdaq gets extremely extended above the 2-year moving average, it reverts to, or beyond, that average. 
  2. The MACD is more extremely extended currently than in the past 25-years. 
  3. The current deviation above the 2-year moving average matches the extension seen in February before the collapse.

On the S&P 500, there are warning signs as well. As shown below, the number of stocks on “bullish buy signals” has reached an extreme weekly. Historically, such extremes have preceded short-term corrections and bear markets.

Also, as noted last week, the number of S&P 500 stocks trading above their 50-dma has peaked and started to turn lower. Such has always been a precursor to a short-term correction or worse.

At the moment, the over-riding investment belief is that markets can’t decline because of the Fed. However, all it will take is an unexpected, exogenous event to trigger selling and quick correction of 10-15% due to the current lack of liquidity in the market.

What could such an event be? I have no clue. The market has already factored that in a second wave of the Virus. However, one thing no one is currently expecting is for states to shut down commerce once again. I don’t think that will happen either, but you get my point.

Again, this is why we maintain our hedges.

The Problem With Two-Year Forecasts

As markets get overly bullish, extended, and exuberant, Wall Street tends to come up with new ways to “sucker,” I mean “rationalize,” investors into taking on additional risk.

One thing I had hoped for in 2018-2019 is that we would get a correction large enough to revert some of the excessive valuation levels which existed. Such would provide higher future rates of return over the next decade, allowing investors to reach their investment goals.

Instead, through the Fed’s actions, the correction was halted, and the “clearing process” was not allowed to occur. The outcome has been even higher levels of corporate leverage, and valuations remain grossly elevated on many different levels.

So, how does Wall Street justify “buying stocks” in the current environment of recessionary economic growth, high unemployment, and collapsing earnings? Easy, you just tell uneducated investors to use earnings estimates 2-years in the future.

“Yes, stocks are expensive based on current earnings, but cheaper using earnings in 2022.” – Wall Street

Faulty Analysis Leads To Faulty Outcomes

There are significant problems with this analysis. The first is that even based on 24-month estimates, stocks are still historically expensive.

Secondly, Wall Street is terrible at estimating forward earnings. Historically, forward estimates are about 33% too high before they are ratcheted sharply lower. So, even if you assume the stock prices don’t move over the next two years, as future estimates are lowered, valuations will rise further.

Using Wall Street logic, if you were buying stocks in 2018 using 2020 estimates, you grossly overpaid for value and wound up paying the price.

profits, Fundamentally Speaking: Estimating The Earnings Crash

Lastly, think about the stupidity of the statement for a moment.

You are paying for earnings two years into the future. Such means that you will have NO appreciation in the price for two years to maintain the “valuation” of what you paid today. Furthermore, every year going forward will have to have higher earnings estimates than current just to maintain the same valuation.

Such is why valuations are so important. By overpaying for assets today, and locking in earnings 24-months into the future, you have guaranteed yourself a long-term period of low returns.

Do you now understand why Buffett is sitting on $137 billion in cash?

A Bearish Pattern Remains

In the short-term, however, the technical backdrop of the market keeps the bulls in control. The market had gotten overheated, but the correction over last week successfully retested the 200-dma.

However, on a monthly basis, there is still a more “bearish” pattern in the works. The broadening range of highs and lows, known as a “broadening” or “megaphone” pattern, is characterized by two diverging trend lines. As noted by Investopedia:

Broadening formations occur when a market is experiencing heightened disagreement among investors over the appropriate price of a security over a short period. Buyers become increasingly willing to buy at higher prices, while sellers always find more motivation to take profits. This creates a series of higher interim peaks in price and lower interim lows. When connecting these highs and lows, the trend lines form a widening pattern that looks like a megaphone or reverse symmetrical triangle.

The price may reflect the random disagreement between investors, or it may indicate a more fundamental factor. These formations are relatively rare during normal market conditions over the long-term since most markets tend to trend in one direction or another over time. For example, the S&P 500 has consistently moved higher over the long-term. Therefore the formations are more common when market participants have begun to process a series of unsettling news topics. Geopolitical conflict or a change of direction in Fed policy, or especially a combination of the two, are likely to coincide with such formations.”

The Technical Chart

You can understand why there is a disagreement among investors given the current backdrop of a recessionary economy and a bullish stock market driven by the Fed. The ongoing “broadening formation,” which is typical of longer-term market tops, is coupled with a negative divergence in the Relative Strength Index.

Given this is a “monthly” chart, such doesn’t mean the market will crash tomorrow, if even at all. However, it is one of those warning signs which continue to suggest a bit of caution in portfolios is likely advisable.

