Monthly Archives: February 2020

RIA PRO: Market Believes It Has Immunity To Risks


  • Market Believes It Has Immunity To Risk
  • MacroView: Debt, Deficits & The Path To MMT
  • Financial Planning Corner: Why Dave Ramsey Is Wrong About Life Insurance
  • Sector & Market Analysis
  • 401k Plan Manager

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Catch Up On What You Missed Last Week


Market Believes It Has Immunity To Risks

As noted last week, the spread of the coronavirus has had little impact on the markets so far.

“”The market bounced firmly off the 50-dma and rallied back to new highs on Thursday. While Friday saw a bit of retracement, which isn’t surprising given the torrid move early in the week, the ‘virus correction’ was recovered. Importantly, sharp early-week rally kept ‘sell’ signal from triggering,

Chart Updated Through Friday

In review, we previously took some profits out of portfolios as we were expecting between a 3-5% correction to allow for a better entry point to add equity exposure. While the “virus correction” did encompass a correction of 3%, it was too shallow to reverse the rather extreme extension of the market.

The continued rally this past week has fully reversed the corrective process and returned the markets to 3-standard deviations above the 200-dma. Furthermore, all daily, weekly, and monthly conditions have returned to more extreme overbought levels as well.

This was a point we discussed with our RIAPRO subscribers (Try for 30-days RISK FREE) in Thursday’s technical market update. To wit:

  • On a weekly basis, the market backdrop remains bullish with a weekly buy signal still intact.
  • However, that buy signal is extremely extended and has started to reverse with the market extremely overbought on a weekly basis.
  • This is an ideal setup for a bigger correction so some caution is advised.
  • With the market trading above 2-standard deviations, and testing the third, of the intermediate term moving average, some caution is suggested in adding additional exposure. A correction is likely over the next month which will provide a better opportunity. Remain patient for now.

It is here that investors tend to go astray.

In the short-term, the market dynamics are indeed bullish which suggests that investors remain invested at the current time.

However, on a long-term basis, the picture becomes much more concerning.

  • As noted above, this chart is not about short-term trading but the long-term management of risks in portfolios. This is a quarterly chart of the market going back to 1920.
  • Note the market has, only on a few rare occasions, been as overbought as it is currently. The recent advance has pushed the market into 3-standard deviations above the 3-year moving average. In every single case, the reversion was not kind to investors.
  • Secondly, in the bottom panel, the market has never been this overbought and extended in history.
  • As an investor it is important to keep some perspective about where we are in the current cycle, there is every bit of evidence that a major mean reverting event will occur. Timing is always the issue which is why use daily and weekly measures to manage risk.
  • Don’t get lost in the mainstream media. This is a very important chart.

Nothing Out Of Kilter

This past week Ed Yardeni via Yardeni Research, made a good point:

“The markets must figure that the coronavirus outbreak will be contained soon and go into remission, as did SARS, MERS, and Ebola. If that doesn’t happen, then there will be a vaccine that will make us feel better. It won’t be a miracle cure coming from a drug company. Rather, it will be injections of more liquidity into the global financial markets by the major central banks.

On Tuesday, Fed Chair Jerome Powell implied that the Fed is on standby to do just that. In his testimony on monetary policy to Congress, he said, ‘Some of the uncertainties around trade have diminished recently, but risks to the outlook remain. In particular, we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy.’”

Not surprisingly, the “ringing of Pavlov’s bell” once again sent investors scurrying to take on risk.

Interestingly, however, was that during Powell’s testimony to the Senate Banking Committee this past week, he said:

“There is nothing about this economy that is out of kilter or imbalanced.”

Okay, I’ll bite.

“Mr. Powell, if there is nothing out of kilter or imbalanced in the economy, then why are you flooding the system with a greater level of ’emergency’ measures than seen during the ‘financial crisis.'”

It is at this point that I feel like Mr. Lorensax from “Ferris Bueller’s Day Off.”

“Anyone…Anyone…”

  • Side Note: The irony of that particular clip, is that Mr. Lorensax is asking his class about the “The Smoot-Hawley Act,” which was intended to raise revenue via tariffs and lift the U.S. out of the “Great Depression.” Just as with Trump’s recent “tariff” and “trade war,” neither worked as intended.

There is clearly something amiss within the financial complex. However, investors have been trained to disregard the “risk” under the assumption the Federal Reserve has everything under control.

Currently, it certainly seems to be the case as markets hover near all-time highs even as earnings, and corporate profit, growth has weakened. If the coronavirus impacts the global supply chain harder than is currently anticipated, which is likely, the deviation between prices and earnings will become tougher to justify.

Scott Minerd, the CIO of Guggenheim Investments, had a salient point:

Yet as a major economic problem looms on the horizon, the cognitive disconnect between current asset prices and reality feels like the market equivalent of “peace for our time.” The average BBB bond yields just 2.9 percent. A recent 10-year BB-rated healthcare bond came to market at 3.5 percent and subsequently was increased in size from $1 billion to $1.7 billion due to excess demand.

For those investors who perceive the disconnect between risk assets which are priced for a rosy outcome and the reality of the looming risks to growth and earnings, any attempt to reduce risk leads to underperformance. It is a mind-numbing exercise for investors who see the cognitive dissonance. The frantic race to accumulate securities has cast price discovery to the side.

I have never in my career seen anything as crazy as what’s going on right now, this will eventually end badly.

Of course, it will.

The only problem, as he notes, is that between now and then, there is a demand for performance regardless of the underlying risk. Or rather, there is a widely adopted belief the markets can never have a decline again as witnessed by an email I received last week:

“Why do you think there will ever be a correction when the central banks are never going to let credit contract. I see no corrections. Ever. When the US enters a recession, the reality is it will be the biggest buy signal yet. There is literally nowhere to go but up in this market.”

The lessons taught by previous bear markets are always forgotten during enduring bull markets which seem without end. The relearning of those lessons are always painful.

The Path Ahead

The path ahead for stocks is much less certain than in late 2018 when we were coming off deeply depressed sentiment levels, and the Fed was rapidly reversing monetary policy from “tightening” to “easing.”

With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and “repo” operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the “coronavirus” has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which as stated above, is going to make justifying record asset prices more problematic.

Conversely, if by some miracle, the economy does show actual improvement, it could result in yields rising on the long-end of the curve, which would also make stocks less attractive.

This is the problem of overpaying for value. The current environment is so richly priced there is little opportunity for investors to extract additional gains from risk-based investments.

There is one true axiom of the market which is always forgotten.

“Investors buy the most at the top, and the least at the bottom.”

If you feel you must chase the markets currently, then at least do it with a set of guidelines to follow in case things turn against you. We printed these a couple of weeks ago but felt there are worth mentioning again.

  1. Move slowly. There is no rush in adding equity exposure to your portfolio. Use pullbacks to previous support levels to make adjustments.
  2. If you are heavily UNDER-weight equities, DO NOT try and fully adjust your portfolio to your target allocation in one move. This could be disastrous if the market reverses sharply in the short term. Again, move slowly.
  3. Begin by selling laggards and losers. These positions are dragging on performance as the market rises and tends to lead when markets fall. Like “weeds choking a garden,” pull them.
  4. Add to sectors, or positions, that are performing with, or outperforming the broader market.
  5. Move “stop-loss” levels up to current breakout levels for each position. Managing a portfolio without “stop-loss” levels is like driving with your eyes closed.
  6. While the technical trends are intact, risk considerably outweighs the reward. If you are not comfortable with potentially having to sell at a LOSS what you just bought, then wait for a larger correction to add exposure more safely. There is no harm in waiting for the “fat pitch” as the current market setup is not one.
  7. If none of this makes any sense to you – please consider hiring someone to manage your portfolio for you. It will be worth the additional expense over the long term.

While we remain optimistic about the markets currently, we are also taking precautionary steps of tightening up stops, adding non-correlated assets, raising some cash, and looking to hedge risk opportunistically.

Just because it isn’t raining right now, doesn’t mean it won’t. Nobody has ever gotten hurt by keeping an umbrella handy.



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


Financial Planning Corner

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

by Danny Ratliff, CFP®


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Discretionary (XLY) and Utilities (XLU)

As noted previously, we reduced exposure to Utilities and Discretionary due to their extreme overbought condition. Unfortunately, that overbought extension has not been alleviated enough at this time to add back to our holdings. We will likely see a correction in the next couple of weeks to re-evaluate our positioning.

Current Positions: Reduced XLY, XLU

Outperforming – Technology (XLK), Communications (XLC)

We previously recommended taking profits in Technology, which has not only been leading the market but has gotten extremely overbought. The rally in markets last week only further extended those overbought conditions in both Technology and Communications. Hold positions for now, and be patient for a correction to add additional exposure.

Current Positions: Target weight XLK, Reduced XLC

Weakening – Financials (XLF), Healthcare (XLV)

We noted previously added a position in Financials to our portfolios, which we will look to build into over the few weeks. We also had previously added to our healthcare slightly. Both positions ran back to overbought and need more of a correction before considering adding to them.

Current Position: 1/2 Weight (XLF), Target weight (XLV)

Lagging – Industrials (XLI), Real Estate (XLRE), Staples (XLP), Materials (XLB), and Energy (XLE)

With the Fed continuing to pump money into the financial markets, bond yields continue to drop which is supportive for interest rate sectors like Real Estate and Utilities. We previously reduced our holdings to these sectors and we need a correction to work off some of the excesses before adding back to our holdings. Both XLRE and XLU are EXTREMELY extended currently.

Industrials rallied back to new highs without working off the overbought condition. With industrials at 3-standard deviations above the long-term mean, be patient adding additional exposures.

Materials tested and failed previous highs and are testing those highs again. With the sector very overbought there is a risk of a reversal, particularly with the sector very close to registering a “sell signal.”

Energy is deeply oversold and due for a rally. We added to our position of AMLP previously, however, we are maintaining tight stops.

Staples remains in a strong uptrend and has not provided an entry point to add exposure safely.

Current Position: Reduced weight XLY, XLP, XLRE, Full weight AMLP, 1/2 weight XLB and XLI

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Despite the rally in the broader markets, Small- and Mid-caps continue to underperform currently. Both markets rallied last week but have failed to set new highs. Small caps did recover their 50-dma, while mid-caps are currently testing previous highs. Overbought conditions are rather extreme in both.

Current Position: KGGIX, SLYV

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

Emerging and International Markets, look a lot like small-caps above. Both had gotten extremely overbought and needed to correct. That correction broke supports and the subsequent rally failed to set new highs. Both markets have climbed back above their respective 50-dma, but are testing that support line. We remain long our holdings currently, but are closely evaluating our positioning.

Current Position: EFV, DEM

Dividends (VYM), Market (IVV), and Equal Weight (RSP) – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with economic growth and inflation. We are currently maintaining our core positions unhedged for now. If we see deterioration in the broader markets, we will begin to add short-positions to hedge our long-term core holdings.

Current Position: RSP, VYM, IVV

Gold (GLD) – Over the last few weeks, gold has been consolidating near recent highs. Gold remains overbought but continues to hold important support. We are at full weight in the positions, however, if this consolidation continues, supports hold, and the overbought condition recedes, we will consider over-weighting our holdings.

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

Bonds (TLT) –

Bonds rallied back towards previous highs on Friday as money rotated into bonds for “safety” as the market weakened. After previously recommending adding to bonds, hold current positions for now and take profits next week to rebalance risks accordingly. Bonds are extremely overbought now, so be cautious, we added a small portion of TLT to portfolios last week to extend our current duration.

Current Positions: DBLTX, SHY, IEF, Added TLT

Sector / Market Recommendations

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

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

Portfolio/Client Update:

The market rallied this past week on continued expectations that the Fed will intervene sooner, or later, with liquidity to offset the risk of the coronavirus. As such, investors don’t want to “miss out” on the liquidity party when it happens, so they are front-running the event.

This past week, we made a couple of very minor changes to the portfolio which change very little in terms of the overall make up.

Importantly, this rebalancing of risk did not dramatically increase equity exposure. This is because, as noted above, the longer-term technical outlook remains “cautious.”

Yes, we realize we are very late-cycle, we also know that with the Fed, and global Central Banks, still intervening, we must give deference to the “bullish bias.” At the moment, that bias clearly remains, and functioned as we discussed last week.

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

There we no additional portfolio actions this past week.

  • New clients: Slowing adding exposure as needed.
  • Dynamic Model: Added LVS, and a Short-S&P 500 hedge to balance risk while trying to build out the overall model.
  • Equity Model: Sold SLYV to make room to add LVS. Also added TLT to our bond portfolio to lengthen duration a little bit. Given the portfolio is fully allocated to the market positions now have to be shifted to make changes.
  • ETF Model: Add a starting position of TLT to our bond portfolio to lengthen the duration of our current bond mix.

Note for new clients:

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


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See below for an example of a comparative model.


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

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#MacroView: Debt, Deficits & The Path To MMT.

In September 2017, when the Trump Administration began promoting the idea of tax cut legislation, I wrote a series of articles discussing the fallacy that tax cuts would lead to higher tax collections, and a reduction in the deficit. To wit:

“Given today’s record-high levels of debt, the country cannot afford a deficit-financed tax cut. Tax reform that adds to the debt is likely to slow, rather than improve, long-term economic growth.

The problem with the claims that tax cuts reduce the deficit is that there is NO evidence to support the claim. The increases in deficit spending to supplant weaker economic growth has been apparent with larger deficits leading to further weakness in economic growth. In fact, ever since Reagan first lowered taxes in the ’80’s both GDP growth and the deficit have only headed in one direction – higher.”

That was the deficit in September 2017.

Here it is today.

As opposed to all the promises made, economic growth failed to get stronger. Furthermore, federal revenues as a percentage of GDP declined to levels that have historically coincided with recessions.

Why Does This Matter?

President Trump just proposed his latest $4.8 Trillion budget, and not surprisingly, suggests the deficit will decrease over the next 10-years.

Such is a complete fantasy and was derived from mathematical gimmickry to delude voters to the contrary. As Jim Tankersley recently noted:

The White House makes the case that this is affordable and that the deficit will start to fall, dropping below $1 trillion in the 2021 fiscal year, and that the budget will be balanced by 2035. That projection relies on rosy assumptions about growth and the accumulation of new federal debt — both areas where the administration’s past predictions have proved to be overconfident.

The new budget forecasts a growth rate for the United States economy of 2.8 percent this year — or, by the metric the administration prefers to cite, a 3.1 percent rate. That is more than a half percentage point higher than forecasters at the Federal Reserve and the Congressional Budget Office predict.

It then predicts growth above 3 percent annually for the next several years if the administration’s economic policies are enacted. The Fed, the budget office and others all see growth falling below 2 percent annually in that time. By 2030, the administration predicts the economy will be more than 15 percent larger than forecasters at the budget office do.

Past administrations have also dressed up their budget forecasts with economic projections that proved far too good to be true. In its fiscal year 2011 budget, for example, the Obama administration predicted several years of growth topping 4 percent in the aftermath of the 2008 financial crisis — a number it never came close to reaching even once.

Trump’s budget expectations also contradict the Congressional Budget Office’s latest deficit warning:

“CBO estimates a 2020 deficit of $1.0 trillion, or 4.6 percent of GDP. The projected gap between spending and revenues increases to 5.4 percent of GDP in 2030. Federal debt held by the public is projected to rise over the ­coming decade, from 81 percent of GDP in 2020 to 98 percent of GDP in 2030. It continues to grow ­thereafter in CBO’s projections, reaching 180 percent of GDP in 2050, well above the highest level ever recorded in the United States.”

“With unprecedented trillion-dollar deficits projected as far as the eye can see, this country needs a serious budget. Unfortunately, that cannot be said of the one the President just submitted to Congress, which is filled with non-starters and make-believe economics.” – Maya Macguineas

Debt Slows Economic Growth

There is a long-standing addiction in Washington to debt. Every year, we continue to pile on more debt with the expectation that economic growth will soon follow.

However, excessive borrowing by companies, households or governments lies at the root of almost every economic crisis of the past four decades, from Mexico to Japan, and from East Asia to Russia, Venezuela, and Argentina. But it’s not just countries, but companies as well. You don’t have to look too far back to see companies like Enron, GM, Bear Stearns, Lehman, and a litany of others brought down by surging debt levels and simple “greed.” Households, too, have seen their fair share of debt burden related disaster from mortgages to credit cards to massive losses of personal wealth.

It would seem that after nearly 40-years, some lessons would have been learned.

Such reckless abandon by politicians is simply due to a lack of “experience” with the consequences of debt.

In 2008, Margaret Atwood discussed this point in a Wall Street Journal article:

“Without memory, there is no debt. Put another way: Without story, there is no debt.

A story is a string of actions occurring over time — one damn thing after another, as we glibly say in creative writing classes — and debt happens as a result of actions occurring over time. Therefore, any debt involves a plot line: how you got into debt, what you did, said and thought while you were in there, and then — depending on whether the ending is to be happy or sad — how you got out of debt, or else how you got further and further into it until you became overwhelmed by it, and sank from view.”

The problem today is there is no “story” about the consequences of debt in the U.S. While there is a litany of other countries which have had their own “debt disaster” story, those issues have been dismissed under the excuse of “yes, but they aren’t the U.S.”

But this lack of a “story,” is what has led us to the very doorstep of “Modern Monetary Theory,” or “MMT.” As Michael Lebowitz previously explained:

“MMT theory essentially believes the government spending can be funded by printing money. Currently, government spending is funded by debt, and not the Fed’s printing press. MMT disciples tell us that when the shackles of debt and deficits are removed, government spending can promote economic growth, full employment and public handouts galore.

Free healthcare and higher education, jobs for everyone, living wages and all sorts of other promises are just a few of the benefits that MMT can provide. At least, that is how the theory is being sold.”

What’s not to love?

Oh yes, it’s that deficit thing.

Deficits Are Not Self-Financing

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

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

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

Examples of such investments range from the Hoover Dam to the Tennessee River Valley Authority. Importantly, “infrastructure spending projects,” must have a long-term revenue stream tied to time. Building roads and bridges to “nowhere,” may create short-term jobs, but once the construction is complete, the economic benefit turns negative.

The problem for MMT is its focus on spending is NOT productive investments but rather social welfare which has a negative rate of return. 

Of course, the Government has been running a “Quasi-MMT” program since 1980.

According to the Center On Budget & Policy Priorities, roughly 75% of every current tax dollar goes to non-productive spending. (The same programs the Democrats are proposing.)

To make this clearer, 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 was financed by Federal revenues, and $1.1 trillion was financed through debt.

In other words, 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. 

There is also clear evidence that increasing debts and deficits DO NOT lead to either stronger economic growth or increasing productivity. As Michael Lebowitz previously 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.”

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

“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.

The larger the balance of debt has become, the more economically destructive it is by diverting an ever-growing amount of dollars away from productive investments to service payments.

Since 2008, the economy has been growing well below its long-term exponential trend. Such has been a consistent source of frustration for both Obama, Trump, and the Fed, who keep expecting higher rates of economic only to be disappointed.

The relevance of debt growth versus economic growth is all too evident. When debt issuance exploded under the Obama administration, and accelerated under President Trump, it has taken an ever-increasing amount of debt to generate $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 been no organic economic growth.

For the 30-years, from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Today, with the economy expected to grow at just 2% over the long-term, the economic deficit has never been higher. If you subtract the debt, there has not been any organic economic growth since 1990. 

What is indisputable is that running ongoing budget deficits that fund unproductive growth is not economically sustainable long-term.

The End Game Cometh

Over the last 40-years, the U.S. economy has engaged in increasing levels of deficit spending without the results promised by MMT.

There is also a cost to MMT we have yet to hear about from its proponents.

The value of the dollar, like any commodity, rises and falls as the supply of dollars change. If the government suddenly doubled the money supply, one dollar would still be worth one dollar but it would only buy half of what it would have bought prior to their action.

This is the flaw MMT supporters do not address.

MMT is not a free lunch.

MMT is paid for by reducing the value of the dollar and ergo your purchasing power. MMT is a hidden tax paid by everyone holding dollars. The problem, as Michael Lebowitz outlined in Two Percent for the One Percent, inflation tends to harm the poor and middle class while benefiting the wealthy.

This is why the wealth gap is more pervasive than ever. Currently, the Top 10% of income earners own nearly 87% of the stock market. The rest are just struggling to make ends meet.

As I stated above, the U.S. has been running MMT for the last three decades, and has resulted in social inequality, disappointment, frustration, and a rise in calls for increasing levels of socialism.

It is all just as you would expect from such a theory put into practice, and history is replete with countries that have attempted the same. Currently, the limits of profligate spending in Washington has not been reached, and the end of this particular debt story is yet to be written.

But, it eventually will be.