Portfolio Positioning Update

With our portfolios almost fully allocated towards equity risk in the short-term, we remain incredibly uncomfortable. As noted on Tuesday:

“From a purely technical perspective, the bulls remain in control for now. Fundamentally speaking. However, we remain ‘bears.’ We also realize that with the Federal Reserve intravenously feeding liquidity into the markets, we need to participate. As we stated last week:

“As a portfolio manager, we buy ‘opportunity’ because we have to. If we don’t, we suffer career risk, plain and simple. However, you don’t have to. If you are indeed a long-term investor, you have to question the risk undertaken to achieve further returns in the market currently.”

As noted, fundamentals will eventually matter. We just don’t know when that will ultimately be the case. However, there are more than enough signs to know we are likely close to a peak:

  1. Wall Street firms using 2-year forward “operating (or B.S.)” earnings to justify valuations.
  2. Investors are chasing bankrupt companies.
  3. Companies rampantly issuing debt to shore up liquidity
  4. A complete lack of market liquidity.
  5. Investor over-confidence
  6. Retail investor exuberance.
  7. Overly estimated future earnings growth.

You get the idea.”

As I stated, we are participating, but it doesn’t mean we have to like it. We just have to respect the market for what is.

We continue to hedge our equity exposure with fixed income, dollar, and gold investments. While such hedging does reduce the participation of our equity portfolio short-term, it has mitigated the risk of sudden and unexpected sell-offs.

We are very confident we are not in a “no risk” market currently.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


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 – Materials (XLB), Industrials (XLI), and Energy (XLE)

While Industrials moved into the improving category, performance overall remains concerning with a failure at the 200-dma. Materials and Energy also corrected this past week. We had previously reduced our exposure to XLE two weeks ago. We recommend profit-taking previously, which worked well, and now we are looking for an opportunity to add exposure safely.

Current Positions: XLE

Outperforming – Technology (XLK), Discretionary (XLY), and Communications (XLC)

Discretionary, which had gotten very extended, and has corrected this past week. The sector is still very overbought, so more correction is possible. We suggested profit-taking in positions last week. The same goes for Communications, which has also had a major rise and is extremely overbought and deviated from long-term trends. Technology, unsurprisingly, moved back into the leading category as money is once again flowing into “big tech” to hide.

Current Positions: XLC, XLK

Weakening – Healthcare (XLV)

Previously, we added to our core defensive positions Healthcare, Staples, and Technology. We continue to hold these sectors as they have been outperforming the market overall during the correction over the last couple of weeks hedging other equity risks.

Current Position: XLK & XLV

Lagging – Utilities (XLU), Financials (XLF), Real Estate (XLRE), and Staples (XLP)

Financials continued to underperform the market. We had recommended taking profits last week, but we currently maintain no exposure.

Our defensive positioning in Real Estate and Utilities has lagged but remains part of the “risk-off” rotation trade. We see early signs of improvement, suggesting it is the right place to be. If it turns up meaningfully, we will add to our current holdings.

Current Position: XLRE, XLU, & XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) We stated last week that both of these markets were extremely overbought and susceptible to a pullback. That pullback continued this week. Both markets violated important support. We maintain no holdings currently.

Current Position: None

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

Same as Small-cap and Mid-cap. As noted last week, “There was a brief rotation rally last week, which will likely fail in the next week or so. Continue to avoid these markets for now.” That rally appears complete for now. We will watch what happens next week.

Current Position: None

S&P 500 Index (Core Holding)Given the overall uncertainty of the broad market, we previously closed out our long-term core holdings. We are currently using DIA as a “Rental Trade” to pick up some bulk exposure for trading purposes.

Current Position: None

Gold (GLD) – We currently remain comfortable with our exposure through IAU. We are also maintaining our Dollar (UUP) position. No changes as these hedges are offsetting our increased equity risk.

Current Position: IAU, UUP

Bonds (TLT) –

As we have been increasing our “equity” exposure in portfolios, we have added more to our holding in TLT to improve our “risk” hedge in portfolios. However, with yields so low, and with the Fed supporting the mortgage-back and corporate bond markets, we swapped our near zero-yielding short-term Treasury funds for Mortgage-Backed and Broad Market bond funds with 2.5% yields. 

Current Positions: TLT, MBB, & AGG

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. Such is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)

Portfolio / Client Update

On Monday and Tuesday, the market rose sharply, holding support at the 200-dma. That hold of support confirmed the bullish trend of the market for now, keeping our portfolios tilted toward equity risk.

Interestingly, last week I made of our position in TLT:

“Not surprisingly, we were getting a lot of phone calls questioning our portfolio hedge in TLT, which was lagging as the market rallied. The surge in TLT during the vicious decline last week was a solid reminder of why we hedge.