#FPC: Dave Ramsey Is Right & Very Wrong About Permanent Life Insurance (Pt. 1)

Let’s start with the basics, Dave Ramsey is great at a couple of things, budgeting, helping people get out of debt, prioritizing material things and/or putting things in perspective. 

BUT…

There are some things where good ole Dave isn’t so great. I know this is going to surprise many of you, but you need to hear this.

DAVE RAMSEY IS NOT GOOD AT FINANCIAL PLANNING OR INVESTMENT ADVICE.

Allow me to give you some additional context. Dave is good at helping people get out of debt and make better financial decisions, in fact he’s really good. His Financial Peace University has helped so many people get on track to a better life. I’m a really big fan of Dave for the work he does, but my clients and most of our readers have graduated beyond Dave’s philosophy’s to needing more sophisticated planning and advice.

Dave Ramsey believes you should buy term life insurance and invest the rest. In theory it sounds great. For example, if you were to spend $1,000 a month on a permanent life insurance policy- according to Dave you should buy a term policy and invest the rest.

And from a RISK MANAGEMENT mindset I love the idea.

In fact, this is where you should start. Buy a term policy to protect your family. There are many factors to consider when purchasing a term policy and how much you need here are a few:

  • Loss of Income
  • Debt
  • Expenses
  • Children
  • Lifestyle
  • Age
  • Do you have insurance through work? Is it portable if you leave?

The rule of thumb is 7 to 10 times your annual salary-BUT we believe each individual should go through a thorough analysis to help determine what’s right for their family.

Now that you have your bases covered to protecting your family what’s next?

I’m making an assumption that you already have an emergency fund, established a “financial vulnerability cushion” and are wondering where to put additional funds.

Here’s what I hear often-

  • I make too much to put into a Roth IRA
  • I make too much to put into a Roth 401(k)- (no you don’t there are no income limitations)
  • I can’t make tax deductible contributions to a Traditional IRA
  • Where do I put funds?
  • Savings aren’t earning much interest,
  • I’m missing out on returns in the markets (High Yield Savings) No FOMO.
  • Or alternatively, Markets are too high to put funds to work

The list goes on and on.

What has the Financial Industry beat into our brains year after year?

 Tax Deferred Savings, Tax Deferred Savings, Tax Deferred Savings!

Times are changing. With the new Secure Act we just saw the death of the Stretch IRA and are in one of the lowest tax brackets we’ve seen in years. Not to mention the TCJA (current tax code) sunsets in 2026 and there is also a political party dead set on raising taxes if elected.  In regard to debt and taxes neither Democrat or Republican party understands a budget or how to truly curtail deficit spending. U.S. Government let me introduce you to Dave. It’s a match made in Heaven-until it causes a massive recession, but that’s beside the point. I’d expect higher taxes, not austerity.

So how will you prepare for higher taxes?

When helping clients prepare for retirement we look for not only the low hanging fruit or the obvious feel good propositions, but also some of the harder ones. Like paying taxes now.  

Right now we’re the bearers of bad news.

You don’t always retire in a lower tax bracket.

AND, most aren’t prepared for the additional stealth taxes Uncle Sam surprises you with.

Stay with me, I know I’m walking you through a dark tunnel. The light is near.

Envision yourself on a 3-legged stool. Each leg represents a different tax ramification.

  • Leg 1-Fully Taxable
  • Leg 2-Partially Taxable
  • Leg 3-Tax Free

If you could put all of your eggs in one leg where would they be?

Exactly, Leg 3-but why are so many stools so wobbly? I’ll go one step further.

  • Leg 1- 401(k)’s, 403(b)’s, Traditional IRA’s (the feel good’s)
  • Leg 2- Saving’s, Brokerage Accounts, After tax investment Vehicles
  • Leg 3- ROTH 401(k)’s, ROTH IRA’s, CASH VALUE FROM PERMANENT LIFE INSURANCE

We focus on so many other things first.  The typical sequence of savings is:

  • 401(k)
  • Savings
  • Investments

What do these all have in common? Taxes

What do we want to get away from? Taxes

Here’s how I want you to look at Leg 1- it’s not all yours. Treat these funds like a business, but you don’t own all of it Uncle Sam has some ownership in your business. However, this partnership is unlike any other-they can increase their ownership at any time therefore decreasing your probability of success in retirement.

Leg 2- the principal is yours (you’ve already paid the taxes,) but any realized growth, interest and dividends are taxable at either ordinary income levels or capital gains tax rates.

Leg 3- like leg 2 you’ve already paid the taxes, but the earning’s when all the rules are followed are tax free. For obvious reasons this is the more difficult leg to stabilize. It’s not easy, it takes some proper planning and it takes some work.

I believe everyone needs to strengthen leg 3. Most people will do it by utilizing a Roth 401k or a Roth IRA, but a few will use a permanent life insurance policy.

This is where Dave is right- for most people.

Buying term and investing the difference if you are diligent enough to do so is a great strategy for the majority of Americans living paycheck to paycheck or the saver who is doing all they can to make the sacrifices for their family, but they just can’t do much more. 

This is where Dave is wrong?

What about our typical client? These are the people who are doing all the right things, maxing out retirement contributions, maxing out their HSA’s, putting funds into their savings accounts regularly with little to no debt. Do they just keep plugging away putting additional funds into accounts that are taxable?

What about our clients who have a true estate tax problem? These are people who’ve built businesses, acquired land, built wealth with hard work, blood, sweat and tears. Do their heirs liquidate assets just to pay the tax bill?

No, no they don’t they use insurance properly.

Is permanent life insurance wrong for them, Dave?

No, they use insurance as one leg of their 3-legged stool. These are people who take a big picture holistic view, have a financial plan and have planned for these events.

Insurance is something that must be planned, not sold.

I know and hear of too many insurance agents who say everyone needs a Variable Universal Life Policy aka (VUL.) Unfortunately, many of these guys primarily sell property and casualty and are looking for a big-ticket item, the VUL. Which typically carry higher fee’s little or no guarantee’s and premiums that can change. The majority of the time a realistic plan wasn’t done, illustrations are done to show only the best case scenarios and many times the agents themselves are captive to one or two carriers and/or don’t quite know what to look for in an insurance policy or how to choose one that really fits your needs. This is the have hammer, everything is a nail syndrome.

Permanent Life Insurance when done right can play a vital role in a retiree’s financial plan, it can help provide tax free income, some provide guarantee’s to principal and offer low fee’s which help with accumulation of cash value when overfunding the contract.

Which is why we believe insurance should be planned, it’s a solution to a sophisticated problem. Insurance is also a sophisticated product, that deserves a better reputation than many give it.

  • Who doesn’t want some guarantee’s?
  • Who doesn’t want to pay 0% in taxes on distributions?
  • Who doesn’t want protection from the governments stealth taxes?
  • Who doesn’t want creditor protection?
  • Who doesn’t want to protect their family and their hard-earned funds?

I hope this post has opened your eyes to another potential avenue to explore in your plan.

Next week in Part 2, we’ll get into the nitty-gritty of different types of permanent life insurance, how to use them, what to look for in a policy and also what to stay away from.

#WhatYouMissed On RIA: Week Of 02-10-20

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

The Week In Blogs

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Our Latest Newsletter

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What You Missed At RIA Pro

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

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The Best Of “The Lance Roberts Show

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Video Of The Week

Conversation with Michael Lebowitz and Lance Roberts on whether, or not, the markets have built up an immunity to QE.

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Our Best Tweets Of The Week

See you next week!

Will The Corona Virus Trigger A Recession?

As if waking up to an economic nightmare, investors see headlines like these and many others flashing across their Bloomberg terminals:

  • Facebook says Oculus headphone production will be delayed due to virus
  • Apple extends country wide store closing for another week
  • Foxconn delays iPhone production
  • Qualcomm cuts production forecast due to virus uncertainty
  • Starbucks announces China store closures through Lunar New Year, uncertain when they may reopen
  • US Steel flashes a warning of a cut in demand
  • Nike shoe production halted
  • Under Armour missed on sales, and their outlook is weak. They partially blamed the Corona Virus outbreak.
  • IEA forecasts drop in oil demand this quarter- first time in a decade

The seemingly never ending list of delays, disruptions, and cuts rolls on from retail to high technology. Even services are impacted as flights and train trips are canceled within and to and from China.  While some technology-based services are provided over the Internet service, restaurants, training, and consulting, as examples, must be performed in person.  Manufacturing operations require workers to be at the factory to produce products. Thus, manufacturing is much more acutely affected by quarantines, shutdowns, transportation disruption, and other government actions.

It is as if an economic tsunami is rolling over the global economy. China’s economy was 18 % of world GDP in 2019.  For most S & P 100 corporations, the Asian giant is their fastest growing market at 20 – 30 % per year.  Even more critical, China has become the hub of world manufacturing after entering the World Trade Organization in 2000. Over the past two decades, U.S. corporations have relocated manufacturing to China to leverage an inexpensive labor force and modern business infrastructure.

Source: The Wall Street Journal – 2/7/20

Prior to the epidemic, world trade had begun to slow as a result of the China – U.S. trade war and other tariffs.  World trade for the first time since the last recession has turned negative.

Source: Haver Analytics, The Wall Street Journal, The Daily Shot – 1/19/20

Based on severity estimates, analysts have forecasted the impact on first-quarter China GDP growth. In the chart below from Fitch Ratings, growth for first quarter drops almost in half and for year growth drops to 5.2 % if containment is delayed:

Sources: The Wall Street Journal, The Daily Shot – 2/6/20

When news of the virus first was announced, the market sustained a quick modest decline. The next day, investors were reassured by official news from China and the World Health Organization that the virus could be contained. Market valuations bounced on optimism that the world economy would see little to no damage in the first quarter of 2020.  Yet, there is growing skepticism that the official tolls of the virus are short of reality. Doctors report that at the epicenter of Wuhan that officials are grossly underestimating the number of people infected and dead. The London School of Hygiene and Tropical Medicine has an epidemic model indicating there will be at least 500,000 infections at the peak in a few weeks far greater than the present 45,000 officially reported.

The reaction, and not statements, of major governments to the epidemic hint that the insider information they have received is far worse and uncertain.  U.S. global airlines have canceled flights to China until mid-March and 30 other carriers have suspended flights indefinitely – severely reducing business and tourist activities.  The U.S. government has urged U.S. citizens to leave the country, flown embassy staff and families back to the U.S., and elevated the alert status of China to ‘Do Not Travel’ on par with Syria and North Korea. All of these actions have angered the Chinese government. While protecting U.S. citizens from the illness it adds stress to an already tense trade relationship. To reduce trade tension, China announced a relaxation of import tariffs on $75 billion of U.S. goods, reducing tariffs by 5 to 10 %.  President Xi on a telephone call with President Trump committed to complete all purchases of U.S. goods on target by the end of the year while delaying shipments temporarily.  It remains to be seen if uncontrolled events will drive a deeper trade wage between the U.S. and China.

Inside China, chaos in the supply chain operations is creating great uncertainty. Workers are being told to work from home and stay away from factories for at least for another week beyond the Lunar New Year and now well into late-February.  Foxconn and Tesla announced plant openings on February 10th, yet ramping up output is still an issue. It will be a challenge to staff factories as many workers are in quarantined cities and train schedules have been curtailed or canceled.  Many factories are dependent on parts from other cities around the country that may have more severe restrictions on transportation and/or workers reporting to work. Thus, even when a plant is open, it is likely to be operating at limited capacity.

On February 7th, the Federal Reserve announced that while the trade war pause has improved the global economy, it cautioned that the coronavirus posed a ‘new threat to the world economy.’  The Fed is monitoring the situation. The central bank of China infused CNY 2 trillion in the last four weeks to provide fresh liquidity.  The liquidity will help financially stretched Chinese companies survive for a while, but they are unlikely to be able to continue operations unless production and sales return to pre epidemic levels quickly.

Will the Federal Reserve really be able to buffer the supply chain disruption and sales declines in the first quarter of 2020?  The Fed already seems overwhelmed, keeping a $1+ trillion yearly federal deficit under control and providing billions in repo financing to banks and hedge funds causing soaring prices in risk assets. While the Fed may be able to assist U.S. corporations with liquidity through a tough stretch of declining sales and supply chain disruptions, it cannot create sales or build products.

Prior to the virus crisis, CEO Confidence was at a ten year low.  Then, CEO confidence levels improved a little with the Phase One trade deal driving brighter business prospects for the coming year. Now, a possible black swan epidemic has entered the world economic stage creating extreme levels of sales and operational uncertainty.  Marc Benioff, CEO of Salesforce, expresses the anxiety many CEOs feel about trade:

 “Because that issue (trade) is on the table, then everybody has a question mark around in some part of their business,” he said. “I mean, we’re in this strange economic time, we all know that.”

Adding to the uncertainty is a deteriorating political environment in China.  During the first few weeks of December, local Wuhan officials denounced a doctor that was calling for recognition of the new virus. He later died of the disease, triggering a social media uproar over the circumstances of his treatment. Many Chinese people have posted on social media strident criticisms of the delayed government response.  Academics have posted petitions for freedom of speech, laying the blame on government censors for making the virus outbreak worse.  The wave of freedom calls is rising as Hong Kong protester’s messages seem to be spreading to the mainland. The calls for freedom of speech and democracy are posing a major challenge to President Xi.  Food prices skyrocketed by 20 % in January with pork prices rising 116 % adding to consumer concerns. Political observers see this challenge to government policies on par with the Tiananmen Square protests in 1989. The ensuing massacre of protestors is still in the minds of many mainland people. As seems to be true of many of these events that it is not the crisis itself, but the reaction and ensuing waves of social disorder which drive a major economic impact.

Oxford Economics has forecast a slowdown in US GDP growth in the first quarter of 2020 to just .6 %

Sources: Oxford Economics, The Wall Street Journal, The Daily Shot – 2/6/20

Will U.S. GDP growth really be shaved by just .4 %?  If we consider the compounding effect of the epidemic to disrupt both demand and supply, the social chaos in China challenging government authority (i.e., Hong Kong), and a lingering trade war – these factors all make a decline into a recession a real and growing possibility.  We hope the epidemic can be contained quickly and lives saved with a return to a more certain world economy.  Yet, 1930s historical records show rising world nationalism, trade wars, and the fracturing of the world order does not bode well for a positive outcome. Mohammed A. El-Arian. Chief Economic Advisor at Allianz in a recent Bloomberg opinion warns of a U shaped recession or worse an L :

I worry that many analysts do not fully appreciate the notable differences between financial and economic sudden stops. Rather than confidently declare a V, economic modelers need more time and evidence to assess the impact on the Chinese economy and the related spillovers – a consideration that is made even more important by two observations. First, the Chinese economy was already in an unusually fragile situation because of the impact of trade tensions with the U.S. Second, it has been navigating a tricky economic development transition that has snared many countries before China in the “middle income trap. All this suggests it is too early to treat the economic effects of the coronavirus on China and the global economy as easily containable, temporary and quickly reversible. Instead, analysts and modelers should respect the degree of uncertainty in play, including the inconvenient realization that the possibility of a U or, worse, an L for 2020 is still too high for comfort.”

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

S&P 500 Technical Analysis Review 02-13-20

A technical review of the S&P 500 using daily, weekly and monthly charts to determine overbought, oversold, and risk/reward scenarios for carrying equity exposure.

We did this analysis at the end of January, but given the recent surge in the market, which is now pushing the S&P 500 back into extreme overbought territory, it is worth reviewing again to determine our next positioning moves.

We are currently looking at shorting the market in our models, given the right setup. We are close to that point currently.

Let’s take a look at the charts.

Daily

  • The S&P 500 had broken out to new highs which is bullish. However, the more extreme overbought condition of the market remains in terms of deviation from its 200-dma. At 3-standard deviations above the longer-term moving average, it suggests that 99.9% of all potential price movement is built into the advance.
  • On a very short term basis, the market is back to very overbought (top panel) which previously suggested the short-term correction.
  • However, the “buy signal” in the lower panel suggests that the current rally could have a bit more upside. But given the deviation to the 200-dma, I don’t suspect there is much “gas left in the tank.”
  • While we have added some exposure to portfolios recently, we have done so very cautiously with tight stops. That is a good plan to follow for now.

Daily Overbought/Sold

  • The chart above shows a variety of measures from the Volatility Index ($VIX) to momentum and deviation from intermediate term moving averages.
  • We noted back in September and early October that a rally into year-end was likely. At that time all of the indicators had pushed down into their respective “BUY” ranges.
  • Now that situation has reversed, with all indicators back into their respective “SELL” ranges.
  • The previous correction at the end of January did little to reverse those more extreme overbought conditions. This is not “bearish” or suggestive of a “crash” coming, but rather just suggesting that currently the risk/reward for adding additional equity risk is not optimal. A consolidation of price would also resolve the overbought conditions.
  • Be patient for a correction back to support that allows for a better entry point for trading positions.

Weekly

  • On a weekly basis, the market backdrop remains bullish with a weekly buy signal still intact.
  • However, that buy signal is extremely extended and has started to reverse with the market extremely overbought on a weekly basis.
  • This is an ideal setup for a bigger correction so some caution is advised.
  • With the market trading above 2-standard deviations, and testing the third, of the intermediate term moving average, some caution is suggested in adding additional exposure. A correction is likely over the next month which will provide a better opportunity. Remain patient for now.

Monthly

  • On a monthly basis we can see a pattern emerging as well as extremes.
  • First, from an investment standpoint, look at the previous two bull market advances compared to the current Central Bank fueled explosion. When the next mean reverting event occurs, make no mistake, it will be brutal for investors.
  • Secondly, the market is trading MORE THAN 2-standard deviations above the long-term mean and is still flirting with reversing the “buy signal” to a sell.
  • As noted in the red lines, the market continues to trade in a bullish trend from the 2009 lows, but with the market pushing back up into more extreme overbought conditions long-term, there is not likely a lot left to the current bull market.
  • Importantly, MONTHLY data is ONLY valid at the end of the month. Therefore, these indicators are VERY SLOW to turn. Use the Daily and Weekly charts to manage your risk. The monthly and quarterly chart (below) is to give you some idea about overall risk management.
  • However, the important takeaway is that the bull market is still largely intact but there is some deterioration around the edges. This suggests that investors should remain invested for now, but maintain risk controls accordingly.
  • All good things do eventually come to an end.

Quarterly

  • As noted above, this chart is not about short-term trading but long-term management of risks in portfolios. This is a quarterly chart of the market going back to 1920.
  • Note the market has, only on a few rare occasions, been as overbought as it is currently. The recent advance has pushed the market into 3-standard deviations above the 3-year moving average. In every single case the reversion was not kind to investors.
  • Secondly, in the bottom panel, the market has never been this overbought and extended in history.
  • As an investor it is important to keep some perspective about where we are in the current cycle, there is every bit of evidence that a major mean reverting event will occur. Timing is always the issue which is why use daily and weekly measures to manage risk.
  • Don’t get lost in the mainstream media. This is a very important chart.

S&P 500 vs Yield Curve (10yr-2yr)

  • The chart above compares the S&P 500 to the 10-2 year yield spread.
  • The relationship between stocks and bonds is the visualization of the “risk/reward” trade off.
  • When investors are exceedingly bullish, money flows out of “safe” assets, i.e. bonds, into “risk” assets, i.e. stocks.
  • What the chart shows is that when the yield-spread reverses, which is normally coincident with the onset of a recession, such tends to mark peaks of markets and ensuing corrections in stock prices.
  • While the recent spike of the ratio has not resulted in a correction just yet, it doesn’t mean it won’t.
  • Pay attention, all of the market indicators currently suggest risk outweighs rewards and patience will likely be rewarded with a better opportunity to add exposure.
  • As with the Monthly and Quarterly charts above, this is a “warning” sign to pay attention and manage risk accordingly. It does NOT mean sell everything and go to cash. Currently the Daily and Weekly charts suggest the bullish trend is intact, so we remain invested, but hedged.

Falling Oil Prices An Economic Warning Sign

On Tuesday morning, I got engaged in a debate on the recent decline in oil prices following my report on COT Positioning in the space. To wit:

“The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will start to get liquidated which will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.”

It didn’t take long before the debate started.

“Aren’t low oil prices good for the economy? They are a tax cut for the consumer?”

There is an old axiom which states that if you repeat a falsehood long enough, it will eventually be accepted as fact.

Low oil prices equating to stronger economic growth is one of those falsehoods.

Oil prices are indeed crucial to the overall economic equation, and there is a correlation between the oil prices, inflation, and interest rates.

Given that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness. We can see this clearly in the chart below which combines rates, inflation, and GDP into one composite indicator. One important note is that oil tends to trade along pretty defined trends (black trend lines) until it doesn’t. Importantly, since the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which has a negative impact on manufacturing and CapEx spending and feeds into the GDP calculation.