Risk is what happens when things go wrong. As noted last week, I am willing to “lose a battle” short-term, to the “win the war” longer-term. After all, it is YOUR money we are putting at risk, and we take that responsibility very seriously.

Given the volatility of the market this past week, TLT, along with positions in the U.S. Dollar and Gold, continued to hedge risk against market volatility.

Changes

In both the ETF and EQUITY portfolios, we added a DIA rental position to give us both some broad market exposure plus some additional exposure to basic materials companies. DIA broke above the 200-dma and is playing catchup with the S&P 500. If the markets are going to move higher, DIA will give us some additional participation in the short-term.

However, we also backed up that increased equity exposure by making some swaps in our bond holdings. With yields so low, and the Fed active in the bond markets, we swapped out of our extremely short-duration Treasury holdings into Mortgage-Backed (MBB) and Broad Bond (AGG) market exposures. This move not only gives us some duration exposure to participate if yields fall further, which we expect, plus an increase in yield towards 2.5%.

We continue to hold our hedges for now as both UUP and TLT have begun to rally from deeply oversold conditions.

We continue to remain defensive, but we are nearly fully allocated to equity markets currently. While the Fed is active in the markets, we must participate, but that doesn’t mean we can’t do it with a bit of “risk” control. 

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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

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Arete’s Observations 6/19/2020

David Robertson, CFA serves as the CEO and lead Portfolio Manager for Arete Asset Management, LLC. Dave has analyzed stocks for thirty years across a wide variety of sizes and styles. Early in his career, he worked intimately with a sophisticated discounted cash flow valuation model which shaped his skill set and investment philosophy. He has worked at Allied Investment Advisers and Blackrock among other money management firms. He majored in math with extensive studies in economics and philosophy at Grinnell. At Kellogg, Dave majored in finance, marketing, and international business while completing the CFA program concurrently.


Areté’s Observations 6/19/20

Market observations

After the market hit an air pocket at the end of last week and futures were down going into Monday morning, it looked like this might be a week of digestion or even reckoning.

As soon as the market opened, however, stocks started moving up and continued to do so steadily through the day. One reason may have been that discussions of a large infrastructure spending plan came up again. Another reason was that the Fed made a surprise announcement that it was expanding its corporate bond buying program.

This happened as the volatility index (VIX) remained elevated from the week before which may have provided some motivation. However, the Fed move also nudged the bond fund LQD up to hit its all-time high. The paradox leaves the Fed’s rationale as an open question, but market participants wasted no time interpreting the move as open season for stocks.

On Tuesday, a strong retail sales report kept the positive sentiment going. Wednesday was quiet and on Thursday, greater than expected new unemployment claims sent prices down again. Friday is a big options expiration day and started on an up note.

Economy

Federal Tax Receipts Show A Record Plunge In May, Raising More Doubts About Employment Data Accuracy

Last week I discussed the surprisingly good May jobs report and the qualifications that should accompany those numbers. This week proves the point. New data from the Monthly Treasury Statement shows “federal withheld income tax receipts falling a record 33% from the comparable period one year ago”. In addition, “The scale of the decline in tax receipts is nearly three times the decline in reported household and payroll employment.”

This discrepancy raises a couple of points. One is that you can increase your conviction about something when you have more data and more confirming data. A single data point can be subject to a lot of error.

Another point is that hard data is better than modeled data and tax receipts are hard data. As a result, the tax receipts are more likely to provide an accurate picture of the situation than the May jobs report.

ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES, MAY 2020

Yet another economic report – the May retail sales report – came out on Tuesday and this time the news was good and fairly uncontroversial. Although a rebound was expected, the reported numbers were better than expected with headline sales up 17.7% sequentially. That said, the year over year change was still down 6.1%. Dig into the sales categories a bit and you can see why it is important to maintain perspective. Clothing sales, for example, were up 188% in May, but are still down 63.4% from where they were a year ago.

This tweet by @TaviCosta also reveals something potentially interesting about spending trends. While OpenTable reservations have trended up, as would be expected, recently they have ticked down again. Why?

There is always a possibility of a data glitch, but that doesn’t seem very likely in this case. I’ll offer another hypothesis – which is also partly a projection of my own experiences: After being cooped up for three months, people are champing at the bit to return to normal ways and experiences.

Once people actually get out to realize those experiences, however, they discover in many cases that the experiences are not as good as they remembered or hoped for. As a result, some enthusiasm for repeating the experience is lost. This isn’t anyone’s fault; it is just a function of the world adapting and trying to keep people safe.

The important question this raises is, how robust will the recovery be? While there are good reasons to be encouraged that some sense of normalcy is returning, this is also happening with the helpful (and temporary) cushions of extended unemployment benefits, rent and mortgage moratoria, and small business loans. When such assistance runs out, there is a good chance that several businesses will not be able to continue.

Nowhere is such caution more appropriate than with the restaurant industry. Many restaurants are independently owned, run on thin margins, and are dependent on relatively dense seating arrangements in order to be economically viable.

85% of independent restaurants may go out of business by the end of 2020, according to the Independent Restaurant Coalition

“As many as 85% of independent restaurants may permanently close because of the pandemic by the end of 2020, according to a report commissioned by the Independent Restaurant Coalition.”

Inequality

This is an issue that I continue to think is hugely underappreciated. The fact is that Millennials have faced more difficult economic conditions than any other generation in a few hundred years. I’m pretty sure most other generations do not appreciate the degree to which this is the case.

Although part of the problem is demographics, and therefore not controllable, part of the problem is excessive debt, which is controllable. Persistent overspending, excessive aversion to paying for it, and an unwieldy backlog of entitlement promises have been dealt with by issuing increasing quantities of debt.

Since the vast majority of the incremental debt is paying for consumption (as opposed to investments), it is simply pulling forward demand at the expense of future growth.

I don’t have kids but I still cannot understand why a society would choose to systematically deprive its kids of a fair chance to be economically productive. Things like Medicare, Social Security, and extended unemployment benefits are not bad things, but they are not free either. The graph at the right is an excellent illustration of the cost of such programs.

Fiscal and monetary policy

Given the scale and prominence of policy initiatives (both fiscal and monetary) since the market’s selloff in March, it is fair reflect on what has been done and how effective it has been. As Nomi Prins tweeted, it appears the Fed’s recent efforts to expand purchases of corporate bonds was wholly unnecessary.

This begs the question of why the Fed felt compelled to act? Was it spooked by the rise in the volatility index the week before? Maybe. Nonetheless, the moves are extremely difficult to justify given the record low yields on corporate bonds.

Is it possible that the Fed has finally capitulated and accepted that this is it’s “do whatever it takes” moment? Possibly, and scary if true. There certainly seems to be some degree of acceptance that this might be the case.

My favorite contender as an explanation is similar but more specific: the Fed can see all-too-clearly how weak the underlying economy is and knows that it needs to do whatever it can to keep things afloat.

John Hussman mentioned a Wapo article that highlights the lack of transparency in regard to the PPP loans. As an analyst, I have found that when companies or people do something well, they have every incentive in the world to publicize that performance. I have also found that there is pretty much only one reason why people fail to disclose information and that is to hide something. Regardless, the recalcitrance of the administration to disclose information regarding the disbursement of public funds not only raises warning flags about potential impropriety, it also raises the hurdles for securing additional funding to support the economy. What Senator or Representative wants to be accused of approving public funds for dubious purposes?

Finally, this note by Brad Huston helps put things in perspective. We all have our own views as to how effective or ineffective policy has been in dealing with the coronavirus. How does that perceived benefit match up with $10,393 for every single person in the US? My vote is less.

Monetary policy

One of the flagship monetary policies the Fed has relied on dating way back to the financial crisis in 2008 is quantitative easing (QE). As Michael Lebowitz describes in a recent post, QE was useful in “forcing investors into riskier assets” by reducing the supply of “safe” Treasuries.

In anticipation of even greater issuance of Treasury debt and the distinct possibility that there will be a dearth of investors willing to buy it at acceptably low yields, the Fed is planning its next moves. Near the top of the agenda is what is referred to as yield curve control (YCC).

As Lebowitz also describes, “Embedded in YCC is the specific goal of targeting particular interest rates across the entire yield curve.” In other words, the Fed buys or sells Treasuries in order to achieve the prescribed interest rate for each tenor.

The only problem is, should the Fed buy Treasuries to achieve the desired rates – or sell them?

Further Investigations into the Term Structure of Interest Rates

“I argue that LSAP [large scale asset purchases such as QE] ultimately result in higher (not lower) Treasury term premia, steeper (not flatter) yield curves and higher (not lower) long-term yields.”

“LSAP are multi-faceted: the signalling and liquidity impacts of LSAP on the demand for government bonds outweigh any scarcity and duration effects.”

Research by Michael Howell not only provides valuable insight into the dynamics of asset purchases, but also raises serious questions about how to conduct monetary policy.

A key assumption behind YCC is that the price (and therefore yield) of Treasuries responds directly to supply and demand. If the Fed steps in to buy existing Treasuries, demand goes up, price goes up, yields go down. Simply dial purchases up or down until you get to the desired yield.