“It should not be surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates.

We can also view the impact of oil prices on inflation by looking at breakeven inflation rates as well.

The short version is that oil prices are a reflection of supply and demand. Global demand has already been falling for the last several months, and oil prices are sending warnings that “market hopes” for a “global reflation” are likely not a reality. More importantly, falling oil prices are going to put the Fed in a very tough position in the next couple of months as deflationary pressures rise. The chart below shows breakeven 5-year and 10-year inflation rates versus oil prices.

Zero Sum

The argument that lower oil prices give consumers more money to spend certainly seems entirely logical. Since we know that roughly 80% of households in America effectively live paycheck-to-paycheck, they will spend, rather than save, any extra disposable income.

However, here is the most important part of the fallacy:

“Spending in the economy is a ZERO-SUM game.”

Falling oil prices are an excellent example since gasoline sales are part of the retail sales calculation.

Let’s take a look at the following example:

  • Oil Prices Decline By $10 Per Barrel
  • Gasoline Prices Fall By $1.00 Per Gallon
  • Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
  • Gas Station Revenue Falls By $16 For The Transaction (-16)
  • End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere, which is true. However, this is the equivalent of “rearranging deck chairs on the Titanic.”

So, let’s now extend our example from above.

Oil and gasoline prices have dropped, so Elaine, who has budgeted $100 to spend each week on retail-related purchases, goes to the gas station to fill up.

  • Elaine fills up her car for $60, which previously cost $80. (Savings +$20)
  • Elaine then spends her normal $20 on lunch with her friends. 
  • She then spends her additional $20 (saved from her gas bill) on some flowers for the dining room.

————————————————-
Total Spending For The Week = $100

Now, economists quickly jump on the idea that because she spent $20 on flowers, there has been an additional boost to the economy.

However, this is not the case. Elaine may have spent her money differently this past week, but she still spent the same amount. Here is the net effect on the economy.

Gasoline Station Revenue = (-$20)
Flower Store Revenue = +$20
—————————————————-
Net Effect To Economy = $0

Graphically, we can show this by analyzing real (inflation-adjusted) gasoline prices compared to total Personal Consumption Expenditures (PCE). I am using “PCE” as it is the broadest measure of consumer spending and comprises almost 70% of the entire GDP calculation.

As shown, falling gasoline prices have historically equated to lower personal consumption expenditures, and not vice-versa. In fact higher oil and gasoline prices have actually been coincident with higher rates of PCE previously. The chart below show inflation-adjusted oil prices as compared to PCE.

While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests this is not the case.

What we find is there is a parity between oil price and the economy. Like “Goldilocks,” prices which are too hot, or too cold, has a negative impact on consumption and economic growth.

Importantly, regardless of the level of oil prices, the only thing which increases consumer spending are increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. They can choose to “save more” which is a drag on economic growth in the short-term (called the “paradox of thrift”), or they can spend what they have. But they can’t spend more, unless they take on more debt. 

Which is what has been occurring as individuals struggle to fill the gap between the cost of living and incomes. (Read more on this chart)

A Bigger Drag Than The Savings

Importantly, falling oil prices are a bigger drag on economic growth than the incremental “savings” received by the consumer.

The obvious ramification of the plunge in oil prices is to the energy sector itself. As oil prices decline, the loss of revenue eventually leads to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all CapEx expenditures in the S&P 500), freezes and/or reductions in employment, not to mention the declines in revenue and profitability.

Let’s walk through the impact of lower oil prices on the economy.

Declining oil prices lead to declining revenue for oil and gas companies. Given that drilling for oil is a very capital intensive process requiring a lot of manufactured goods, equipment, supplies, transportation, and support, the decrease in prices leads to a reduction in activity as represented by Capital Expenditures (CapEx.) The chart below shows the 6-month average of the 6-month rate of change in oil prices as compared to CapEx spending in the economy.

Of course, once CapEx is reduced the need for employment declines. However, since drilling for oil is a very intensive process, losses in employment may start with the energy companies, but eventually, all of the downstream suppliers are impacted by slower activity. As job losses rise, and incomes decline, it filters into the economy.

Importantly, when it comes to employment, the majority of the jobs “created” since the financial crisis has been lower wage-paying jobs in retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc.

In fact, each job created in energy-related areas has had a “ripple effect” of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.

Given that oil prices are a reflection of global economic demand, falling oil prices have a negative feedback loop in the economy as a whole. The longer oil prices remain suppressed, the negative impacts of loss of employment, reductions in capital expenditures, and declines in corporate profitability will begin to outstrip any small economic benefit gained through consumption.

Simply put, lower oil and gasoline prices may actually have a bigger detraction on the economy than the “savings” provided to consumers.

Newton’s third law of motion states:

“For every action, there is an equal and opposite reaction.”

In any economy, nothing works in isolation. For every dollar increase that occurs in one part of the economy, there is a dollars’ worth of reduction somewhere else.

Selected Portfolio Position Review: 02-12-2020

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

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

ABT – Abbott Laboratories

  • We bought ABT in early 2019, and have taken profits twice along the way.
  • ABT has been on a deep “sell signal” for a while and has now reversed that signal maintaining a fairly tight consolidation range over the last 7-months.
  • We are maintaining our current stop level, and will look to add to our holding on a pullback to 82.50.
  • Stop is set at $77.50

JNJ – Johnson & Johnson

  • We bought JNJ when it was out of favor with the market over their “talc” lawsuit issues.
  • With the bulk of the those issues behind them, the stock has rebounded sharply. We took profits in the position as it is now EXTREMELY overbought and more than 2-standard deviations above the 200-dma.
  • We are moving our stop up to $135

AGNC – Agency Mortgage REIT

  • We bought 2 positions to benefit from a steepening of the 10-2 yield curve which came to pass and has now begun to invert again. However, our “steepner play” continues to rise.
  • Since we were at full weight in AGNC, and only 1/2 weight in NLY, we took profits in AGNC and reduced the position as it remains grossly extended and deviated from its long-term mean.
  • The buy signal is also extremely extended as well.
  • We are moving our stop up to $15.25

AMZN – Amazon.com, Inc.

  • We bought AMZN in 2019 heading into the winter shopping season. It did nothing for quite some time but in just the last couple of weeks, it has exploded higher.
  • The buy signal is now getting extended and AMZN is now 4-standard deviations above the long-term mean. This is not sustainable. We will likely take profits out of this position if we see weakness in the broader market begin to exert itself.
  • Stop is moved up to $1800.

AEP – American Electric Power Co.

  • AEP has remained a strong performer for us, and we like Utilities into 2020.
  • AEP has triggered a buy signal which got extremely extended very quickly with the sharp spurt higher over the last few weeks.
  • At 3-standard deviations above the longer-term mean we will have to wait for a correction or consolidation to add further exposure.
  • Stop is set at $90

IAU – Gold

  • We sold 1/2 of IAU near the peak in gold prices (as it was 2-standard deviations above the 200-dma) to bring in profits and protect our position. When then added back to IAU in early December.
  • IAU has broken out to new highs and while overbought on a short-term basis it has now registered a buy signal.
  • If we get some more consolidation or a bit of correction that holds support, we will look to overweight our position.
  • Stop is moved up to $14.

DOV – Dover Corp.

  • DOV has been a great performer for the portfolio particularly as the “trade war” has gotten resolved.
  • DOV is exceedingly overbought and the buy signal extremely extended. A correction is inevitable.
  • We have taken profits previously, but we are monitoring the position for an opportunity to reweight the position in the portfolio.
  • Stop loss moved up to $102.50

MU – Micron Technology

  • MU was an add for us in 2019. We had owned it previously but got stopped out, however, our second entry has performed much better.
  • MU is now exceedingly overbought with an extended buy signal
  • We took some profits and rebalanced our risk in the position. We will look for a pullback in the next month or two to add back to our exposure if needed.
  • Stop-loss moved up to $46

UNH – United Healthcare

  • UNH has surged higher in recent months after struggling with “Medicare for all” from Democratic candidates last year.
  • We love this position and will continue to hold it, however, the position is SO extremely extended we reduced our overweight holding to portfolio weight.
  • We did add UNH to our Dynamic model and will look to increase our weight in the Equity model on a bit more consolidation.
  • Stop loss moved up to $250

UTX – United Technology

  • UTX shot higher as conflict rose with Iran.
  • UTX, like many other of our positions, is now extremely overbought and extended above the 200-dma.
  • We reduced our position slightly and took in some profits but are looking to add back to UTX at a lower price.
  • Stop loss is moved up to 137.50

Why “Not-QE” is QE: Deciphering Gibberish

I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”  – Alan Greenspan

Imagine if Federal Reserve (Fed) Chairman Jerome Powell told the American people they must pay more for the goods and services they consume.

How long would it take for mobs with pitchforks to surround the Mariner Eccles building?  However, Jerome Powell and every other member of the Fed routinely and consistently convey pro-inflationary ideals, and there is nary a protest, which seems odd. The reason for the American public’s complacency is that the Fed is not that direct and relies on carefully crafted language and euphemisms to describe the desire for higher inflation.

To wit, the following statements from past and present Fed officials make it all but clear they want more inflation:  

  • That is why it is essential that we at the Fed use our tools to make sure that we do not permit an unhealthy downward drift in inflation expectations and inflation,” – Jerome Powell November 2019
  • In order to move rates up, I would want to see inflation that’s persistent and that’s significant,” -Jerome Powell December 2019
  • Been very challenging to get inflation back to 2% target” -Jerome Powell December 2019
  • Ms. Yellen also said that continuing low inflation, regarded as a boon by many, could be “dangerous” – FT – November 2017
  • One way to increase the scope for monetary policy is to retain the Fed’s current focus on hitting a targeted value of inflation, but to raise the target to, say, 3 or 4 percent.” –Ben Bernanke October 2017
  • Further weakness in inflation could prompt the U.S. Federal Reserve to cut interest rates, even if economic growth maintains its momentum”  -James Bullard, President of the Federal Reserve Bank of St. Louis  May 2019
  • Fed Evans Says Low Inflation Readings Elevating His Concerns” -Bloomberg May 2019
  • “I believe an aggressive policy action such as this is required to re-anchor inflation expectations at our target.”  Neel Kashkari, President Minneapolis Fed June 2019

As an aside, it cannot be overemphasized the policies touted in the quotes above actually result in deflation, an outcome the Fed desperately fears.

The Fed, and all central banks for that matter, have a long history of using confusing economic terminology. Economics is not as complicated as the Fed makes it seem. What does make economics hard to grasp is the technical language and numerous contradictions the Fed uses to explain economics and justify unorthodox monetary policy. It is made even more difficult when the Fed’s supporting cast – the media, Wall Street and other Fed apologists – regurgitate the Fed’s gibberish.   

The Fed’s fourth installment of quantitative easing (“QE4”, also known as “Not-QE QE”) is vehemently denied as QE by the Fed and Fed apologists. These denials, specifically a recent article in the Financial Times (FT), provide us yet another opportunity to show how the Fed and its minions so blatantly deceive the public.

What is QE?

QE is a transaction in which the Fed purchases assets, mainly U.S. Treasury securities and mortgage-backed-securities, via their network of primary dealers. In exchange for the assets, the Fed credits the participating dealers’ reserve account at the Fed, which is a fancy word for a place for dormant money. In this transaction, each dealer receives payment for the assets sold to the Fed in an account that is essentially the equivalent of a depository account with the Fed. Via QE, the Fed has created reserves that sit in accounts maintained by it.

Reserves are the amount of funds required by the Fed to be held by banks (which we are using interchangeably with “primary dealer” for the remainder of this discussion) in their Fed account or in vault cash to back up a percentage of specified deposit liabilities. While QE is not directly money printing, it enables banks to create loans at a multiple of approximately ten times the reserves available, if they so choose.

Notice that “Quantitative Easing” is the preferred terminology for the operations that create additional reserves, not something easier to understand and more direct like money/reserve printing, Fed bond buying program, or liquidity injections. Consider the two words used to describe this policy – Quantitative and Easing. Easing is an accurate descriptor of the Fed’s actions as it refers to an action that makes financial conditions easier, e.g., lower interest rates and more money/liquidity. However, what does quantitative mean? From the Oxford Dictionary, “quantitative” is “relating to, measuring, or measured by the quantity of something rather than its quality.”   

So, QE is a measure of the amount of easing in the economy. Does that make sense to you? Would the public be so complacent if QE were called BBMPO (bond buying and money printing operations)? Of course not. The public’s acceptance of QE without much thought is a victory for the Fed marketing and public relations departments.

Is “Not-QE” QE?

The Fed and media are vehemently defending the latest round of repurchase market (“repo”) operations and T-bill purchases as “not QE.” Before the Fed even implemented these new measures, Jerome Powell was quick to qualify their actions accordingly: “My colleagues and I will soon announce measures to add to the supply of reserves over time,” “This is not QE.”

This new round of easing is QE, QE4, to be specific. We dissect a recent article from the FT to debunk the nonsense commonly used to differentiate these recent actions from QE.  

On February 5th, 2020, Dominic White, an economist with a research firm in London, wrote an article published by the FT entitled The Fed is not doing QE. Here’s why that matters.

The article presents three factors that must be present for an action to qualify as QE, and then it rationalizes why recent Fed operations are something else. Here are the requirements, per the article:

  1. “increasing the volume of reserves in the banking system”
  2. “altering the mix of assets held by investors”
  3. “influence investors’ expectations about monetary policy”

Simply:

  1.  providing banks the ability to make more money
  2.  forcing investors to take more risk and thereby push asset prices higher
  3.  steer expectations about future Fed policy. 

Point 1

In the article, White argues “that the US banking system has not multiplied up the Fed’s injection of reserves.”

That is an objectively false statement. Since September 2019, when repo and Treasury bill purchase operations started, the assets on the Fed’s balance sheet have increased by approximately $397 billion. Since they didn’t pay for those assets with cash, wampum, bitcoin, or physical currency, we know that $397 billion in additional reserves have been created. We also know that excess reserves, those reserves held above the minimum and therefore not required to backstop specified deposit liabilities, have increased by only $124 billion since September 2019. That means $273 billion (397-124) in reserves were employed (“multiplied up”) by banks to support loan growth.

Regardless of whether these reserves were used to back loans to individuals, corporations, hedge funds, or the U.S. government, banks increased the amount of debt outstanding and therefore the supply of money. In the first half of 2019, the M2 money supply rose at a 4.0% to 4.5% annualized rate. Since September, M2 has grown at a 7% annualized rate.  

Point 2

White’s second argument against the recent Fed action’s qualifying as QE is that, because the Fed is buying Treasury Bills and offering short term repo for this round of operations, they are not removing riskier assets like longer term Treasury notes and mortgage-backed securities from the market. As such, they are not causing investors to replace safe investments with riskier ones.  Ergo, not QE.

This too is false. Although by purchasing T-bills and offering repo the Fed has focused on the part of the bond market with little to no price risk, the Fed has removed a vast amount of assets in a short period. Out of necessity, investors need to replace those assets with other assets. There are now fewer non-risky assets available due to the Fed’s actions, thus replacement assets in aggregate must be riskier than those they replace.

Additionally, the Fed is offering repo funding to the market.  Repo is largely used by banks, hedge funds, and other investors to deploy leverage when buying financial assets. By cheapening the cost of this funding source and making it more readily available, institutional investors are incented to expand their use of leverage. As we know, this alters the pricing of all assets, be they stocks, bonds, or commodities.

By way of example, we know that two large mortgage REITs, AGNC and NLY, have dramatically increased the leverage they utilize to acquire mortgage related assets over the last few months. They fund and lever their portfolios in part with repo.

Point 3

White’s third point states, “the Fed is not using its balance sheet to guide expectations for interest rates.”

Again, patently false. One would have to be dangerously naïve to subscribe to White’s logic. As described below, recent measures by the Fed are gargantuan relative to steps they had taken over the prior 50 years. Are we to believe that more money, more leverage, and fewer assets in the fixed income universe is anything other than a signal that the Fed wants lower interest rates? Is the Fed taking these steps for more altruistic reasons?

Bad Advice

After pulling the wool over his reader’s eyes, the author of the FT article ends with a little advice to investors: Rather than obsessing about fluctuations in the size of the Fed’s balance sheet, then, investors might be better off focusing on those things that have changed more fundamentally in recent months.”

After a riddled and generally incoherent explanation about why QE is not QE, White has the chutzpah to follow up with advice to disregard the actions of the world’s largest central bank and the crisis-type operations they are conducting. QE 4 and repo operations were a sudden and major reversal of policy. On a relative basis using a 6-month rate of change, it was the third largest liquidity injection to the U.S. financial system, exceeded only by actions taken following the 9/11 terror attacks and the 2008 financial crisis. As shown below, using a 12-month rate of change, recent Fed actions constitute the single biggest liquidity injection in 50 years of data.

Are we to believe that the latest round of Fed policy is not worth following? In what is the biggest “tell” that White is not qualified on this topic, every investment manager knows that money moves the markets and changes in liquidity, especially those driven by the central banks, are critically important to follow.

The graph below compares prior balance sheet actions to the latest round.

Data Courtesy St. Louis Federal Reserve

This next graph is a not so subtle reminder that the current use of repo is simply unprecedented.

Data Courtesy St. Louis Federal Reserve

Summary

This is a rebuttal to the FT article and comments from the Fed, others on Wall Street and those employed by the financial media. The wrong-headed views in the FT article largely parrot those of Ben Bernanke. This past January he stated the following:

“Quantitative easing works through two principal channels: by reducing the net supply of longer-term assets, which increases their prices and lower their yields; and by signaling policymakers’ intention to keep short rates low for an extended period. Both channels helped ease financial conditions in the post-crisis era.”   -LINK

Bourbon, tequila, and beer offer drinkers’ very different flavors of alcohol, but they all have the same effect. This round of QE may be a slightly different cocktail of policy action, but it is just as potent as QE 1, 2, and 3 and will equally intoxicate the market as much, if not more.

Keep in mind that QE 1, 2, and 3 were described as emergency policy actions designed to foster recovery from an economic crisis. Might that fact be the rationale for claiming this round of liquidity is far different from prior ones? Altering words to describe clear emergency policy actions is a calculated effort to normalize those actions. Normalizing them gives the Fed greater latitude to use them at will, which appears to be the true objective. Pathetic though it may be, it is the only rationale that helps us understand their obfuscation.

Sector Buy/Sell Review: 02-11-20

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • XLB rallied back into resistance on Friday and failed on Monday once again. There is the beginning of downtrend channel forming which needs to be reversed if Materials are going to rally further. However, the risk of the virus to the global supply chain makes Materials tricky.
  • The sector has gotten back to short-term overbought, but a sell signal is close to being triggered.
  • We currently hold 1/2 a position and until we get a better handle on the “coronavirus” impact we are going to maintain a reduced exposure for now.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with a tighter stop-loss.
    • Stop-loss moved back to $57 to allow for entry.
  • Long-Term Positioning: Neutral

Communications

  • We previously reduced our allocations slightly to the sector due to the rather extreme extension. The recent correction, and reversal, were not enough to allow us a decent entry point to add back to our holdings.
  • With a “buy signal” in place, but extended, there is more correction likely. This is particularly the case since XLC has not reversed its extreme overbought condition as of yet. XLC must hold support at $50.
  • XLC is currently 2/3rds weight in our portfolios.
  • Short-Term Positioning: Bullish
    • Last Week: Reduced weighting in portfolio.
    • This Week: Hold positions.
    • Stop adjusted to $50
  • Long-Term Positioning: Neutral

Energy

  • Energy has failed at all levels.
  • We have been trying to add XLE to our portfolios but XLE broke back below the 200-dma, the downtrend line, and now sits at the last level of support and the stop level.
  • With the buy signal close to reversing, but with the sector very oversold. a short-term bounce is likely. Use that bounce to sell into for now.
  • We had noted previously, we were remaining cautious as rallies had repeatedly failed in the past. And, as expected, it happened again.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Sell into rally.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • As noted previously, XLF was extremely extended above the 200-dma which put the sector at risk of a more severe correction.
  • The buy signal is correcting but remains a bit extended along but the sector is now approaching oversold.
  • XLF succesfully tested the bullish trend line, which give us an opportunity to add 1/2 position to our portfolio.
  • Short-Term Positioning: Bullish
    • Last week: Hold for now.
    • This week: Added 1/2 Position.
    • Stop-loss adjusted to $28
  • Long-Term Positioning: Neutral

Industrials

  • XLI remains exceedingly overbought short-term and the “buy signal” remains very extended as well. No rush chasing the sector currently. Also, there is a good risk the “coronavirus” will have a direct impact on the global supply chains of industrial companies.
  • We are holding reduced position weightings until we can assess the impact of the virus on the sector.
  • We have adjusted our stop-loss for the remaining position.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $77
  • Long-Term Positioning: Neutral

Technology

  • XLK had only a SLIGHT correction and rocketed off to nearly 4-standard deviations above the 200-dma. Currently, just 5-stocks make up 20% of the index which is what is driving the index higher.
  • We reduced our position in XLK from overweight to target portfolio weight due to the extreme extension and noted a correction is coming. That is still the case currently.
  • The bullish trend line is the first level of support XLK needs to hold while reversing the overbought condition. A failure at that support is going to bring the 200-dma into focus.
  • Be careful chasing the sector currently. Take profits and rebalance risks accordingly.
  • Short-Term Positioning: Bullish
    • Last week: Reduce Overweight to Target Weight
    • This week: Rebalance To Target Weights
    • Stop-loss adjusted to $80
    • Long-Term Positioning: Neutral

Staples

  • Defensive sectors continue to perform as interest rates have fallen as money is rotating to risk-off positioning despite the drive of the market higher.
  • XLP continues to hold its very strong uptrend and remains close to all-time highs.
  • XLP is back to more extreme overbought and extended above the 200-dma, however, the “buy signal” has been registered. Look for pullbacks to support to add weight to portfolios. Maintain a stop at the 200-dma.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $59
    • Long-Term Positioning: Bullish

Real Estate

  • Last week we noted that XLRE had broken out back to new highs. We took profits recently, and reduced our risk a bit in the position as interest rates are extremely overbought.
  • With XLRE very extended short-term, we previously suggested looking for a short-term reversal in interest rates to create an entry point. That has not occurred as of yet, so patience is needed to add exposure accordingly.
  • We had previously noted that while we are holding our long-position, trading positions could be added to portfolios. Hold off adding any new positions currently and wait for this correction to complete.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Took profits and reduced weighting slightly.
    • Stop-loss adjusted to $37.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • XLU, like XLRE, is benefiting from the decline in interest rates. XLU is extremely extended above the 200-dma, and the “buy signal” is now extremely extended as well.
  • We took profits in our holdings and will wait for a correction back to support to bring our holdings back to overweight. Such will give us a much better risk/reward entry.
  • The long-term trend line remains intact.
  • We are currently at 2/3rds weight.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Took profits and reduced weight slightly.
    • Stop-loss adjusted to support at $64.00
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and has rallied after a brief correction which we used to add to our current holdings.
  • The move in Healthcare has started to consolidate and the overextended buy signal has begun to correct. We will look to add to our holdings if support holds and more of the overbought condition is reduced.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Brought holdings back to target weightings.
    • Stop-loss adjusted to $94
  • Long-Term Positioning: Bullish

Discretionary

  • XLY, due to the impact of AMZN, has pushed into rather extreme extensions from the 200-dma.
  • We took profits last week and reduced the position slightly.
  • Hold current positions for now, New positions can be added on a pullback to the breakout level that holds and works off the overbought condition.
  • A “buy signal” has been triggered which gives the sector support.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $120.
  • Long-Term Positioning: Neutral

Transportation

  • XTN held its previous breakout level and is consolidating at recent levels.
  • We remain out of the economically sensitive sector currently particularly due to the impact of the “coronavirus” which will likely have global supply chain impacts.
  • The sector is moving back towards overbought territory short-term but is working off the extended buy signal. Hold adding new positions for the moment, we will likely see another pullback shortly to buy into if needed.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: COT Positioning – Risk Of Correction Still High (Q1-2020)

As discussed in this past weekend’s newsletter, the market remains overly extended as the recent correction sharply reversed on expectations for more Fed liquidity. However, with the market extremely deviated from the long-term moving average, a correction is once again a high probability event. 

“Previously, we discussed that we had taken profits out of portfolios as we were expecting between a 3-5% correction to allow for a better entry point to add equity exposure. While the “virus correction” did encompass a correction of 3%, it was too shallow to reverse the rather extreme extension of the market. The rally this past week has reversed the corrective process, and returned the markets to 3-standard deviations above the 200-dma. Furthermore, all daily, weekly, and monthly conditions have returned to more extreme overbought levels as well.”

But it isn’t just the more extreme advance of the market over the past 5-weeks which has us a bit concerned in the short-term, but a series of other indications which typically suggest short- to intermediate-terms corrections in the market.

Furthermore, the markets are completely entirely the impact the “coronavirus” will have on the supply-chain globally. As David Rosenberg noted Monday:

“The impact of this virus is lasting longer and the effects, relative to SARS, are larger at a time when the Chinese economy is far softer. The follow-on effects on other markets has yet to be fully appreciated.”

Had the markets completed a correction that reduced the extreme overbought and extended conditions of the market, such would have offset the risk of the “viral impact” to the economy. However, without that correction, the eventual slowdown will likely have a great impact than is currently anticipated. 

However, even if we set aside investor sentiment and positioning for a moment, the rapid reversion is price has sent our technical composite overbought/oversold gauge back towards more extreme levels of overbought conditions. (Get this chart every week at RIAPRO.NET)

What we know is that markets move based on sentiment and positioning. This makes sense considering that prices are affected by the actions of both buyers and sellers at any given time. Most importantly, when prices, or positioning, becomes too “one-sided,” a reversion always occurs. As Bob Farrell’s Rule #9 states:

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

So, how are traders positioning themselves currently? 

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three key commodity-trading groups, namely:

  • Commercial Traders: this group consists of traders that use futures contracts for hedging purposes and whose positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and/or processing of the underlying commodity.
  • Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.
  • Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders.

This is the group that speculates on where they believe the market is headed. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to “human fallacy” and “herd mentality” as everyone else.

Therefore, as shown in the series of charts below, we can take a look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

The extreme net-short positioning on the volatility before to the correction last week, had suggested the correction was coming. However, while the correction reduced the net-short positioning somewhat, it remains at historical extremes. What the more extreme positioning tells us is there is plenty of “fuel” to drive a correction when one occurs.

Investors have gotten used to extremely low levels of volatility, which is unique to this market cycle. This complacency, due to low volatility, has encouraged investors to take on greater levels of risk than they currently realize. When volatility eventually makes it return, the consequences to investors will not be kind.

Crude Oil Extreme

The recent attempt by crude oil to get back above the 200-dma coincided with the Fed’s initiation of QE-4. Historically, these liquidity programs tend to benefit highly speculative positions like commodities, as liquidity seeks the highest rate of return. 

However, beginning in December, that support for oil prices gave way, and prices have collapsed along with expectations for global economic recovery. We have been warning our RIAPro Subcribers (30-Day Risk Free Trial) for the last couple of months about the potential for this decline.

  • As noted previously, “Oil completely broke down last week, and collapsed below all of the important levels. Oil is now testing critical support at $51. A failure there and a break into the low $40’s is probable.”
  • The support is barely holding and oil looks extremely weak. However, oil is extremely oversold so a counter-trend rally is highly likely and can be used to “sell” into.
  • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Despite the decline in oil prices over the last year, it is worth noting that crude oil positioning is still on the bullish side with 397,000 net long contracts. 

The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will start to get liquidated which will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.

U.S. Dollar Extreme

Another index we track each week at RIAPRO.NET is the U.S. Dollar.

  • As noted previously: “The dollar has rallied back to that all-important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • That is exactly what happened over the last two weeks. The dollar has strengthened that rally as concerns over the “coronavirus” persist. With the dollar close to testing previous highs, a break above that resistance could result in a sharp move higher for the dollar.
  • The rising dollar is not bullish for Oil, commodities or international exposures.
  • The “sell” signal has began to reverse. Pay attention.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE, but as shown above, that has yet to be the case. However, it is worth noting that positioning in the US Dollar has been weakening. Historically, these reversals are markets of more important peaks in the market and subsequent corrections. 

It is also worth watching the net-short positioning the Euro-dollar as well. Historically, when positioning in the Eurodollar becomes NET-LONG, as it is currently, such has been associated with short- to intermediate corrections in the markets, including outright bear markets.

Net-long Eurodollar positioning has recently started to reverse from an all-time record. While the market hasn’t corrected as of yet, if foreign banks begin to extract dollar-denominated assets to a large degree, the risk to the market rises sharply. 

Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. In March of last year, I wrote “The Bond Bull Market” which was a follow up to our earlier call for a sharp drop in rates as the economy slowed. That call was based on the extreme “net-short positioning” in bonds which suggested a counter-trend rally was likely.

Since then, rates fell back to some of the lowest levels in 10-years as economic growth continues to slow, both domestically and globally. Importantly, while the Federal Reserve turned back on the “liquidity pumps” last October, juicing markets to all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Not surprisingly, despite much commentary to the contrary, the number of contracts “net-short” the 10-year Treasury remains at some of the highest historical readings.

Importantly, even while the “net-short” positioning on bonds has been reversed, rates have failed to rise correspondingly. The reason for this is due to the near-record levels of Eurodollar positioning, as noted above.

This suggests a high probability rates will fall further in the months ahead. This will most likely occur in concert with further deterioration in economic growth as the impact of the “coronavirus” is realized. 

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that financial markets can only rise further. The arguments supporting those beliefs are based on comparisons to previous peak market cycles. Unfortunately, investors tend to be wrong at market peaks and bottoms.

The inherent problem with much of the mainstream analysis is that it assumes everything remains status quo. However, such never tends to be the case for long.  

“Oil prices down 20% is not a good thing, even if it means lower gasoline prices. This is swamped by the negative implications for capital spending and employment in the key oil-producing regions of the U.S. Copper prices have dropped 11% in just the past two weeks and just above a three-year low, and this is a global macro barometer. Money flowing into bond funds, the lagging performance in the high-yield market, the slump in commodity markets and the weakness, both relative and absolute, in the Russell 2000 small-cap index, surely cannot be making the economic growth bulls feeling too comfortable right now..” – David Rosenberg

We agree.

With retail positioning very long-biased, the implementation of QE4 has once again removed all “fears” of a correction, a recession, and a bear market, which existed just this past summer. Historically, such sentiment excesses form around short-term market peaks.

This is a excellent time to remind you of the other famous “Bob Farrell Rule” to remember: 

“#5 – The public buys the most at the top and the least at the bottom.”

What investors miss is that while a warning doesn’t immediately translate into a negative consequence, such doesn’t mean you should not pay attention to it.

It is akin to constantly running red lights and never getting into an accident. We begin to think we are skilled at running red lights, rather than just being lucky.

Eventually, your luck will run out.

Pay attention, have a plan, and act accordingly.

Market Downturn? Putting Corrections Into Perspective

Shawn Langlois recently penned an interesting article:

“Despite a few notable hiccups along the way, the bull market continues to prove insanely resilient.”

What was most interesting, however, was the following quote:

“Current hyper-valued extremes are likely to be followed by market losses on the order of two-thirds of the value of the S&P 500.” 

The immediate response by most individuals is a 60%+ decline is an outlandish and impossible event given ongoing Central Bank interventions.

But is it really?

The risk of a larger mean reverting event is a possibility even though such is entirely dismissed by the mainstream media under the guise of “this time is different.”  With the market trading more than 3-standard deviations above the 50-week moving average, historical reversions have tended to be more brutal. 

The chart below uses key support levels as potential reversion levels. The lows of 2018. The highs and lows of 2015-2016, and the 2007 highs.

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

Those levels are still short of the 67% decline discussed above.

Such a level certainly seems preposterous, as Shawn quoted:

I recognize that the notion of a two-thirds market loss seems preposterous. Then again, so did similar projections before the 2000-2002 and 2007-09 collapses.”

While the current belief is that such declines are no longer a possibility, due to Central Bank interventions, we had two 50% declines just since the turn of the century. The cause was different, but the end result was the same. The next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of “stock buybacks,” which have accounted for almost 100% of net purchases since 2018.

Market downturns are a historical constant for the financial markets. Whether they are minor, or major, the impacts go beyond just the price decline when it comes to investors. This was a discussion I had in more detail in “Retired, Or Retiring Soon? Yes, Worry About A Correction.”

“In 2000, the average ‘baby boomer’ was around 45-years of age. The ‘dot.com’ crash was painful, but with 20-years to go before retirement, there was time to recover. In 2010, following the financial crisis, the time to retirement for the oldest boomers was depleted, and the average boomer only had 10-years to recover. During both of these previous periods, portfolios were still in accumulation mode. However, today, ONLY the youngest tranche of ‘boomers,’ have the luxury of ‘time\ to work through the next major market reversion. (This also explains why the share of workers over the age of 65 is at historical highs.) 

With the majority of ‘boomers’ now faced with the implications of a transition into the distribution phase of the investment cycle, such has important ramifications during market declines. The following example shows a $1 million portfolio with, and without, an annualized 4% withdrawal rate.”

“While a 10% decline in the market will reduce a portfolio from $1 million to $900,000, when combined with an assumed monthly withdrawal rate, the portfolio value is reduced by almost 14%. This is the result of taking distributions during a period of declining market values. Importantly, while it ONLY requires a non-withdrawal portfolio an 11.1% return to break even, it requires nearly a 20% return for a portfolio in the distribution phase to attain the same level.

Impairments to capital are the biggest challenges facing pre- and post-retirees currently. 

This is an important distinction. Most articles written about retirees, or those ready to retire, is an unrealized assumption of an indefinite timeline.

While the market may not be different than in the past, YOU ARE!”

This is an important point.

Investing is about growing your savings over time, and controlling the risk which could lead to a significant loss of principal. Taking on excruciating losses is not investing, nor is it financially feasible to do so, and still reach your retirement goals successfully. 

Putting Corrections Into Perspective

The real problem with discussing corrections is three-fold:

  1. It is has been so long since we have had a correction of magnitude, many investors have forgotten what happens, and more importantly, how they reacted previously.
  2. The majority of mainstream media advice is written or prognosticated by individuals who don’t manage money for a living, have substantial investment  capital at risk, and have never actually been through a bear market. 
  3. Given the extremely long market expansion, many investors have truly come to believe “this time is different.” 

If we put corrections into a bit of perspective, it becomes easier to visualize that damage which could, and most likely will, eventually occur.

10% Correction 

A correction of 10% is entirely normal for a market in any given year. While a 10% decline in a bit painful, such a decline from current levels would only set the market back October of 2019 when the Federal Reserve started their latest liquidity interventions.

20% Correction

A 20% correction from the recent highs is a bit more serious. The last time we came close to a 20% reset was in December, 2018. Try and remember how you felt during that decline.

Currently, a 20% decline would reset your portfolio back to where it was in December 2017, wiping out all the gains of the past two-years. While not the end of the world, your retirement is now set back by almost 4-years as you will have to make up the 30% gain from 2019 plus two-more years of lost growth.

30% Correction

A 30% correction gets much more serious. A decline of this magnitude takes you back to the beginning of 2017. While losing just 3-years of growth may not seem that bad, assuming you need 6% a year to reach your retirement goal, you will need almost 9-years to recover. (Remember, it takes 42.9% to recover the 30% loss, plus you have to make up the 6% annual gains you needed, but didn’t accrue, during each year of recovering the previous loss.)

40% Correction

Okay, this is starting to get a bit uglier. A 40% decline takes the market back to 2014 levels and has now wiped out 6-years of your gains. While a 40% decline requires a 66.7% recovery to breakeven, (10 years at 6%,) the lost accrual years are going to make it very difficult to meet retirement goals.

50% Correction

I know…I know…this can’t happen. (It just happened twice the century already.)

A 50% decline is effectively “game over” for investors at this point. A decline of this magnitude will reset the market essentially back to the market highs of 2000 and 2007. For individuals who were close to retirement in 2000, their portfolio, on an inflation-adjusted basis, will have been completely reset.

At this point, retiring is no longer an option for most.

60% Correction

A 60% correction is not entirely out of the question. As I have discussed previously, the next mean reverting event will likely be the last. Corrections of such a magnitude would reset portfolios back to 1999 levels. The devastation will be greater than investors can currently imagine and retirement goals would be erased entirely.

There are numerous catalysts which could pressure such a downturn in the equity markets:

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

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

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

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

It will be worse.

None of this will happen, you say?

Maybe? I certainly hope not.

But are you actually willing to bet your retirement on it?

Major Market Buy/Sell Review: 02-10-20

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

S&P 500 Index

  • As noted last week: “With the market now trading 12% above its 200-dma, and well into 3-standard deviations of the mean, a correction is coming.” That correction started last week, but was completely reversed this week with the market winding up right back where it started.
  • As noted, the sell-off barely registered in terms of reducing the overbought or extended levels of the market. There is likely a bit more correction to come to buy into so be patient.
  • We did add some short-term trading positions early in the week, but we will be patient to take on more weight.
  • Short-Term Positioning: Neutral Due To Extension
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $300
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

  • As goes the S&P 500, goes the DIA, especially when MSFT & AAPL are the two top holdings and drivers of the advances in both indexes.
  • Like SPY, the sell-off barely registered on the chart. The “buy” signal remains extremely extended along with a very overbought condition.
  • Take profits, but as with SPY, wait for a correction before adding further exposure.
  • Short-Term Positioning: Neutral due to extensions
    • Last Week: Hold current positions
    • This Week: Hold current positions
    • Stop-loss moved up to $275
  • Long-Term Positioning: Neutral

Nasdaq Composite

  • Like SPY, the sell-off on Friday barely registered. The Nasdaq remains “extremely” extended currently. As noted last week, “With QQQ now pushing towards a 4-standard deviation event. A correction is inevitable, it is just a function of time now.”
  • Despite the correction, nothing changed as the rally this week reversed the entire correction and the extension is now nearly 19% above the long-term mean.
  • The Nasdaq “buy signal” is also back to extremely overbought levels. It is likely a correction is coming and it may be bigger than expected.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $195
  • Long-Term Positioning: Neutral due to valuations

S&P 600 Index (Small-Cap)

  • Small caps corrected more than the major markets, but they also haven’t moved as much.
  • The buy signal remains extended, but the index has corrected some of the short-term overbought.
  • The correction is trying to hold the previous breakout levels with a stop moved up to the 200-dma.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop loss moved up to $68
  • Long-Term Positioning: Neutral

S&P 400 Index (Mid-Cap)

  • Like SLY, MDY also started to correct this past week.
  • MDY remains extremely extended above the 200-dma, so more corrective action is likely. MDY is working off the overbought condition and holding breakout support.
  • The previous breakout level needs to hold while the overbought condition is reversed.
  • Short-Term Positioning: Neutral
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bullish

Emerging Markets

  • EEM was more deeply impacted last week, and did hold stop levels at the 200-dma.
  • EEM is holding breakout level support at the moment and is oversold. However, the entire technical performance is a bit weak at the moment.
  • The Dollar (Last chart) is the key to our international positioning. The dollar looks to have reversed its move lower which isn’t beneficial for international exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $42
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA also sold off last week, and is testing important support.
  • As we stated last week, “Any good news with the virus and international exposure should rally. EFA looks better than EEM, so we will likely revisit our holding on a rally.”
  • That good news came, and EFA rallied as expected holding previous important support. EFA is working off the overbought condition but is still extended currently. Be patient.
  • As with EEM, the key to our positioning is the US Dollar which is beginning to rally.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $67
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • As noted last week:
  • “Oil completely broke down last week, and collapsed below all of the important levels. Oil is now testing critical support at $51. A failure there and a break into the low $40’s is probable.”
  • The support is barely holding and oil looks extremely weak. However, oil is extremely oversold so a counter-trend rally is highly likely.
  • We remain on hold for now, as stops are close to being triggered.
  • Short-Term Positioning: Neutral
    • Last Week: No positions
    • This Week: No positions
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • As noted last week, Gold had rallied sharply and broke out to new highs, suggesting there was something amiss with the stock market exuberance.
  • On Friday, gold rallied holding support at the previous breakout level which is bullish.
  • Our positioning looks good particularly since gold has registered a new “buy signal.”
  • We used the recent weakness to add to our GDX and IAU positions taking them back to full weightings.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position adjusted to $137
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • The correction in bond prices we had previously suggested occurred as bonds broke out of their declining trend sending yields lower. That breakout was a decent entry point to add exposure to bonds if you need it. However, that opportunity has now passed.
  • Take profits and rebalance holdings and look for a trade on the equity side short-term. However, another trade for bonds is likely setting up shortly with a buy signal approaching. Be patient.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $132
  • Long-Term Positioning: Bullish

U.S. Dollar

  • As noted previously: “The dollar has rallied back to that all important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle. It may be too early for a sharper dollar decline currently, as the U.S. economy is still the “cleanest shirt in the dirty laundry.”
  • That is exactly what happened over the last two weeks and the dollar has strengthened that rally as concerns over the “coronavirus” persist. With the dollar close to testing previous highs, a break above that resistance could result in a sharp move higher for the dollar.
  • The rising dollar is not bullish for Oil, commodities or international exposures.
  • The “sell” signal has began to reverse. Pay attention.