Howell indicates that things are not nearly so straightforward. Although purchases of Treasuries have an incremental effect on demand, those purchases have an even greater (and opposite) effect by signaling an improved environment for risk-taking. Recent experience with Treasury purchases through QE has also shown that those purchases cause prices to go down and yields to go up instead of the other way around.

This puts the Fed in quite a quandary and one that I have not yet heard discussed. If the Fed implemented YCC, it could purchase Treasuries with the intent of lowering yields, but inadvertently send yields higher. Alternatively, it could sell Treasuries, and inadvertently send the wrong signal. My conclusion is that there is a significant chance of some severe interest rate volatility in the foreseeable future.

Media

The American Press Is Destroying Itself

“It’s established now that anything can be an offense, from a UCLA professor placed under investigation for reading Martin Luther King’s “Letter from a Birmingham Jail” out loud to a data scientist fired* from a research firm for — get this — retweeting an academic study suggesting nonviolent protests may be more politically effective than violent ones!”

“All these episodes sent a signal to everyone in a business already shedding jobs at an extraordinary rate that failure to toe certain editorial lines can and will result in the loss of your job.”

While Matt Taibbi is sure to provoke some disfavor by writing, “the American left has lost its mind,” he goes on to address an important issue for all of us who rely on news and information. Increasingly, reporters and editors are being penalized for doing what they are supposed to do: report the news.

Of course there are reporters who misrepresent situations and those who act unethically. But there are also journalists who investigate wrongdoing, who speak truth to power, and who provide a platform for discussing serious issues. None of the examples Taibbi highlights were people with an intent to cause harm. Quite the opposite. They were people with the courage to address important issues. It’s not that hard to tell the difference.

I’m not sure what motivates people to try to shut down constructive conversation and I am still struggling to understand why so many people passively allow it to happen. Regardless, the effect is to significantly constrain society in its effort to work through difficult challenges. It also dilutes the quality of information we receive and therefore makes it even harder to make good decisions on things that require good information (like investing).

Implications for investment strategy

So, we have an environment in which GDP is going to be terrible for the second quarter but we are clearly recovering. The big outstanding question is, recovering to what?

At the same time, fiscal policy is filling in for lost income in a number of places but in doing so, is also masking some of the permanent damage underneath. Monetary policy has been even more aggressive seemingly jumping into action at any little flinch in the markets. How should investors balance these tradeoffs?

An easy answer is to simply capitulate and concede that the Fed is “all-in” when it comes to keeping markets afloat and there is no use fighting it. There is at least some truth to this although it is more of a pragmatic decision than an investment decision.

One thing that has been abundantly clear is that the Fed is determined to push investors further and further out on the risk curve (I addressed this subject earlier in the year in a blog post). Evidence of this can be seen in growth stocks that discount absurdly high growth rates, pension funds further increasing exposure to higher returning assets such as private equity, and unusually large equity exposures for retirees.  

How far is too far? We may be getting close. Advisors who manage money for other people must do so in a way that is responsible and prudent if they want to be registered advisors. If valuations get stretched, implied growth numbers get too high, or exposure to risky assets creeps up, there is usually enough wiggle room to explain discrepancies away.

However, there are things that cannot be explained away. For example, last week I mentioned that some of the best performing stocks were from companies that were either severely distressed or actually bankrupt. Hertz (HTZ) was a prime example.

Since then, HTZ decided to exploit this good fortune by petitioning the bankruptcy court to do a secondary offering of up to $500 million. In the registration statement the company states as a risk:

“Consequently, there is a significant risk that the holders of our common stock, including purchasers in this offering, will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.”

Indeed, with stock valued at approximately negative $2 billion, the offering of $500 million would most likely end up being a direct transfer of value from equity holders to debt holders. As such, it is hard to imagine a situation in which a registered advisor could argue that such an investment is prudent. If this is an indication of how far the Fed is willing to push investors out on the risk curve, they are going to push registered advisors right out of the business.

Interestingly, on Wednesday, the SEC (which is broadly tasked with protecting investors) intervened and HTZ withdrew the offering. So, on one hand a government agency is incentivizing investors to take on more and more risk, and on the other hand a different government agency is stepping in to protect investors from the recklessness that ensues from those actions.

The HTZ example, although extreme, does provide a useful benchmark for investors. If the value proposition of an investment is so poor that an investment professional would risk breaching their fiduciary duty by recommending it, it probably is not suited to your long-term investment needs. Trade, speculate, gamble with money you can afford to lose, sure. But remember that’s all it is.

Feedback

This publication is an experiment intended to share some of the ideas I come across regularly that I think might be useful. As a result, I would really appreciate any comments about what works for you, what doesn’t work, and what you might like to see in the future. Please email comments to me at drobertson@areteam.com. Thanks!        – Dave

Principles for Areté’s Observations

  1. All of the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

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#MacroView: Retail Sales Bounce, But Consumers Are Tapped Out.