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Catch Up On What You Missed Last Week


Market Vaccine For Virus Is More Fed 

Last week, I asked the question of whether the “correction was over?” To wit:

“On a very short-term basis, there is a potential for a reflexive bounce. If your ‘investment duration,’ or rather your ‘investment holding period’ is very short, there may be a ‘trading’ opportunity for you.”

Well, that bounce came hard and fast during the first half of the week, as the S&P 500 rebounded off the 50-dma to set new highs on Thursday. 

The Good News

As noted, the market bounced firmly off the 50-dma and rallied back to new highs on Thursday. While Friday saw a bit of retracement, which isn’t surprising given the torrid move early in the week, the “virus correction” was recovered. Importantly, the “buy signal,” in the lower panel, was close to registering a “sell signal.” The sharp early-week rally kept that signal from triggering, which would have confirmed the “sell signal” in the top panel. Historically, when both “sell signals” are triggered, deeper corrections have tended to follow.

The Not-So-Good News

Previously, we discussed that we had taken profits out of portfolios as we were expecting between a 3-5% correction to allow for a better entry point to add equity exposure. While the “virus correction” did encompass a correction of 3%, it was too shallow to reverse the rather extreme extension of the market. The rally this past week has reversed the corrective process, and returned the markets to 3-standard deviations above the 200-dma. Furthermore, all daily, weekly, and monthly conditions have returned to more extreme overbought levels as well.

Of course, the reason for the rally was more liquidity from the Federal Reserve. 

While the economic impact from the virus is likely to be substantial, as discussed previously, traders looked past economic realities. They focused instead on more liquidity being pumped into the markets by both the Fed, and the PBOC (Peoples Bank of China).

“The PBOC decided that instead of unwinding the large liquidity provision, they would double-down on it… and that they did in size. The last four weeks have seen China supply over CNY2 trillion (net!) into its financial system – something we have never seen anything like before…” – Zerohedge

But, as I stated, it wasn’t just the PBOC, but also the Federal Reserve dumping tremendous amounts of liquidity into the markets which only had one place to go….equities.

While the Fed continues to deny current liquidity interventions are indeed “QE,” they have been clearly concerned about the potential of global instability impacting the U.S. In their most recent report to Congress, the “coronavirus” made its appearance as the latest threat to the global economic instability. 

Do NOT dismiss that last sentence lightly. 

Since last October, the Fed has been injecting the financial system with massive quantities of liquidity to fix “short-term funding needs.” Each time they have tried to slow the rates of funding, the market has declined, so they extended the facility. Initially, the facility was for October tax payments. Then it was extended for the “year-end” turn. Then it was extended for April “tax payments.” The “coronavirus” will be the next reason to extend the program into June.

Just in case you missed our previous report on this issue, the importance is that this type of funding has not occurred to such a magnitude outside of a financial crisis.

The question you should be asking is: “exactly what is going on?”

Dollar Rally

Currently, the flood of liquidity has been pulling foreign capital back into U.S. Dollars. While the U.S. dollar had previously started to breakdown heading into year-end, which gave a boost to commodities and oil. Unfortunately, that breakdown has been reversed.

We did this analysis for our RIAPRO Subscribers (Risk-Free Trial For 30-Days) this past week, which warned them of the potential for a continued dollar rally. The importance of this rally is that a stronger U.S. Dollar is not friendly to commodities, international, and emerging market exposure.

While there has been a good bit of excitement over the last couple of weeks of improving economic data points, it will likely be short-lived. Given these data points are both “sentiment surveys” and “lagging” in nature, what they captured was the uptick in commodities seen at the end of 2019 as the dollar weakened on “trade deal” hopes.

What has yet to be captured is the subsequent reversion in the major, economically sensitive, components. While the markets have rallied on news of more liquidity, the impact from the “coronavirus” has only yet started to be felt economically. Even if the virus was cured today, the economic impact will continue to be felt over the rest of this year. 

Importantly, the impact on China will be substantially greater, which will undermine any potential positive to the U.S. from the “trade deal.” That impact will result not only in the form of weaker economic growth in China, but globally as well due to the interlinked supply chains. This is going to manifest itself in weaker earnings and corporate profits, which will continue to make elevated asset prices harder to justify. 

As shown in the long-term chart below, despite the short-term correction, which is barely noticeable, the market remains extremely extended, overbought, and pushing into the top of its long-term trading range. 

Furthermore, the put/call ratio, which warned of the previous correction is once again pushing extreme levels rarely seen from a historical perspective.

The rally this past week serves as a stern reminder that market participants are trained to respond to “Pavlov’s Bell.” 

For the time being, investors have gotten away with overpaying for value, ignoring risk, and chasing yield. Eventually, the party ends, and it always ends in the most brutal of fashions.

This is why it’s important to have a process and adhere to it.

Trust The Process

We have had quite a few emails from readers over the past week asking why we were “buying” into our RIAPRO portfolios this past week(You can register for a 30-day RISK-FREE trial if you want to view our current portfolios.)

The short answer is: 

“Because that is what our process required us to do.” 

To understand the process, we have to go back. 

A few weeks ago, Shawn Langlois at MarketWatch picked up our article discussing why we were selling positions in our portfolio. To wit:

“Specifically, Roberts raised cash by selling off shares of Apple, Microsoft, United Healthcare, Johnson & Johnson, and Micron, and scaling back overweight holdings in various ETF sector plays, such as the Technology Select Sector SPDR, and the Health Care Select Sector.

While at the time, it seemed like a wrong move, a couple of weeks later, the market sold off. The benefit was the extra cash, and reduced exposure, help limit the downside draw to about 1/3rd of the market decline. 

Then, last week, things changed:

“With bond yields plummeting this past week, our bond exposures have gotten extremely stretched. The sell-off in the market, combined with the ‘risk off’ rotation to bonds, sets the market up for a reflexive bounce. The duration and magnitude of that bounce will be critical as to our next steps in positioning.” 

Chart updated through Friday

As noted, the market had gotten oversold on a short-term basis, which brought the risk/reward measures back into better alignment. This is where our process required we add equity exposure back into portfolios. 

  • In the ETF Model, we added Financials (XLF) and increased our stake in HealthCare (XLV) with both of those sectors having gotten oversold and bouncing off their respective 50-dma’s.
  • In the EQUITY Model, we added JP Morgan (JPM) and Pfizer (PFE) while increasing our stakes in Abbvie (ABBV), United Healthcare (UNH), and Alerian MLP (AMLP). 

Importantly, this rebalancing of risk did not dramatically increase our equity exposure. This is because, as noted above, the longer-term technical outlook remains “cautious.”

Yes, we realize we are very late-cycle, we also know that with the Fed, and global Central Banks, still intervening, we must give deference to the “bullish bias.” At the moment, the bullish bias remains, and functioned as we predicted last week.

“The ‘bullish bias’ is not dead as of yet, and investors will be quick to try and ‘write off’ the impact of the ‘virus.’ After a decade of ‘macro-events’ not stopping the bullish charge, the belief the market is ‘bulletproof’ has become so deeply ingrained into investor mentality it won’t be dislodged until it is far too late to matter.”

We have no certainty about when, or what will trigger the next bear market. 

What we do know is that such an event will likely be far more brutal than most realize due to years of excess risk-taking, leverage, and demographics. 

However, this is what our process is designed to handle:

  • The portfolio is managed for risk by adjusting the level of equity exposure relative to market dynamics, return outlooks, and technical deviations from long-term means.
  • The allocation is managed for risk by balancing positions for relative performance to our benchmark.
  • The positions are managed for risk by:
    • Employing trailing stop-losses
    • Regularly rebalancing positions back to target weights (taking profits)
    • Cutting laggards which aren’t performing as expected
    • Monitoring relative performance and participation

Importantly, notice that everything the process covers is the management against the “risk” of loss. 

If we manage against the risk of capital loss, we can safely participate with markets as they rise. When something eventually does goes wrong, the process will systematically close out positions, protecting our investment capital, until that process is complete. Then the process reverses to rebuild exposure when risk/reward dynamics are greatly improved. 

As long as the process is followed, risk can be controlled. Where the majority of investors go wrong, is by not having a process.

“Hoping” markets will continue higher indefinitely, is not a process.

As we concluded last week:

“We won’t know for sure until after the fact. This is why we manage risk in the short-term. Managing risk allows us to navigate the ‘twists and turns’ of the market without careening off the cliff.”



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


Financial Planning Corner

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

by Danny Ratliff, CFP®


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite 


ETF Model Relative Performance Analysis


Sector & Market Analysis:

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

Sector-by-Sector

Improving – Discretionary (XLY) and Utilities (XLU)

As noted previously, we reduced exposure to Utilities and Discretionary due to their extreme overbought condition. The brief correction was cut short, and the rally was so quick, it failed to reduce any of the previous overbought, extended, or deviated conditions. We will likely see a correction in the next couple of weeks to re-evaluate our positioning.

Current Positions: Underweight XLY, XLU

Outperforming – Technology (XLK), Healthcare (XLV),  Communications (XLC)

We previously recommended taking profits in Technology and Healthcare, which have not only been leading the market but have gotten extremely overbought. Last week, Healthcare pulled back enough to allow us to reweight the position in portfolios. The rally in markets last week, reversed those conditions so we will remain pat on adding new positions for now.

Current Positions:  Target weight XLK, XLV, Underweight XLC

Weakening – Financials (XLF)

We noted previously that Financials have been running hard on Fed rate cuts and more QE and that the sector was extremely overbought and due for a correction. That correction allowed us to add a position to our portfolios, which we will look to build into over the next couple of weeks. 

Current Position: 1/2 Weight (XLF)

Lagging – Industrials (XLI), Real Estate (XLRE), Staples (XLP), Materials (XLB), and Energy (XLE)

With the Fed and the PBOC liquifying markets last week, everything rallied sharply. However, the technical damage in the lagging sectors still exists, so we are monitoring closely. 

Industrials tested and failed at previous highs and remains on a sell-signal suggesting a retest of the 50-dma is likely. 

Materials tested and failed previous highs and IS testing the 50-dma. It must hold next week, but the sector remains on a sell-signal.

Energy is deeply oversold and due for a rally. We added to our position of AMLP last week. 

Staples remains in a strong uptrend and has not provided an entry point to add exposure safely. 

Real Estate is testing previous highs and is back to overbought. There isn’t a clear opportunity to add to our holdings just yet. Be patient.

Current Position: Reduced weight XLY, XLP, XLRE, Full weight AMLP, 1/2 weight XLB and XLI

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Despite the rally in the broader markets, Small- and Mid-caps continue to underperform currently. Both markets rallied last week and then failed without setting new highs. Unfortunately, small caps broke below the 50-dma, while mid-caps are currently testing that important support. We are close to being stopped out on our positions currently.

Current Position: KGGIX, SLYV

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

Emerging and International Markets, look just like small and mid-caps above. Both had gotten extremely overbought and needed to correct. That correction broke supports and the subsequent rally failed to set new highs. Emerging markets have now broken the 50-dma again, and International is testing that critical support. If we don’t see improvement next week, we are likely to be stopped out of our holdings. 

Current Position: EFV, DEM

Dividends (VYM), Market (IVV), and Equal Weight (RSP) – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with economic growth and inflation. We are currently maintaining our core positions unhedged for now. If we see deterioration in the broader markets, we will begin to add short-positions to hedge our long-term core holdings.

Current Position: RSP, VYM, IVV

Gold (GLD) – Over the last few weeks, gold has been consolidating near recent highs. Gold remains overbought, but continues to hold important support. We are at full weight in the positions, however, if this consolidation continues, supports hold, and the overbought condition recedes, we will consider over-weighting our holdings.

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

Bonds (TLT) – 

Bonds rallied back towards previous highs on Friday as money rotated into bonds for “safety” as the market weakened. After previously recommending adding to bonds, hold current positions for now and take profits next week to rebalance risks accordingly. Bonds are extremely overbought now.

Current Positions: DBLTX, SHY, IEF

Sector / Market Recommendations

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

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

Portfolio/Client Update:

Last week, the markets got oversold on a short-term basis to allow us to add some positions to portfolios. 

Please Read TRUST THE PROCESS in the main body of this week’s missive.

As noted, the market had gotten oversold on a short-term basis, which brought the risk/reward measures back into better alignment. This is where our process required we add equity exposure back into portfolios. 

  • In the ETF Model we added Financials (XLF) and increased our stake in HealthCare (XLV) with both of those sectors having gotten oversold and bouncing off their respective 50-dma’s.
  • In the EQUITY Model we added JP Morgan (JPM) and Pfizer (PFE) while increasing our stakes in Abbvie (ABBV), United Healthcare (UNH), and Alerian MLP (AMLP). 

Importantly, this rebalancing of risk did not dramatically increase our equity exposure. This is because, as noted above, the longer-term technical outlook remains “cautious.”

Yes, we realize we are very late-cycle, we also know that with the Fed, and global Central Banks, still intervening, we must give deference to the “bullish bias.” At the moment, that bias clearly remains, and functioned as we predicted last week.

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

There we no additional portfolio actions this past week.

  • New clients: Slowing adding exposure as needed.
  • Dynamic Model: Bought positions in JPM, PRE, AMLP, UNH, ABBV. Reduced market hedge by 1/2.
  • Equity Model: Bought positions in JPM & PFE, added to existing holdings of AMLP, UNH, ABBV.
  • ETF Model: Added 1/2 position XLF, add to existing position XLV.

Note for new clients:

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


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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

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

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

See below for an example of a comparative model.


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

401k Plan Manager Live Model

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

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

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

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

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

MacroView: The Next “Minsky Moment” Is Inevitable

In 2007, I was at a conference where Paul McCulley, who was with PIMCO at the time, was discussing the idea of a “Minsky Moment.”  At that time, this idea fell on “deaf ears” as the markets, and economy, were in full swing.

However, it wasn’t too long before the 2008 “Financial Crisis” brought the “Minsky Moment” thesis to the forefront. What was revealed, of course, was the dangers of profligacy which resulted in the triggering of a wave of margin calls, a massive selloff in assets to cover debts, and higher default rates.

So, what exactly is a “Minskey Moment?”

Economist Hyman Minsky argued that the economic cycle is driven more by surges in the banking system, and in the supply of credit than by the relationship which is traditionally thought more important, between companies and workers in the labor market.

In other words, during periods of bullish speculation, if they last long enough, the excesses generated by reckless, speculative, activity will eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

Hyman Minsky argued there is an inherent instability in financial markets. He postulated that an abnormally long bullish economic growth cycle would spur an asymmetric rise in market speculation which would eventually result in market instability and collapse. A “Minsky Moment” crisis follows a prolonged period of bullish speculation which is also associated with high amounts of debt taken on by both retail and institutional investors.

One way to look at “leverage,” as it relates to the financial markets, is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to be levered (borrow money) to invest, which leaves them with “negative” cash balances.

While margin balances did decline in 2018, as the markets fell due to the Federal Reserve hiking rates and reducing their balance sheet, it is notable that current levels of “leverage” are still excessively higher than they were either in 1999, or 2007.

This is also seen by looking at the S&P 500 versus the growth rate of margin debt.

The mainstream analysis dismisses margin debt under the assumption that it is the reflection of “bullish attitudes” in the market. Leverage fuels the market rise. In the early stages of an advance, this is correct. However, in the later stages of an advance, when bullish optimism and speculative behaviors are at the peaks, leverage has a “dark side” to it. As I discussed previously:

“At some point, a reversion process will take hold. It is when investor ‘psychology collides with ‘leverage and the problems associated with market liquidity. It will be the equivalent of striking a match, lighting a stick of dynamite, and throwing it into a tanker full of gasoline.”

That moment is the “Minsky Moment.”

As noted, these reversion of “bullish excess” are not a new thing. In the book, The Cost of Capitalism, Robert Barbera’s discussed previous periods in history:

The last five major global cyclical events were the early 1990s recession — largely occasioned by the U.S. Savings & Loan crisis, the collapse of Japan Inc. after the stock market crash of 1990, the Asian crisis of the mid-1990s, the fabulous technology boom/bust cycle at the turn of the millennium and the unprecedented rise and then collapse for U.S. residential real estate in 2007-2008.

All five episodes delivered recessions, either global or regional. In no case was there as significant prior acceleration of wages and general prices. In each case, an investment boom and an associated asset market ran to improbably heights and then collapsed. From 1945 to 1985 there was no recession caused by the instability of investment prompted by financial speculation — and since 1985 there has been no recession that has not been caused by these factors. 

Read that last sentence again.

Interestingly, it was post-1970 the Federal Reserve became active in trying to control interest rates and inflation through monetary policy.

As noted in “The Fed & The Stability Instability Paradox:”

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

The Fed Is Doing It Again

As noted above, “Minsky Moment” crises occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during prosperous times, or bull markets. The longer a bull market lasts, the more investors borrow to try and capitalize on market moves.

However, it hasn’t just been investors tapping into debt to capitalize on the bull market advance, but corporations have gorged on debt for unproductive spending, dividend issuance, and share buybacks. As I noted in last week’s MacroView:

“Since the economy is driven by consumption, and theoretically, companies should be taking on debt for productive purposes to meet rising demand, analyzing corporate debt relative to underlying economic growth gives us a view on leverage levels.”

“The problem with debt, of course, is it is leverage that has to be serviced by underlying cash flows of the business. While asset prices have surged to historic highs, corporate profits for the entirety of U.S. business have remained flat since 2014. Such doesn’t suggest the addition of leverage is being done to ‘grow’ profits, but rather to ‘sustain’ them.”

Over the last decade, the Federal Reserve’s ongoing liquidity interventions, zero interest-rates, and maintaining extremely “accommodative” policies, has led to substantial increases in speculative investment. Such was driven by the belief that if “something breaks,” the Fed will be there to fix to it.

Despite a decade long economic expansion, record stock market prices, and record low unemployment, the Fed continues to support financial speculation through ongoing interventions.

John Authers recently penned an excellent piece on this issue for Bloomberg:

“Why does liquidity look quite so bullish? As ever, we can thank central banks and particularly the Federal Reserve. Twelve months ago, the U.S. central bank intended to restrict liquidity steadily by shrinking the assets on its balance sheet on “auto-pilot.” That changed, though. It reversed course and then cut rates three times. And most importantly, it started to build its balance sheet again in an attempt to shore up the repo market — which banks use to access short-term finance — when it suddenly froze up  in September. In terms of the increase in U.S. liquidity over 12 months, by CrossBorder’s measures, this was the biggest liquidity boost ever:”

While John believes we are early in the global liquidity cycle, I personally am not so sure given the magnitude of the increase Central Bank balance sheets over the last decade.

Currently, global Central Bank balance sheets have grown from roughly $5 Trillion in 2007, to $21 Trillion currently. In other words, Central Bank balance sheets are equivalent to the size of the entire U.S. economy.

In 2007, the global stock market capitalization was $65 Trillion. In 2019, the global stock market capitalization hit $85 Trillion, which was an increase of $20 Trillion, or roughly equivalent to the expansion of the Central Bank balance sheets.

In the U.S., there has been a clear correlation between the Fed’s balance sheet expansions, and speculative risk-taking in the financial markets.

Is Another Minsky Moment Looming?

The International Monetary Fund (IMF) has been issuing global warnings of high debt levels and slowing global economic growth, which has the potential to result in Minsky Moment crises around the globe.

While this has not come to fruition yet, the warning signs are there. Globally, there is roughly $15 Trillion in negative-yielding debt with asset prices fundamentally detached for corporate profitability, and excessive valuations on multiple levels.

As Desmond Lachman wrote:

“How else can one explain that the risky U.S. leveraged loan market has increased to more than $1.3 trillion and that the size of today’s global leveraged loan market is some two and a half times the size of the U.S. subprime market in 2008? Or how else can one explain that in 2017 Argentina was able to place a 100-year bond? Or that European high yield borrowers can place their debt at negative interest rates? Or that as dysfunctional and heavily indebted government as that of Italy can borrow at a lower interest rate than that of the United States? Or that the government of Greece can borrow at negative interest rates?

These are all clear indications that speculative excess is present in the markets currently.

However, there is one other prime ingredient needed to complete the environment for a “Minsky Moment” to occur.

That ingredient is complacency.

Yet despite the clearest signs that global credit has been grossly misallocated and that global credit risk has been seriously mispriced, both markets and policymakers seem to be remarkably sanguine. It would seem that the furthest thing from their minds is that once again we could experience a Minsky moment involving a violent repricing of risky assets that could cause real strains in the financial markets.”