There was a good bit of excitement on Tuesday with the release of the retail sales report, which came in stronger than expectations. However, the bounce will be difficult to maintain as tapped out consumers face high unemployment and a slow recovery.

As we have discussed many times previously, the consumer is the lynchpin to the economy, comprising roughly 70% of economic growth.

The most valuable thing about the consumer is they are “financially stupid.” But what would expect from a generation whose personal motto is “YOLO – You Only Live Once.” However, this is why you “never count the consumer out,” as they always find a way to go further into debt.

Consumers are also why companies spend billions on social media, personal influencers, television, radio, and internet advertising. If there is an outlet where someone will watch, listen, or read, you will find ads on it. Why? Because psychologically, consumers are “trained” to “shop till they drop.” 

As long as individuals have a paycheck; they will spend it. Give them a tax refund; they will spend it. Issue them a credit card; they will max it out. Give them a government stimulus check; they will spend it as well. Don’t believe me, then why is consumer debt at record levels?

Debt-Driven Consumption

If consumers were even partially responsible, financial guru’s like Dave Ramsey wouldn’t have a job selling products to get people out of debt.

However, consumers spending themselves further into debt is what keeps stock markets going higher and the economy going. Note, that I said “going,” and not “growing,” Take a look at the chart below:

In 1980, household credit market debt stood at $1.3 Trillion. To move consumption from 61% to 65% of GDP by 2000, it required an increase of $5.5 Trillion in debt. Since 2000, consumption as a percent of the economy has risen by just 3% over the last 20 years. To support that increase in consumption, it required an increase in personal debt of more than $11 Trillion.

You should not dismiss the importance of that statement. It has required twice as much debt to increase consumption by 3% of the economy since 2000 than it did to increase it by 4% from 1980-2000. The problem is quite clear. With interest rates already at historic lows, consumers heavily leveraged and economic growth running at sub-par rates; there is not much capability to increase consumption that would replicate the economic growth rates of the past.

The Mirage Of Wealth

The mirage of consumer wealth has been a function of surging debt levels. “Wealth” is not borrowed but “saved.” Such is a lesson too few individuals have learned.

This record level of household debt is also why the Fed’s measure of “Saving Rates” is entirely wrong. It is also why economic growth will continue to weaken as debt continues to deter disposable incomes away from consumption into debt service.

“The ‘gap’ between the ‘standard of living’ and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the ‘gap.’ However, following the ‘financial crisis,’ even the combined levels of income and debt no longer fill the gap. Currently, consumers cannot fill the record $2654 annual deficit to maintain their lifestyle without more debt.”

The gap between the standard of living and incomes is another reflection of the wealth inequality which is pervasive in the economy.

Less Than Meets The Eye

While there was a massive jump in retail sales in May, a look below the headlines revealed a different picture. As noted by Mish Shedlock:

“Despite the surge, sales numbers are back to levels seen in late 2015 and early 2016. On a year-over-year basis, sales are  6.1% below May 2019. Total  sales for the March 2020 through May 2020 period are down -10.5% from the same period a year ago. 

Here are the 5-month totals:

  • Total: -4.7%
  • Motor Vehicles and Parts: -10.5%
  • Furniture: –18.1%
  • Electronics and Appliances: -19.3%
  • Building Materials: +6.7%
  • Food and Beverage Stores: +13.1%
  • Health & Personal Care: -2.4%
  • Gasoline: -16.7%
  • Clothing: -42.9%
  • Sporting Goods: -9.9%
  • Department Stores: -21.0%
  • Nonstore Retailers: +16.6
  • Food and Drinking Places: -22.3%”

Notice the only positive sectors were those directly related to the partial reopening of the economy. Such was not unexpected, but it is also likely unsustainable. The stimulus checks are gone and more checks may be problematic to get through a deeply divided Congress. The additional $600 in unemployment benefits runs out next month, and there is only talk of a bill to extend them at reduced levels.

Unemployment is still a problem.

No Getting Back

Given that retail sales make up roughly 40% of personal consumption expenditures which in turn comprises roughly 70% of GDP, the impact to sustained economic growth is important to consider. As noted unemployment is running at very high levels, but without a substantial pickup in retail sales, re-employment may be disappointing.

What the headlines miss is the growth in the population. The chart below shows retails sales divided by the current 16-and-over population. (If you are alive, you consume.) 

Retail sales per capita were previously on a 5% annualized growth trend beginning in 1992. However, after the financial crisis, the gap has yet to be filled and currently runs at just a 3% growth rate. Assuming we recover to full-employment next month, and retail sales return to its 3% growth trend, retail sales will take another step backward.