Desmond is correct. Currently, despite record asset prices, leverage, debt, combined with slowing economic growth, the level of complacency is extraordinarily high. Given that no one currently believes another “credit-related crisis” can occur is what is needed to allow one to happen.

Professor Minsky taught that markets have short memories, and that they repeatedly delude themselves into believing that this time will be different. Sadly, judging by today’s market exuberance in the face of mounting economic and political risks, once again, Minsky is likely to be proved correct.

At this point in the cycle, the next “Minsky Moment” is inevitable.

All that is missing is the catalyst to start the ball rolling.

An unexpected recession would more than likely due to trick.

#WhatYouMissed On RIA: Week Of 02-03-20

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

The Week In Blogs

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Our Latest Newsletter

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What You Missed At RIA Pro

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

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The Best Of “The Lance Roberts Show

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Video Of The Week

Conversation with Michael Lebowitz and Lance Roberts on the “Fed’s Betrayal” and the impact to the average American who is suffering real inflation that is higher than reported.

________________________________________________________________________________

Our Best Tweets Of The Week

See you next week!

#FPC: 5-Things You Aren’t Being Told About HSA’s.

With the passage of the SECURE ACT and the death of the STRETCH IRA there has been a lot of noise about Health Savings Accounts or HSA’s for short. The role, or lack of, that people use a Health Savings Account as investment vehicles in their financial plans has been highly debatable, but not anymore. In 2020, we are finally seeing a shift in financial advice to find ways to put funds aside and avoid taxes altogether down the road.

Health Savings Accounts are becoming common place now that employers are shifting more of the burden of Health Insurance to the employees with the use of high deductible health plans. If you don’t have access to one now, those days may be numbered.

With all of the attention HSA’s have been given; there has been an enormous amount of “advice” on how you should use these accounts. Let’s take a look at what your advisor probably isn’t telling you:

Your broker confuses an HSA and FSA.

Not everyone is eligible for a Health Savings Account, to have access to an HSA you must be in a High-Deductible Health Plan. This means your out of pocket deductibles must be at minimum $1,400 and your max out of pocket can be no greater than $6,900 for a single insured and for a family the minimum deductible can be no less than $2,800 and maximum out of pocket expenses can be no greater than $13,800 for a family in 2020.

If your health insurance plan meets those parameters you can contribute to a Health Savings Account.

The annual 2020 contribution limit, (employer+employee) is $3,550 for a single insured and $7,100 for a family. If you’re over 55 you’re allowed an additional $1,000 catch up contribution annually.

Most employers who have high deductible health plans are beginning to start HSA’s for their employees. However, if you’re not satisfied with your company’s plan or they don’t offer one you can certainly shop around for your own HSA. Keep in mind if your company offers a plan and makes contributions to your account it would be wise to use your employer’s plan. A study from the Employee Benefit Research Group found that in 2015 employers who contributed averaged an annual contribution of $948. Other more recent studies show the employer contributions typically varies by the size of the company, but varying between $750 and $1250.

When doing your own shopping, remember to check costs, ease of use and investment options available.

Flexible Spending Accounts are much different from HAS’s. They are offered through an employer-established benefit plan.  Unlike the HSA if you are self-employed, you aren’t eligible for an FSA.  A Flexible Spending Account will allow participants to put up to $2,750 annually in their account. FSA’s also provide you the ability to access funds throughout the year for qualified medical expenses even if you haven’t contributed them to the account yet.

Some Key differences: 

  • HSA’s will allow you to retain all of your funds in the account each year-even if you don’t use them.
  • An FSA may allow for a rollover of unused funds of up to $500, but only if your company agrees to it and anything remaining over the $500 will go back to the company’s coffers.
  • The HSA’s ability to make tax free contributions, allow the funds to grow tax free year after year and then make tax free withdrawals when used for medical expenses make this a great tool to utilize as part of diversifying the type of accounts in your financial plan.
  • The HSA also allows employees to retain their funds long after their employment.
  • Contributions to an HSA should stop permanently 6 months prior to starting Medicare. Medicare enrollment can be delayed past 65 if you’re still covered under an employer plan, but one should be familiar with the system and potential penalties if not enrolled properly and on time.
  • Once on Medicare you can use your HSA to pay premiums, meet deductibles and cover other qualified medical expenses.

Your broker doesn’t care about the trend in health care costs

As discussed in our RIA Financial Guardrails, the cost of health care is growing twice as fast as the typical Cost of Living Adjustment in Social Security benefits.

Healthview Services put’s out an annual report on the trends and costs of health care. In their 2018 Retirement Healthcare Costs Data Report they found that health care expenses are projected to rise at an annual rate of 4.22%. The report also found that the average healthy 65 year old couple who is retiring this year should expect to spend $363,946 in today’s dollars in health care premiums, deductibles and out-of-pocket expenses.

These are scary numbers if you ask me. Is your advisor using standard income replacement ratios of the past or are they updating their numbers annually or is this even a consideration in your overall financial plan?

In your financial plan what is your health care expense and at what % is it inflated each year?

Time and time again financial plans use unrealistic return numbers, little or no inflation and health care considerations have been either missed or an altogether after-thought. 

If you don’t know-ask your advisor what type of assumption’s they are using. This should be an easy conversation to have and if it’s a conversation you don’t feel comfortable having with your advisor it may be time to start kicking tires.

Your advisor’s job is to be your advocate and more importantly in financial planning to play devil’s advocate.

Fund your HSA over your 401(k)

Now this one tends to scare the bejesus out of people, but hear me out.  According to a 2018 Economic News Release by the Bureau of Labor Statistics the median number of years an employee stays at one job is 4.2 years. Now that number is even smaller (2.8 years) if you’re between the ages of 25-34. The trend that people are spending less time at one employer is probably why we have seen an increase in vesting schedules for employer matching contributions or an all-out stop in employer matches.

The U.S. Bureau of Labor Statistics 2019 National Compensation study shows that of the only 64% of employers who offer a 401k plan and on average 74% take advantage of those plans. Out of the 64% who do offer a plan around half of them don’t even offer a match.  As labor markets continue to tighten hopefully we’ll see employers begin to sweeten the pot on 401(k) plans as they try to retain and entice talented workers.

Now if you’re lucky enough to get that illusive bonus of a match you must think about your company’s vesting schedule.

Companies matching contributions are vested a couple of different ways: Immediately, a cliff vesting schedule or graded vesting schedule.

  • An immediate schedule works just like it sounds once your funds are matched in your 401k the employer contribution is 100% vested. I think of that as a unicorn in this day and age, those good companies are few and far between.
  • A cliff schedule means that once you have worked at an employer for a specified period of time (think years) you will be 100% vested in their contributions. When using a cliff schedule by Federal law the company must transfer their match to you by the end of year 3.
  • A graded schedule will vest employer contributions gradually.  In many cases we see the magic number of 20% per year, but employers can’t take that any longer the six years before you are fully vested.

Why is this important? With so many people on the move looking for employment opportunities you must be mindful of your expected time with a company to make the most of any match. As people spend less time at one employer one must consider the length of how long you may continue your employment in regard to your vesting schedule. This will certainly play a factor in determining if funding an HSA prior to your 401k makes sense for you.

When funding an HSA you get to utilize a TRIPLE TAX ADVANTAGE: 

  1. Employee contributions are tax deductible,
  2. Interest is allowed to grow tax free; and,
  3. You can pull the funds out for qualified medical expenses at no tax!

This is extremely powerful and is one reason why there is so much buzz around these accounts.

NO TAX GOING IN, NO TAX ON YOUR EARNINGS AND IF YOU USE IT PROPERLY YOU WON’T BE TAXED ON THE WAY OUT!

In a traditional 401k plan your contributions are put in pretax, funds grow tax deferred and THEN your distributions are taxed when you begin to use them.

As health care expenses become a larger part of our spending in retirement it only makes sense to use an HSA to your family’s advantage.

Medicare and Cobra Payments

Unlike most other accounts utilized for retirement or health care you can use your HSA funds for not only your day to day qualified medical expenses, but also your Medicare and Cobra premiums without incurring taxes or a penalty. The ability to use the funds to pay premiums is a great benefit that is often overlooked.

As referenced earlier in our RIA Financial Guardrails. Per Medicare Trustees as reported by Savvy Medicare, a training program for financial planners, Part B and Part D insurance costs have averaged an annual increase of 5.6% and 7.7% respectively, over the last 5 years and are expected to grow by 6.9% and 10.6% over the next five years.

As inflationary pressure has been weighing on Medicare premiums and expectations for increasing costs to continue now may be a great time to start saving in your HSA.

How to invest your HSA properly

This is one of those things that when I open my computer and see article after article on how to invest aggressively in your Health Savings Accounts it makes me want to bang my head against a wall.

Let’s get this straight, an HSA has the ability to be a powerful investment vehicle with the triple tax-free benefits when used the right way. However, just like with any good financial plan you need to start by having a cushion of emergency funds. This cushion will look different for everyone, but we would recommend having at minimum 2 years of deductibles and premiums saved in a very low risk allocation before you started dipping your toes in the markets with these funds. Life has a way of slapping you upside the head from time to time, just as markets do. When life takes you for a ride we want you to be ready to access your hard earned funds should you need to use them in a medical emergency without regard for asset prices.

Do you pay top dollar for your houses, real estate or a business venture? Or are you looking for a deal? No one wants to buy anything only to have to turn around and sell it later for a loss.

Valuations are high- Not just a little bit high, but near all time. If we look at Shiller’s CAPE-10 Valuation Measures & Forward Returns we can see that current valuation levels are above what we have seen at every previous bull market.

I’m not saying we’re headed into our next recession; the momentum of this market could continue to carry on for some time. Like any other investment thoughtful allocations need to be made in late stage market cycles-especially in an account such as an HSA where you may need the funds sooner rather than later.

There is no one size fits all in the use of a Health Savings Account, but if you use these tips as a template and factor your HSA into your financial plan you’ll be well on your way to success in retirement.

Robertson: Only Time Will Tell

A great way to learn more about any phenomenon is to gain perspective by examining it from different angles. While it is certainly true that a great deal is known about stock returns, it is also true that a broader understanding of the subject has been hampered by overly simplified narratives and recency bias.

What is needed is a fresh perspective and a fairly recent (2018) study provides just that. The study helps to better understand the proposition of investing in stocks and in doing so, provides valuable insights for long-term investors.

The study in question was conducted by Hendrik Bessembinder from the W.P. Carey School of Business at Arizona State University (h/t Steve Bregman from Horizon Kinetics by way of his interview with Real Vision). A key difference in Bessembinder’s approach is that rather than looking at returns from broadly diversified stock portfolios, he focuses his attention on “returns to individual common stocks.”

More specifically, he looks at the excess market value created from holding a stock over the value of simply holding a one-month Treasury bill. Drawing on data from the Center for Research in Securities Prices (CRSP) database, he analyzes the series of one month returns of each stock relative to a T-bill from 1926 to 2016. His finding is somewhat surprising at first look:

“More than half of CRSP common stocks deliver negative lifetime returns. The single most frequent outcome (when returns are rounded to the nearest 5%) observed for individual common stocks over their full lifetimes is a loss of 100%.”

He goes on to explain how this happens: “These results highlight the important role of positive skewness in the distribution of individual stock returns.” In other words, stocks have very asymmetric returns. Most stocks don’t create value relative to Treasuries (over their lifetimes), but a small subset of stocks create vast amounts of value. Bessembinder’s work highlights just how lopsided the contributions are:

“When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926, as other stocks collectively matched Treasury bills.”

Importantly, the poor performance record for most individual stocks casts a very different light on both active and passive management and therefore has important implications for investors.

For active investors, it highlights both a challenge and an opportunity. Since only a relatively few stocks drive all of the wealth creation, failure to have adequate exposure to those few will severely impair portfolio performance. This can be seen quite clearly in the comparison of median and mean buy-and-hold returns for the universe:

“The mean annual buy-and-hold return is 14.74%, while the median is 5.23%. The divergence is more notable for the decade horizon, where the mean buy-and-hold return is 106.8%, compared to a median of 16.1%.”

The key challenge of active management, then, is to establish sufficient exposure to the relatively few disproportionate value creating stocks. If a manager has no special capability to single out these types of stocks, active returns are more likely to be close to the median than the mean.

This reality also creates opportunities, however. Insofar as a manager does have research and analytical processes that create an edge in identifying value creating stocks, the chances of outperforming a passive index are pretty decent. Bessembinder notes, “Investors with long investment horizons who particularly value positive return skewness” can significantly increase their chances of outperforming. The reason is that such an effort can focus on the types of stocks that create disproportionate wealth and concentrate them in a portfolio.

Active management also creates other opportunities. Bessembinder’s study focuses on buy-and-hold returns which excludes the universe of stocks that create value for some period of time before losing that capacity. Active management allows managers to reap the benefits of value creation for part of a company’s life cycle and then to eliminate exposure if evidence of erosion arises. Further, when active managers focus on value creating stocks, there is far less need to offset the performance drag caused by the majority of stocks in the universe.

Of course, the implications for passive investing are just opposite side of the same coin. While passive funds are often lauded for their low costs, little attention is paid to their investment merits. Bessembinder reveals the investment proposition of broad index funds fairly clearly – and the main advantage is diversity. More specifically, owning a piece of everything ensures that you get exposure to the relatively few stocks that create excess wealth.

Along with that benefit, however, comes the baggage of exposure to a lot of stocks that do not create any value. Further, such funds also necessarily include exposure to stocks that are visibly overvalued with no inherent mechanism to hedge that exposure. Stocks that create value for some period of time but then lose out to competition and fade away are included on the way up – and on the way down.

This highlights another point, “Individual common stocks tend to have rather short lives” with a median of seven-and-a-half years. This means that long-term investors in broad market passive funds will churn through several generations of failed companies through the course of their investment horizons.

Based on these insights, we can characterize passive investing more by what it is NOT, than what it is. A broad market passive fund is NOT a collection of mostly value creating securities (over their lifetimes) nor is it an efficient way to gain exposure to businesses that do create long-term value.

Yet another useful lesson from Bessembinder’s study is that it lends historical perspective to individual stock returns by illustrating some important changes over time. For instance, “the percentage of stocks that generate lifetime returns less than those on Treasury bills is larger for stocks that entered the CRSP database in recent decades.” So, as skewed as the returns have been, they have become even more so over time. This progression is evidenced by the fact that “the median lifetime return is negative for stocks entering the database in every decade since 1977.”

Not surprisingly, the worsening trend in performance also coincides with “a sharp decline in survival rates for newly listed firms after 1980.” While a number of potential causes are at play,  prominent ones feature the increased prevalence of stocks “with high asset growth but low profitability”. History suggests this combination leads to lower survival rates.

This history is especially interesting because it contrasts so sharply with today’s market ethos. For example, many of the current market darlings such as Netflix and Tesla not only exhibit high growth and low profitability, but also embrace and promote those attributes. History suggests such companies are overfit for very specific business conditions that are unlikely to persist and therefore are unlikely to survive more challenging conditions.

The issue of resilience is one that Nassim Taleb captured well in his book, Antifragile. For example, he described how he only drinks wine, water, and coffee based on the logic that liquids that are at least a thousand years old have been adequately tested for fitness. While Taleb’s standards of fitness for beverages may be extreme, the point is still a valid one: With such a long history, these beverages have proven themselves safe over a wide variety of conditions.

The concept of resilience is also critical for long-term investors. Part of the reason is that companies that regularly operate at (or beyond) the thresholds of prudence are completely beholden to the graces of a favorable environment. Just as soon as things become even modestly more difficult for whatever reason, they do not have the wherewithal to survive.

This matters because for firms to be able to create a great deal of wealth, they must be able to generate excess returns, and also to do so repeatedly so returns can compound. That means survivability is also a precondition for significant wealth creation.

It really helps for long-term investors to keep this in mind. When stocks keep running up and the news is positive, it is easy to get caught up and lose perspective. Bessembinder’s study provides a striking reminder that the vast majority of these price moves do not reflect lasting value creation. In order to track lasting value creation, it takes company and industry research along with detailed analysis of economic returns and sustainable growth rates.

Finally, one of the great benefits of studying history is that it expands understanding well beyond our own personal experiences. Bessembinder’s study provides useful historical context but also much more. By uncovering the net returns of individual stocks over Treasuries, he also creates a much richer understanding from which to evaluate active and passive approaches to investing. Time will tell which approach is more useful for investors with long time horizons.

Dallas Fed President Sees “No Move” In Fed Funds Rate

Dallas Fed President Robert Kaplan made some interesting comments today on interest rates, repos, and the coronavirus.


Dallas Fed President Robert Kaplan was on panel discussion today at the University of Texas McCombs School of Business on the “2020 Business Outlook: Real Estate and the Texas Economy” in Austin, Texas.

Bloomberg Econoday Synopsis

  1. Dallas Fed President Robert Kaplan is neutral right now on monetary policy, saying neither a rate cut nor a rate hike are necessary in the medium term. “My base case is no movement up or down in the Fed funds rate [in 2020], but I’ll be monitoring [things] carefully … this year,” Kaplan said in a panel discussion.
  2. Kaplan believes the outlook for the economy has stabilized and if anything has “firmed”, and though he now has “a more confident outlook” he isn’t ready to commit to a rate hike saying it’s “too soon to judge if a hike is coming, and you’ve got a number of [risky] factors going on.”
  3. Regarding a so-called “coronavirus cut” to reassure markets, Kaplan doesn’t see justification yet adding, however, that he is carefully watching how the virus unfolds and that he will have a better sense of its effects over the next few months. Kaplan also noted that he will be watching the first-half impact of the Boeing 737 production shutdown.
  4. On repo operations, Kaplan described the rise in the Fed’s balance sheet through year-end as “substantial” but he sees slowing growth through June. “I’d be hopeful and expect that as we continue bill purchases during the second quarter, the repo usage will begin to decline and the headline net balance-sheet growth for the Fed will moderate – certainly far more moderate than what’s we’ve seen to this period.”
  5. On inflation, Kaplan’s base case is an upward trend toward 2 percent in the medium term. Kaplan said the Fed is debating whether to lengthen out its look at inflation from a one-year average to perhaps a two-year average. “We look at a variety of factors to make our judgment.”

Regarding no interest rate movement, the market disagrees, and so do I.

On inflation, the entire fed is clueless about what it is.

In regards to a firming economic outlook, Kaplan may wish to ponder Coronavirus Deaths Surge, No Containment In Sight.

The supply chains disruptions will be massive. A “Made in China” Economic Hit is coming right up.

On repo operations, yep, it’s entirely believable the Fed will keep ballooning its balance sheet risking even bigger bubbles.

The yield curve is inverted once again. And that’s flashing another recession signal. On Average, How Long From Inversion to Recession?

SOTM 2020: State Of The Markets

“I am thrilled to report to you tonight that our economy is the best it has ever been.” – President Trump, SOTU

In the President’s “State of the Union Address” on Tuesday, he used the podium to talk up the achievements in the economy and the markets.

  • Low unemployment rates
  • Tax cuts
  • Job creation
  • Economic growth, and, of course,
  • Record high stock markets.

While it certainly is a laundry list of items he can claim credit for, it is the claim of record-high stock prices that undermines the rest of the story.

Let me explain.

The stock market should be a reflection of actual economic growth. Since corporate earnings are derived primarily from consumptive spending, corporate investments, and imports and exports, actual economic activity should be reflected in the price investors are willing to pay for the earnings being generated.

For the majority of the 20th century, this was indeed the case as corporate earnings were reflective of economic activity. The chart below shows the annual change in reported earnings, nominal GDP, and the price of the S&P 500.

Not surprisingly, as the economy grew at 6.47% annually, earnings also grew at 6.68% annually as would be expected. Since investors are willing to a premium for earnings growth, the S&P 500 grew at 9% annually over that same period.

Importantly, note that long-term economic growth has averaged 6% annually. However, as shown in the lower panel, economic growth has been running below the long-term average since 2000, but has been substantially weaker since 2007, growing at just 2% annually.

The next chart shows this weaker growth more clearly. Since the financial crisis, economic growth has failed to recover back to its long-term exponential growth trend. However, reported earnings are exceedingly deviated from what actual underlying economic growth can generate. This is due to a decade of accounting gimmickry, share buybacks, wage suppression, low interest rates, and high corporate debt levels.

The next chart looks at the deviation by looking at the market itself versus long-term economic growth. The S&P 500 and GDP have been scaled to 100, and displayed on a log-scale for comparative purposes.

The current growth trend of the economy is running well below its long-term exponential trend, but the S&P 500 is currently at the most significant deviation from that growth on record. (It should be noted that while these deviations from economic growth can last for a long-time, the eventual mean reversion always occurs.)

The Spending Mirage

Take a look at the following chart.