Such is the same outcome as we discussed last week with expectations for economic recovery. To wit:

“Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.”

stocks economy, #MacroView: The Great Divide Between Stocks &#038; The Economy

Employment Problem

There are two reasons for this, which are continually overlooked or worse simply ignored, by the mainstream media and economists. The first is that despite the “longest run of employment growth in U.S. history,” those who are finding jobs continues to grow at a substantially slower pace than the growth rate of the population. The economic shutdown exposed this weakness.

“Since the beginning of the last economic expansion, the working-age population has grown by 25.3 million while employment has fallen by 1.14 million through May. As the BLS confirms above, there are over 26 million who are “missing” due to how employment is calculated.”

Market, The Bull Is Back! Markets Charge As Economy Lags 06-05-20

“What is crucially important to the economy is full-time employment, which creates enough income to expand economic growth. The number of full-time employees to the working-age population is at 44.81%, which is not high enough to support economic growth.”

Market, The Bull Is Back! Markets Charge As Economy Lags 06-05-20

If you don’t have a job, and primarily live on government support (as 1-in-4 Americans currently do), it is difficult to consume at higher levels to support economic growth.

Consumers Are All Tapped Out

Secondly, while stimulus checks and extra-benefits may provide a temporary boost to incomes, that income boost is only temporary. The reality is that 80% of Americans continue to live paycheck-to-paycheck and have little saved in the bank. As shown above, after years of wage stagnation, the cost of living now exceeds what incomes and debt increases can sustain.

It is also why despite the annual hopes of “stronger economic growth,” the 3-year average of economic growth continues to deteriorate. With consumers forced to consume more on credit, such will lead to a slower economic recovery as the ability to tap additional credit becomes problematic.

The impact on the economy from record levels of unemployment will have a wide range of impacts forestalling an economic recovery. The first, is a deep suppression of wage growth, which is derived from both recessionary drags and job losses.

"savings mirage" save economy, #MacroView: &#8220;Savings Mirage&#8221; Won&#8217;t Save The Economy

Tightening Up

As stated, with reduced incomes, it is harder to make ends meet harder to obtain additional credit. Given consumers are dependent upon credit to “fill the gap,” and with banks tightening lending standards, access to credit will become more difficult.

"savings mirage" save economy, #MacroView: &#8220;Savings Mirage&#8221; Won&#8217;t Save The Economy

Both of these factors will likely ensure the expected “V-shape” recovery in the economy is overly optimistic. While the data has certainly bounced as the economy is reopened, the headwinds will likely stall the advance.

One of the ongoing problems with the data is that aging demographics, massive monetary interventions, and the structural change in employment has skewed the seasonal-adjustments in economic data. These issues skew every report from employment, retail sales, and manufacturing to appear more robust. Such is a problem mainstream analysis continues to overlook but will be used as an excuse when the data reverses.

Deterioration in economic confidence is hugely important. The most significant factors weighing on consumption are job losses which crush spending decisions by consumers. Such starts a virtual spiral in the economy as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices, until the cycle is complete.

Conclusion

As I discussed last week, the current detachment of the stock market from the economy is likely an illusion that will not last long.

“The economic destruction playing out in real-time will eventually weigh on markets. There is a negative feedback loop between employment and consumption. As unemployment rises, consumption falls due to a lack of income. Since businesses operate based on demand for goods and services, the correlation between PCE, fixed investment, and employment is high.”

stocks economy, #MacroView: The Great Divide Between Stocks &#038; The Economy

As noted, even with the reopening of the economy, businesses will not immediately return to full operational activity, until consumption returns to normalized levels. Without a ready vaccine, if there is a second wave of the virus, consumer confidence would likely reverse. Such would put further pressure on sales and, ultimately, corporate profits.

stocks economy, #MacroView: The Great Divide Between Stocks &#038; The Economy

As I concluded in a note last year:

“It is hard for consumers to remain ‘confident’ and continue spending when they have lost their source of income.

While the markets have indeed managed a strong “rally” from the March lows, there are reasons to be cautious.

We are just entering into what will likely be a more protracted, deeper, and more damaging recession than what we saw in 2008. Defaults and bankruptcies are only in the very early stages. Liquidity from the Fed has repaired credit spreads for the time being. Still, the longer this recession drags on, the higher the risk is the Fed only delayed the inevitable.

The Federal Reserve did move quickly to assist the credit markets in remaining operational, as discussed here. However, those “emergency measures” don’t translate into more robust economic prosperity, revenues, or corporate profits.

Despite the bounce in retail sales, there will still be no “V-shaped” recovery. 

Invest accordingly.

#WhatYouMissed On RIA This Week: 06-19-20

What You Missed On RIA This Week.

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

Here is this week’s rundown of what you missed. A collection of our best thoughts on investing, retirement, markets, and your money.

Webinar: Candid Coffee

After our recent “Great Reset” webinar there were so many questions, we couldn’t get to them all. Candid Coffee is an upcoming series of events specifically designed to answer YOUR questions.

Got a question you want us to answer? CLICK HERE

Join Us: Saturday, June 27th from 8-9 am.

The Week In Blogs

Each week, the entire team at RIA publishes the research and thoughts which drive the portfolio management strategy for our clients. The important focus are the risks which may negatively impact our client’s capital. If you missed our blogs last week, these are the risks we are focusing on now.

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Our Latest Newsletter

Each week, our newsletter covers important topics, events, and how the market finished up the week. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how to trade it.

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What You Missed: RIA Pro On Investing

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

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The Best Of “The Real Investment Show”

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

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What You Missed: Video Of The Week

What The Heck Is “Yield Curve Control”

Michael Lebowitz and I discuss the Fed’s buying of corporate bonds and delve into the issues of “yield curve control” and what it means for the markets, gold, and inflation.

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What You Missed: Our Best Tweets

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. Here are a few from this past week that we thought you would enjoy. Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Relative Value Report 6/18/2020

This week’s report uses data through Wednesday’s closes instead of Thursday.  

The Relative Value Report provides guidance on which sectors, indexes, and bond classes are likely to outperform or underperform their appropriate benchmark.

Click on the Users Guide for details on the model’s relative value calculations as well as guidance on how to read the model’s graphs. 

This report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary

  • In general, based on the sector changes over the last week, most sectors didn’t move as much as we have been witnessing. It is worth pointing out that the data from 5 days ago was the sharp 5% equity decline on June 11th.
  • Healthcare improved slightly but remained the only oversold sector. There are no deeply overbought sectors.
  • Despite reduced movement on the sector front, the indexes showed a little more change. Value remains the most oversold index, and the Dow Jones Industrial Average and Small Caps remain the most overbought.
  • Developed and Emerging foreign equity markets (EFA and EEM) continue to move away from deeply overbought conditions, toward fair value versus the S&P 500.
  • Long Treasury bonds (TLT) moved back to oversold versus the S&P and versus shorter-term Treasury bonds (IEI).
  • The R-squared on the sigma/20 day excess return (Sectors) scatter plot is .4712. Again, the weaker correlation versus prior weeks is not surprising given the recent daily volatility.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

Shedlock: The Myth of the V-Shaped Recovery in One Chart

Retail sales surged in May but manufacturing is another story.

The Fed’s Industrial Production and Capacity Utilization puts a big negative spotlight on the emerging V-shaped recovery thesis.

Industrial Production Highlights

  • Industrial production increased a weaker than expected  1.4% in May. The Econoday consensus was 2.9%.
  • A negative revision took April from -11.2% to -12.5% so essentially there was no rebound at all. 
  • Industrial production in May was 15.4% below its pre-pandemic level in February. 
  • Manufacturing output rose 3.8% in May but languishes near the lows in the Great Recession.
  •  At 92.6% of its 2012 average, the level of total industrial production was 15.3% lower in May than it was a year earlier. 
  • Capacity utilization for the industrial sector increased 0.8 percentage point to 64.8% in May, a rate that is 15.0 percentage points below its long-run (1972–2019) average and 1.9 percentage points below its trough during the Great Recession.

Manufacturing and Motor Vehicles and Parts

  • Motor vehicles and parts production has “rebounded” to a level “below” the bottom of the 1990 recession.
  • Manufacturing is at a 1988 level

Rebound Detail

Rebound Detail

V-Shape Recovery?

These numbers are not remotely close to anything one would ever associate with a V-shaped recovery.

Retail Sales vs Industrial Production

Earlier today I reported Retail Sales Surge Most on Record But Number is Misleading

  • Retail sales surged a greater than expected 17.7% in May but the numbers are still well below the pre-pandemic levels.
  • Despite the surge, sales numbers are back to levels seen in late 2015 and early 2016. 

Stimulus Checks

People got money and spent it, but they also skipped mortgage payments and credit card payments.

What happens when the checks run out?

Those Out of a Job

There are still 20 million people out of work.

It is foolish to believe they will all be back working the same number of hours at the end of June.

Fed vs Kudlow

True State of the Economy

Today’s dismal industrial production numbers put a better spotlight than retail sales on the true state of the economy.

Off to the Races Not

There are too many things that can go wrong and many of them will. 

It will take years for this economy to recover.