While the President’s claims of an exceptionally strong economy rely heavily on historically low unemployment and jobless claims numbers, historically high levels of asset prices, and strong consumer spending trends, there is an underlying deterioration which goes unaddressed.

So, here’s your pop quiz?

If consumer spending is strong, AND unemployment is near the lowest levels on record, AND interest rates are low, AND job creation is high – then why is the economy only growing at 2%?

Furthermore, if the economy was doing as well as government statistics suggest, then why does the Federal Reserve need to continue providing the economy with “emergency measures,” cutting rates, and giving “verbal guidance,” to keep the markets from crashing?

The reality is that if it wasn’t for the Government running a massive trillion-dollar fiscal deficit, economic growth would actually be recessionary.

In GDP accounting, consumption is the largest component. Of course, since it is impossible to “consume oneself to prosperity,” the ability to consume more is the result of growing debt. Furthermore, economic growth is also impacted by Government spending, as government transfer payments, including Medicaid, Medicare, disability payments, and SNAP (previously called food stamps), all contribute to the calculation.

As shown below, between the Federal Reserve’s monetary infusions and the ballooning government deficit, the S&P 500 has continued to find support.

However, nothing is “produced” by those transfer payments. They are not even funded. As a result, national debt rises every year, and that debt adds to GDP.

Another way to look at this is through tax receipts as a percentage of GDP.  If the economy was indeed “the strongest ever,” then we should see an increase in wage growth commensurate with increased economic activity. As a result of higher wages, there should be an increase in the taxes collected by the Government from wages, consumption, imports, and exports.

See the problem here?

Clearly, this is not the case as tax receipts as a percentage of GDP peaked in 2012, and have now declined to levels which historically are more coincident with economic recessions, rather than expansions. Yet, currently, because of the artificial interventions, the stock market remains well detached from what economic data is actually saying.

Corporate Profits Tell The Real Story

When it comes to the state of the market, corporate profits are the best indicator of economic strength.

The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to “remain irrational longer than logic would predict,” but it never lasts indefinitely.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

As shown, when we look at inflation-adjusted profit margins as a percentage of inflation-adjusted GDP, we see a clear process of mean-reverting activity over time. Of course, those mean reverting events are always coupled with recessions, crises, or bear markets.

More importantly, corporate profit margins have physical constraints. Out of each dollar of revenue created, there are costs such as infrastructure, R&D, wages, etc. Currently, the biggest contributors to expanding profit margins has been the suppression of employment, wage growth, and artificially suppressed interest rates, which have significantly lowered borrowing costs. Should either of the issues change in the future, the impact to profit margins will likely be significant.

The chart below shows the ratio overlaid against the S&P 500 index.

I have highlighted peaks in the profits-to-GDP ratio with the green vertical bars. As you can see, peaks, and subsequent reversions, in the ratio have been a leading indicator of more severe corrections in the stock market over time. This should not be surprising as asset prices should eventually reflect the underlying reality of corporate profitability.

It is often suggested that, as mentioned above, low interest rates, accounting rule changes, and debt-funded buybacks have changed the game. While that statement is true, it is worth noting that each of those supports are artificial and finite.

Another way to look at the issue of profits as it relates to the market is shown below. When we measure the cumulative change in the S&P 500 index as compared to the level of profits, we find again that when investors pay more than $1 for a $1 worth of profits, there is an eventual mean reversion.

The correlation is clearer when looking at the market versus the ratio of corporate profits to GDP. (Again, since corporate profits are ultimately a function of economic growth, the correlation is not unexpected.) 

It seems to be a simple formula for investors that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy doesn’t matter. 

However, investors are paying more today than at any point in history for each $1 of profit, which history suggests will not end well.

While the media is quick to attribute the current economic strength, or weakness, to the person who occupies the White House, the reality is quite different.

The political risk for President Trump is taking too much credit for an economic cycle which was already well into recovery before he took office. Rather than touting the economic numbers and taking credit for liquidity-driven financial markets, he should be using that strength to begin the process of returning the country to a path of fiscal discipline rather than a “drunken binge” of government spending.

With the economy, and the financial markets, sporting the longest-duration in history, simple logic should suggest time is running out.

This isn’t doom and gloom, it is just a fact.

Politicians, over the last decade, failed to use $33 trillion in liquidity injections, near-zero interest rates, and surging asset prices to refinance the welfare system, balance the budget, and build surpluses for the next downturn.

Instead, they only made the deficits worse, and the U.S. economy will enter the next recession pushing a $2 Trillion deficit, $24 Trillion in debt, and a $6 Trillion pension gap, which will devastate many in their retirement years.

While Donald Trump talked about “Yellen’s big fat ugly bubble” before he took office, he has now pegged the success of his entire Presidency on the stock market.

It will likely be something he eventually regrets.

“Then said Jesus unto him, Put up again thy sword into his place: for all they that take the sword shall perish with the sword.” – Matthew 26, 26:52

Commodity Review 02-06-20

A review of important commodities which may provide clues as to both the strength and direction of the markets and the economy.

CRB Index

  • After rising from October of 2019 into December, in anticipation of the “Trade Deal,” the CRB index has collapsed in the last month suggesting the pickup in economic activity seen last year is over.
  • This same story SHOULD be evidenced in the following economically sensitive commodities as well.
  • Currently, commodities are just registering a “sell signal,” but are oversold currently. This suggests that with the outbreak of the “Coronavirus,” which will further impact economic growth, we could see weaker commodity prices ahead.
  • Previous positions should have been stopped out at $180.

Copper

  • Copper, often called “Dr. Copper” because of its sensitivity to economic demand has also collapsed suggesting the same “economic weakness” story.
  • We previously recommended a trading position with a tight stop at $2.50 and profits should have been taken on that recommendation.
  • Stops were moved up to $2.65 on current positions which have now all been triggered.

Lumber

  • There has been a lot of talk about the strength of the housing market, and home builder stocks have been on fire as of late.
  • However, while Lumber broke out of the previous consolidation range, it hasn’t really performed as well as one would suspect given the run up in housing stocks. Such suggests the economy, and the housing market, is likely running at weaker rates than the stocks suggests. (Such suggests taking profits out of housing stocks which are overvalued currently.)
  • We previously noted that a break above $400 would make a trade more interesting, and would confirm a pickup in economic growth. However, while lumber suggests economic activity may be improving some, the rest of the commodity complex doesn’t agree.
  • We previously recommended a position could be added with a tight stop at $380. Hold positions now and wait for the overbought condition to be corrected before adding further.

Soybeans

  • One look at this chart and you can understand why American farmers are filing for bankruptcy. It also makes you question the real “deal” that was cut with China.
  • If China was really going to massively accelerate purchases of agricultural products, Soybeans should be hitting all-time highs. Since they remain bound to a lower trading range, the question that should be asked is what do traders know that you don’t.
  • Soybeans are extremely oversold currently, but with a sell signal being triggered, there is risk to the downside especially since China will not meet their goals.
  • A break above $940 makes Soybeans much more interesting, but the current risk/reward doesn’t suggest a trade.
  • No trade recommended.

US Dollar Index

  • With roughly 40-50% of corporate profits coming from exports, all commodities globally traded in dollars, and the dollar impact on the bond market, this is a key measure to watch.
  • We previously suggested the dollar would potentially weaken, which it started to do, but the reversal in bond yields, and better than expected economic strength, the dollar reversed course and has moved back into its trading range.
  • With the dollar breaking above its moving averages, you can add long-dollar positions with a stop at $97.
  • A strong dollar also suggests continued pressure on commodities, oil, and gold.

10-Year Interest Rates

  • The “trade war” and “strong dollar” has pushed a lot of money into the U.S. Treasury market over the last year pushing rates to multi-year lows.
  • We previously discussed the extreme overbought condition needed to be reversed and that reversal in rates occurred but was short-lived until the “Coronavirus” hit.
  • As we said previously: “It is unlikely that rates can rise too far before they begin to impact an already weak economy, but an initial retracement back to 2.1% is likely. A weekly close above 1.9% will signal a move higher is coming.”
  • Well, we never got above 1.9% before rates plunged back to test previous lows.
  • With rates again very overbought, look for a retracement back to 1.7-1.8% to add to bond holdings in portfolios. This is a reasonable time to take profits in bonds if you haven’t done so previously.

Gold

  • We previously sold half of our position to protect gains, and then added back into our positions with Gold holding important support at $1470.
  • Gold is close to triggering a short-term buy signal, and the recent pullback should provide a decent entry opportunity if support holds at $1550.
  • Hold current positions for now.
  • Move stop-losses up to $1500

Oil – Black Gold

  • Oil has been in a fight with trying to maintain price in the face of overwhelming supply and weakening demand. Oil lost.
  • Oil failed to hold support at the 200-dma, then again at $54 and $52 breaking final support. There is nothing good going on with oil currently.
  • However, in the short term oil is extremely oversold and a bounce is likely that positions can be cleared into at a better price.
  • Look for a rally back into the high 50’s to close out positions and rebalance risks in portfolios. A stronger dollar isn’t going to play well with oil prices in the future.

Selected Portfolio Position Review: 02-05-2020

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

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

HOW TO READ THE CHARTS

There are four primary components to each chart:

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

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

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

ABBV – AbbVie Inc.

  • We bought ABBV back in August of last year, as the stock had gotten extremely oversold. At the time we bought 1/2 position with an intention on adding to the holding.
  • However, the stock went straight up not really offering a good point to add to our position.
  • With ABBV now oversold and pulling back towards previous support levels, we are looking to add the second 1/2 to our position.
  • We may see a bit more correction first, so we will be patient but will likely add to the position shortly.
  • Stop is set at $70

AMLP – Alerian MLP ETF

  • We bought 1/2 of AMLP back in December expecting an opportunity to add to the holding. With the decline in oil, we may be getting that opportunity.
  • If AMLP can hold support, over the next few days, and continue to base at these levels, we will be able to add our holding.
  • With a near 10% yield we can give the holding a bit of room to wait out the current correction in oil. The sector is VERY beaten up and we are looking at other opportunities in the space.
  • We are moving our stop to $7

CMCSA – Comcast Corp.

  • We previoulsy bought CMCSA in January of last year and it has performed well. We have take profits as well.
  • With the recent correction to the 200-dma, and lots of support just below that level, we can look to add back to our holding.
  • With the position oversold, and on a “sell signal” currently, we will give CMCSA a little room and then add to the position opportunistically.
  • We are maintaining our stop at $40.

CVS – CVS Health Corp.

  • We bought CVS in April of last year as the stock bottomed after concerns of “Medicare for all” ran rampant through the healthcare system.
  • We took profits after a stellar run, but now the position is pulling back to support and is oversold enough to warrant adding to the position.
  • We are looking for CVS to stabilize at current levels and not trigger a sell signal. If it does in the next day or two, we can add to our holding.
  • Stop is moved up to $62

DEM – Emerging Market High Yield Dividend.

  • We bought DEM on anticipation of a bit weaker dollar, and then “coronavirus” showed up.
  • With a 5% yield we can be a little patient here, but if the 200-dma support can hold, along with the position being very oversold, there is a good tradeable rally on any news the “virus” is coming under some control or improvement.
  • We are likely going to add to the position for a trade back to the top of the range with a stop at $41.
  • Stop is moved up to $41 on whole position.

EFV – iShares EAFE Value ETF

  • As with DEM, EFV sports a yield of nearly 5% and is now very oversold.
  • As noted above, any improvement in the “virus” situation is likely to lead to a fairly sharp counter trend rally.
  • We are looking to add to the position for a trade higher and then we may step out of international again entirely due to underperformance relative to domestic holdings.
  • We need to see EFV hold support at the 200-dma which is were we are moving stops up to.
  • Stop is currently set at $47

KHC – Kraft Heinz Co.

  • We bought a position in KHC back near the September lows in anticipation of an improvement in earnings. That led to a pop in in the stock short-term.
  • With KHC now oversold, but still on a buy signal, earnings are due on February 13th. If there is a good earnings report we will expect to see the position improve and we will add to our holding.
  • If earnings disappoint, we will re-evaluate our thesis on the company and take action accordingly.
  • Stop loss remains at $25

STZ – Constellation Brands, Inc.

  • We have been watching STZ for a while and have been considering adding it to the portfolio.
  • STZ has been unable to move above the 200-dma which has kept us on hold.
  • STZ is close to registering a buy signal now, which makes things more interesting. We are continuing to monitor the position but may consider adding a trading position if the buy signal is triggered.
  • Stop-loss would be set at $175

UNH – United Healthcare

  • UNH has surged higher in recent months after struggling with “Medicare for all” from Democratic candidates last year.
  • We love this position and will continue to hold it, however, the position is SO extremely extended we did take profits recently.
  • With the pullback we are now looking to add back to our holdings as long as support holds at the 200-dma.
  • With UNH now back to an oversold condition the opportunity to add to our holding is approaching.
  • Stop loss moved up to $250

XOM – Exxon Mobil

  • Technically we should be stopped out of XOM after it broke our stop level on Tuesday.
  • However, with XOM on a very deep oversold condition and 3-standard deviations below the 200-dma, we are looking for a sellable rally to reduce the position into. Counter-trend rallies from these levels have tended to be rather sharp.
  • With a near 6% yield we will give XOM a little wiggle room. However, we aren’t giving it much.
  • Stop loss triggered at $62.

Jerome Powell & The Fed’s Great Betrayal

“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

John Maynard Keynes – The Economic Consequences of Peace 1920

“And when we see that we’ve reached that level we’ll begin to gradually reduce our asset purchases to the level of the underlying trend growth of demand for our liabilities.” –Jerome Powell January 29, 2020.

With that one seemingly innocuous statement, Chairman Powell revealed an alarming admission about the supply of money and your wealth. The current state of monetary policy explains why so many people are falling behind and why wealth inequality is at levels last seen almost 100 years ago. 

REALity

 “Real” is a very important concept in the field of economics. Real generally refers to an amount of something adjusted for the effects of inflation. This allows economists to measure true organic growth or decline.

Real is equally important for the rest of us. The size of our paycheck or bank account balance is meaningless without an understanding of what money can buy. For instance, an annual income of $25,000 in 1920 was about eight times the national average. Today that puts a family of four below the Federal Poverty Guideline. As your grandfather used to say, a dollar doesn’t go as far as it used to.

Real wealth and real wage growth are important for assessing your economic standing and that of the nation.

Here are two facts:

  • Wealth is largely a function of the wages we earn
  • The wages we earn are predominately a function of the growth rate of the economy

These facts establish that the prosperity and wealth of all citizens in aggregate is meaningfully tied to economic growth or the output of a nation. It makes perfect sense.

Now, let us consider inflation and the role it plays in determining our real wages and real wealth.

If the rate of inflation is less than the rate of wage growth over time, then our real wages are rising and our wealth is increasing. Conversely, if inflation rises at a pace faster than wages, wealth declines despite a larger paycheck and more money in the bank.

With that understanding of “real,” let’s discuss inflation.

What is Inflation?

Borrowing from an upcoming article, we describe inflation in the following way:

“One of the most pernicious of these issues in our “modern and sophisticated” intellectual age is that of inflation. Most people, when asked to define inflation, would say “rising prices” with no appreciation for the fact that price movements are an effect, not a cause. They are a symptom of monetary circumstances. Inflation defined is, in fact, a disequilibrium between the amount of currency entering an economic system relative to the productive output of that same system.”

The price of cars, cheeseburgers, movie tickets, and all the other goods and services we consume are chiefly based on supply and demand. Demand is a function of both our need and desire to own a good and, equally importantly, how much money we have. The amount of money we have in aggregate, known as money supply, is governed by the Federal Reserve. Therefore, the supply of money is a key component of demand and therefore a significant factor affecting prices.

With the linkage between the supply of money and inflation defined, let us revisit Powell’s recent revelation.

“And when we see that we’ve reached that level we’ll begin to gradually reduce our asset purchases to the level of the underlying trend growth of demand for our liabilities.”

In plain English, Powell states that the supply of money is based on the demand for money and not the economic growth rate.  To clarify, one of the Fed’s largest liabilities currently are bank reserves. Banks are required to hold reserves for every loan they make. Therefore, they need reserves to create money to lend. Ergo, “demand for our liabilities,” as Powell states, actually means bank demand for the seed funding to create money and make loans.

The relationship between money supply and the demand for money may, in fact, be aligned with economic growth. If so, then the supply of money should rise with the economy. This occurs when debt is predominately employed to facilitate productive investments.

The problem occurs when money is demanded for consumption or speculation. For example:

  • When hedge funds demand billions to leverage their trading activity
  • When Apple, which has over $200 billion in cash, borrows money to buy back their stock  
  • When you borrow money to buy a car, the size of the economy increases but not permanently as you are not likely to buy another car tomorrow and the next day

Now ask, should the supply of money increase because of those instances?

The relationship between the demand for money and economic activity boils down to what percentage of the debt taken on is productive and helps the economy and the populace grow versus what percentage is for speculation and consumption.

While there is no way to quantify how debt is used, we do know that speculative and consumptive debt has risen sharply and takes up a much larger percentage of all debt than in prior eras.  The glaring evidence is the sharp rise of debt to GDP.

Data Courtesy St. Louis Federal Reserve

If most of the debt were used productively, then the level of debt would drop relative to GDP. In other words, the debt would not only produce more economic growth but would also pay for itself.  The exact opposite is occurring as growth languishes despite record levels of debt accumulation.

The speculative markets provide further evidence. Without presenting the long list of asset valuations that stand at or near record levels, consider that since the last time the S&P 500 was fairly valued in 2009, it has grown 375%. Meanwhile, total U.S. Treasury debt outstanding is up by 105% from $11 trillion to $22.5 trillion and corporate debt is up 55% from $6.5 trillion to $10.1 trillion. Over that same period, nominal GDP has only grown 46% and Average Hourly Earnings by 29%.

When the money supply is increased for consumptive and speculative purposes, the Fed creates dissonance between our wages, wealth, and the rate of inflation. In other words, they generate excessive inflation and reduce our real wealth.  

If this is the case, why is the stated rate of inflation less than economic growth and wage growth?

The Wealth Scheme

This scheme works like all schemes by keeping the majority of people blind to what is truly occurring. To perpetuate such a scheme, the public must be convinced that inflation is low and their wealth is increasing.

In 2000, a brand new Ford Taurus SE sedan had an original MSRP of $18,935. The 2019 Ford Taurus SE has a starting price of $27,800.  Over the last 19 years, the base price of the Ford Taurus has risen by 2.05% a year or a total of 47%. According to the Bureau of Labor Statics (BLS), since the year 2000, the consumer price index for new vehicles has only risen by 0.08% a year and a total of 1.68% over the same period.

For another instance of how inflation is grossly underreported, we highlighted flaws in the reporting of housing prices in MMT Sounds Great in Theory But…  To wit: 

“Since then, inflation measures have been tortured, mangled, and abused to the point where it scarcely equates to the inflation that consumers deal with in reality. 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%. Needless to say, house prices, which currently comprise almost 25% of CPI, have 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, especially for just one line item.”

Those two obscene examples highlight that the government reported inflation is not the same inflation experienced by consumers. It is important to note that we are not breaking new ground with the assertion that the government reporting of inflation is low. As we have previously discussed, numerous private assessments quantify that the real inflation rate could easily be well above the average reported 2% rate. For example, Shadow Stats quantifies that inflation is running at 10% when one uses the official BLS formula from 1980.

Despite what we may sense and a multitude of private studies confirming that inflation is running greater than 2%, there are a multitude of other government-sponsored studies that argue inflation is actually over-stated. So, the battle is in the trenches, and the devil is in the details.

As defined earlier, inflation is “a disequilibrium between the amount of currency entering an economic system relative to the productive output of that same system.”

The following graph shows that the supply of money, measured by M2, has grown far more than the rate of economic growth (GDP) over the last 20 years.

Data St. Louis Federal Reserve

Since 2000, M2 has grown 234% while GDP has grown at half of that rate, 117%. Over the same period, the CPI price index has only grown by 53%. M2 implies an annualized inflation rate over the last 20 years of 6.22% which is three times that of CPI. 

Dampening perceived inflation is only part of the cover-up. The scheme is also perpetuated with other help from the government. The government borrows to boost temporary economic growth and help citizens on the margin. This further limits people’s ability to detect a significant decline in their standard of living.

As shown below, when one strips out the change in government debt (the actual increase in U.S. Treasury debt outstanding) from the change in GDP growth, the organic economy has shrunk for the better part of the last 20 years. 

Data St. Louis Federal Reserve

It doesn’t take an economist to know that a 6.22% inflation rate (based on M2) and decade long recession would force changes to our monetary policy and send those responsible to the guillotines. If someone suffering severe headaches is diagnosed with a brain tumor, the problem does not go away because the doctor uses white-out to cover up the tumor on the x-ray film.

Despite crystal clear evidence, the mirages of economic growth and low inflation prevent us from seeing reality.

Summary

Those engaging in speculative ventures with the benefit of cheap borrowing costs are thriving. Those whose livelihood and wealth are dependent on a paycheck are falling behind. For this large percentage of the population, their paychecks may be growing in line with the stated government inflation rate but not the true inflation rate they pay at the counter. They fall further behind day by day as shown below.

While this may be hard to prove using government inflation data, it is the reality. If you think otherwise, you may want to ask why a political outsider like Donald Trump won the election four years ago and why socialism and populism are surging in popularity. We doubt that it is because everyone thinks their wealth is increasing. To quote Bill Clinton’s 1992 campaign manager James Carville, “It’s the economy, stupid.”

That brings us back to Jerome Powell and the Fed. The U.S. economy is driven by millions of individuals making decisions in their own best interests. Prices are best determined by those millions of people based on supply and demand – that includes the price of money or interest rates. Any governmental interference with that natural mechanism is a recipe for inefficiency and quite often failure.

If monetary policy is to be set by a small number of people in a conference room in the Eccles Building in Washington, D.C. who think they know what is best for us based on flawed data, then they should prepare themselves for even more radical social and political movements than we have already seen.

Where’s the Adult Merit Badge for Super Savers?

Super Savers are a special breed.

They are not concerned about keeping up impressions; they exist outside the mainstream of seductive consumerism.

Call it a mindset, call it walking a different path; perhaps it’s an offbeat childhood money script. Whatever it is, those who fall into this category or save 20% or more of their income on a consistent basis are members of an elite group who strive for early financial independence.

Speaking of independence: At RIA we believe households should maintain 3-6 months of living expenses in a savings account for emergencies like car and house repairs.  They should also maintain an additional 6 months of living expenses as a “Financial Vulnerability Cushion,”  whereby cash is set aside for the big, life-changing stuff like extended job loss especially as we believe the economy is in a late-stage expansionary cycle. Job security isn’t what it used to be; best to think ahead.

In 2018, TD Ameritrade in conjunction with Harris Poll, completed a survey among 1,503 U.S. adults 45 and older to understand the habits that set Super Savers apart from the pack. The results are not surprising. However, they do validate habits all of us should adopt regardless of age.

Like a physical exercise regimen, shifting into Super Saver mode takes small, consistent efforts that build on each other.

So, what lessons can be learned from this elite breed?

First, on average, Super Savers sock away 29% of their income compared to non-super savers. 

Super Savers place saving and investing over housing and household expenses.

Keep in mind, the Personal Saving Rate as of December 2019 according to the Federal Reserve Bank of St. Louis was a paltry 7.6%.  How does this group manage to accomplish such an arduous task? They abhor the thought of being house poor. They focus attention on the reduction of spending on the big stuff, or the fixed costs that make a huge impact to cash flow. Candidly, they’re not concerned about cutting out lattes as a viable strategy to save money. Super Savers spend 14% on housing, 16% on essential household expenses compared to non-supers who spend 23% and 21%, respectively. Any way you cut it, that’s impressive!

Perhaps it’s because Super Savers think backwards, always with a financially beneficial endgame in mind. There is great importance placed on financial security, peace of mind and freedom to do what they want at a younger age. They consider the cumulative impact of monthly payments on their bottom line, which is not common nature for the masses.  They internalize the opportunity cost of every large or recurring expenditure.

Super Savers weigh the outcome of every significant purchase, especially discretionary items, which invariably increases their hesitancy to spend. This manner of thought provides breathing room to deliberate less expensive alternatives and thoroughly investigate the pros and cons of their decisions.

Tip for the Super Saver in training: Sever the mental connection between monthly payments and affordability. How? First, calculate the interest cost of a purchase. For example, let’s say you’re looking to purchase an automobile. First, never go further than 36 months if you must make payments. Why? Because longer loan terms like 48 to 72 months is a payment mentality that will undoubtedly increase interest costs.

For example, let’s say an auto purchase is financed for $23,000. At 3.49% for 36 months, the payment is roughly $674 with total loan interest of $1,258. For 72 months, naturally there’s a lower monthly obligation – $354. However, total loan interest amounts to $2,525.

A Super Saver’s consideration would be on the interest incurred over the life of a loan, not the affordability of monthly payments. An important difference between this manner of thinking and most, is to meet a lifestyle, it’s common for households to go for the lowest monthly payment with little regard to overall interest paid. Super savers will either consider a less expensive option or adjust household budgets to meet higher payments just to pay less interest in the long run.

Second, Super Savers live enriching lives; they don’t deprive themselves.

Members of the super crowd don’t live small lives -a big misnomer. I think people are quick to spread this narrative to ease personal guilt or envy. Certainly, a fiscal discomfort mindset is part of who they are when they believe personal financial boundaries are breached. However, the TD Ameritrade survey shows that both super and non-super savers spend the same 7% of their income on vacations!

Third, starting early is key for Super Savers.

Per the study, more than half of Super Savers started investing by age 30 (54%).  I’m not a fan of personal finance dogma. Many of the stale tenets preached by the brokerage industry are part of a self-serving agenda to direct retail investor cash into cookie-cutter asset allocation portfolios; all to appease shareholders.

However, one rule I’m happily a complete sucker for is Pay Yourself First. It’s not just a good one. It’s the core, the very foundation, of every strong financial discipline. Why? Paying yourself first, whereby dollars are directed to savings or investments before anything else, reflects a commitment to delayed gratification. An honorable trait that allows the mental breathing room to avoid impulse buys, raise the bar on savings rates and minimize the addition of debt.

Per Ilene Strauss Cohen, Ph.D. for Psychology Today, people who learn how to manage their need to be satisfied in the moment thrive more in their careers, relationships, health and finances when compared to those who immediately give in to gratification. Again, the root of Pay Yourself First is delayed gratification; the concept goes back further than some of the concepts the financial industry has distorted just to part you from your money.

Fourth, Super Savers embrace the simple stuff.

When it comes to financial decisions, basics work. For example, Super Savers avoid high-interest debt (65% vs. 56% for non-super savers),  stick to a budget (60% vs. 49%), invest in the market (58% vs. 34%) and max out retirement savings (55% vs. 30%).

Listen, these steps aren’t rocket science; they’re basic financial literacy.

For example, I’ve been ‘pencil & paper’ budgeting since I began my Daily News Brooklyn paper route at age 11. Budgeting over time fosters an awareness of household cash flow.  Try micro-budgeting for a few months. It will help you intimately engage with  personal spending trends.

Micro-budgets are designed to increase awareness through simplicity.

Yes, they’re a bit time-consuming, occasionally monotonous; however the goal is worth it – to uncover weaknesses and strengths in your strategy and build a sensitivity to household cash-flow activities. My favorite old-school book for budgeting comes from the Dome companies. For a modest investment of $6.50, a Dome Budget Book is one of the best deals on the market.

Last, Super Savers believe in diversified streams of income and accounts!

44% of Super Savers prefer to bolster already impressive savings rates by funding diversified sources of income, compared to only 36% of their non-super brethren. In addition, Super Savers are especially inclined to lean into Roth IRAs compared to non-super savers. It is rewarding to discover how the best of savers seek various income streams to build their top-line.  They are also tremendous believers in Roth IRAs. The reason I’m glad is this information further validates why our advisors and financial planning team members have passionately communicated the importance of the diversification of accounts for several years.

Super Savers build the following income streams outside of employment income – Dividends, investment real estate, annuities (yes, annuities – 21% vs. 14% for non-super savers), and business ownership (14% compared to 8%).

Their retirement accounts are diversified; over 53% of Super Savers embrace Roth options (53% compared to 29%). A great number of Super Savers fund Health Savings Accounts and strive to defer distributions until retirement when healthcare costs are expected to increase.

Why diversification of accounts?

Imagine never being able to switch lanes as you head closer to the destination called retirement. Consider how suffocating it would be to never be able to navigate away from a single-lane road where all distributions are taxed as ordinary income. There lies the dysfunctional concept that Super Savers are onto – They do not believe every investment dollar should be directed to pre-tax retirement accounts.

Congratulations -With the full support of the financial services industry you’ve created a personal tax time bomb!

As you assess the terrain for future distributions, tax diversification should be a priority.  Envision a retirement paycheck that’s a blend of ordinary, tax-free and capital gain income (generally taxed at lower rates than ordinary income). The goal is to gain the ability to customize your withdrawal strategy to minimize tax drag on distributions throughout retirement. Super Savers have figured this out. Regardless of your savings habits, you should too.

Many studies show that super savers are independent thinkers. Working to create and maintain a lifestyle that rivals their neighbors is anathema to them.

Now, as a majority of Americans are utilizing debt to maintain living standards, Super Savers set themselves apart as a badge of courage. No doubt this group is unique and are way ahead at crafting a secure, enjoyable retirement. and financial flexibility. Whatever steps taken to join their ranks will serve and empower you with choices that those with overwhelming debt cannot consider.

And speaking of badges: Did you know Amazon sells Merit badges for adulting? It’s true. I believe they need to add a “I’M A SUPER SAVER” badge to the collection.

If you’d like to read the complete T.D. Ameritrade survey, click here.

Quick Take: The Great “Tesla” Hysteria Of 2020

“Let us see how high we can fly before the sun melts the wax in our wings.” – E. O. Wilson

Since January 1, 2020, Tesla’s (TSLA) stock price has risen by $462 or 110%. TSLA’s market cap now exceeds every automaker except for Toyota. In fact, it exceeds not only the combined value of the “big three” automakers GM, Ford, and Chrysler/Fiat, but also companies like Charles Schwab, Target, Deere, Eli Lily, and Marriot to name a few large companies.

Seem crazy? Not as crazy as what comes next. Crazy are the expectations of Catherine Wood of ARK Invest. This well-known “disruptive innovation” based investor put out the following chart showing an expected price of $7,000 in 2024 with a $15,000 upside target.

Siren songs such as the one shown above encourage investors to chase the stock higher with reckless abandon, and maybe that is ARK’s intent. Given their large holding of TSLA, it certainly makes more sense than their price targets. Instead of taking her recommendations with blind faith, here are some statistics to illustrate what is required for TSLA to reach such lofty goals.

To start, let’s compare TSLA to their peer group, the auto industry. The chart below shows that TSLA has the second largest market cap in the auto industry, only behind Toyota. Despite the market cap, its sales are the lowest in the industry and by a lot. According to figures published on their website, TSLA sold 367,500 cars in 2019. General Motors sold 2.9 million and Ford sold 2.4 million.

Clearly investors are betting on the future, so let’s put ARK’s forecast into context.  

If the TSLA share price were to rise to their baseline forecast of 7,000, the market cap would increase to $1.26 trillion. Currently, the auto industry, as shown above, and including TSLA, aggregates to $772 billion. At the upside scenario of 15,000, the market cap of TSLA ($2.7 trillion) would be almost four times the current market cap of the entire auto industry.  More stunning, it would be greater than the combined value of Apple and Microsoft.

Even if we make the ridiculous assumption that TSLA will be the world’s only automaker, a price of 15,000 still implies a valuation that is three to four times the current industry average based on price to sales and price to earnings. At 7,000, its valuation would be 1.6 times the industry average. Again, and we stress, that is if TSLA is the world’s only automaker.

Summary

Tesla is one of a few poster children for the latest surge in the current bull market. That said, it’s worth remembering some examples from the past. For instance, Qualcomm (QCOM) was a poster child for the tech boom in the late 1990s. Below is a chart comparing the final surge in QCOM (Q4 1999) to the last three months of trading for TSLA.

In the last quarter of 1999, QCOM’s price rose by 277%. TSLA is only up 181% in the last three months and may catch up to QCOM’s meteoric rise. However, if history is any guide, QCOM likely offers what a textbook example of a blow-off top is. By 2003 QCOM lost 90% of its value and would not recapture the 1999 highs for 15 years. 

Tesla may be the next great automaker and, in doing so, own a sizeable portion of market share. However, to have estimates as high as those proposed by ARK, they must be the only automaker and assume fantastic growth in the number of cars bought worldwide. Given their technology is replicable and given the enormous incentives for competitors, we not only find ARK’s wild forecast exceedingly optimistic, but we believe it is already trading near a best-case scenario level.

One final factor that ARK Invest also seems to have neglected is the risk of an economic downturn. Although they do highlight a “Bear Case” price target of $1,500, that too seems incoherent. Given that TSLA is still losing money and is also heavily indebted, an economic slowdown would raise the risk of their demise. In such an instance, TSLA would probably become the property of one of the major car companies for less than $50 per share.

TSLA’s stock may run higher. Its price is now a function of all the key speculative ingredients – momentum, greed, FOMO, and of course, short covering. The sky always seems to be the limit in the short run, but as Icarus found out, be careful aiming for the sun.

**As we published the article Tesla was up 20% on the day. The one day jump raised their market cap by an amount greater than the respective market caps of KIA, Hyundai, Nissan, and Fiat/Chrysler!!

Sector Buy/Sell Review: 02-03-20

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

The correction we have been discussing over the last several weeks has finally come to fruition. We are now looking for entry points to add to or build exposure in portfolios as needed OR rebalancing holdings accordingly.

Basic Materials

  • XLB tested and failed at all-time highs. Furthermore, the break below the breakout support level has completed a “head and shoulders” formation which suggest lower levels are coming.
  • The sector has gotten back to short-term oversold, and the buy signal is still intact, so it will be critical this correction holds the 200-dma which was tested yesterday.
  • We currently hold 1/2 a position and have been looking to add the second 1/2 during a corrective process. We are watching support levels closely.
  • Short-Term Positioning: Neutral
    • Last Week: Hold current positions with a tighter stop-loss.
    • This Week: Hold current positions with a tighter stop-loss.
    • Stop-loss moved back to $57 to allow for entry.
  • Long-Term Positioning: Neutral

Communications

  • As noted previously, XLC was more than 3-standard deviations above the 200-dma. This is rare, and the last time we saw this was at the peak of the market in January and June of 2018, both of which preceded significant corrections.
  • Because of the extension we did reduce our allocation to the sector modestly. We are now watching the correction to see if a successful test of the previous breakout level, which should coincide with the 200-dma, is successful. We will look to use that pullback to support to reweight the sector.
  • With a “buy signal” in place, but extended, there is more correction likely. This is particularly the case since XLC has not reversed its extreme overbought condition as of yet. XLC must hold support at $50. With GOOG missing earnings yesterday, we expect to see a further decline.
  • XLC is currently 2/3rds weight in our portfolios.
  • Short-Term Positioning: Bullish
    • Last Week: Reduced weighting in portfolio.
    • This Week: Hold positions.
    • Stop adjusted to $50
  • Long-Term Positioning: Neutral

Energy

  • Energy has failed at all levels.
  • We have been trying to add XLE to our portfolios but XLE broke back below the 200-dma, the downtrend line, and now sits at the last level of support and the stop level.
  • With the buy signal close to reversing, but with the sector very oversold. a short-term bounce is likely. Use that bounce to sell into for now.
  • We had noted previously, we were remaining cautious as rallies had repeatedly failed in the past. And, as expected, it happened again.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Sell into rally.
    • No position currently
  • Long-Term Positioning: Bearish

Financials

  • As noted previously, XLF was extremely extended above the 200-dma which put the sector at risk of a more severe correction.
  • The buy signal is correcting but remains a bit extended along but the sector is now approaching oversold.
  • XLF is currently testing the bullish trend line, which may give us an opportunity to add 1/2 position to our portfolio currently. We will wait and see if the trendline support can hold, otherwise, the 200-dma comes into focus.
  • Short-Term Positioning: Bullish
    • Last week: Take profits and rebalance risk.
    • This week: Hold for now.
    • Stop-loss adjusted to $28
  • Long-Term Positioning: Neutral

Industrials

  • XLI had pushed well above the 200-dma and a correction was inevitable.
  • While XLI remains exceedingly overbought short-term, the “buy signal” remains very extended as well. No rush chasing the sector currently.
  • We have been looking for a pullback to work off some of the extreme overbought condition before increasing our weighting. We will continue to patient for now.
  • We have adjusted our stop-loss for the remaining position.
  • Short-Term Positioning: Neutral
    • Last week: Hold 1/2 position
    • This week: Hold 1/2 position.
    • Stop-loss adjusted to $77
  • Long-Term Positioning: Neutral

Technology

  • XLK has only had a very SLIGHT correction at this point and remains extremely overbought on both a price and momentum basis.
  • We reduced our position in XLK from overweight to target portfolio weight due to the extreme extension and noted a correction is coming.
  • The bullish trend line is the first level of support XLK needs to hold while reversing the overbought condition. A failure at that support is going to bring the 200-dma into focus. $AAPL and $MSFT will likely determine the fate of XLK during this earnings season.
  • Be careful chasing the sector currently. Take profits and rebalance risks accordingly.
  • Short-Term Positioning: Bullish
    • Last week: Reduce Overweight to Target Weight
    • This week: Rebalance To Target Weights
    • Stop-loss adjusted to $80
    • Long-Term Positioning: Neutral

Staples

  • As we noted last week, defensive sectors have started to perform better suggesting a risk-off trade might be coming.
  • XLP continues to hold its very strong uptrend and remains close to all-time highs.
  • XLP is back to more extreme overbought and extended above the 200-dma, however, the “buy signal” has been registered. Look for pullbacks to support to add weight to portfolios. Maintain a stop at the 200-dma.
  • We previously took profits in XLP and reduced our weighting from overweight.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions, take profits if needed.
    • This week: Hold positions, take profits if needed.
    • Stop-loss adjusted to $59
    • Long-Term Positioning: Bullish

Real Estate

  • Last week we noted that XLRE had broken out back to new highs. We took profits yesterday, and reduced our risk a bit in the position as interest rates are extremely overbought.
  • With XLRE very extended short-term, we previously suggested looking for a short-term reversal in interest rates to create an entry point. That is occurring which should give us a better entry point to increase our holdings at a better entry point.
  • We had previously noted that while we are holding our long-position, trading positions could be added to portfolios. Hold off adding any new positions currently and wait for this correction to complete.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Took profits and reduced weighting slightly.
    • Stop-loss adjusted to $35.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

  • As noted last week, XLU is extremely extended above the 200-dma, and the “buy signal” is now extremely extended.
  • We took profits in our holdings yesterday and will wait for a correction back to support to bring our holdings back to overweight. Such will give us a much better risk/reward entry.
  • The long-term trend line remains intact.
  • We are currently at 2/3rds weight.
  • Short-Term Positioning: Bullish
    • Last week: Hold position.
    • This week: Took profits and reduced weight slightly.
    • Stop-loss adjusted to support at $59.00, $61 for new positions.
  • Long-Term Positioning: Bullish

Health Care

  • XLV has remained intact and is now more extended than we have seen it in quite some time.
  • As noted last week, XLV was extremely overbought and would give way sooner than later.That started this week and may have more to go. Because of the extension we reduced the overweight position in our portfolios to target weight.
  • The move in Healthcare has been parabolic, and the sector is too extended to add positions currently. We will look to add to our holdings but need a bit more corrective action first. The sector is back to short-term oversold.
  • Short-Term Positioning: Neutral
    • Last week: Took profits – reduced overweight to target weight.
    • This week: Hold positions
    • Stop-loss adjusted to $94
  • Long-Term Positioning: Bullish

Discretionary

  • The correction in XLY started this week and is testing the breakout support level. While XLY is holding support currently, a failure will bring the 200-dma into focus.
  • We took profits last week and reduced the position slightly.
  • Hold current positions for now, but take profits and rebalance risks accordingly. New positions can be added on a pullback to the breakout level that holds and works off the overbought condition.
  • A “buy signal” has been triggered which gives the sector support.
  • Short-Term Positioning: Neutral
    • Last week: Hold position
    • This week: Hold position
    • Stop-loss adjusted to $120.
  • Long-Term Positioning: Neutral

Transportation

  • XTN broke back below its breakout level yesterday, negating the previous bullish setup.
  • We remain out of the economically sensitive sector currently particularly due to the impact of the “Wuhan Virus” which will likely have global supply chain impact.
  • As noted last week: “A pullback to $63 must hold if positions are going to be added. However, with the global economy slowing, I have a hunch it won’t.”
  • We are testing that level currently. Let’s see if it can hold.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Technically Speaking: Market Bounce, January, & The Super Bowl.

In this past weekend’s newsletter, we stated the market was likely to bounce due to the short-term oversold condition which existed following Friday’s rout. To wit:

“With a ‘sell signal’ clearly triggered (lower panel), it suggests, on a short-term basis, we are likely to see a ‘tradeable bounce.’ However, until the signal reverses, any short-term bounce should probably be ‘sold into.’

Make no mistake, there is currently downside risk below the 50-dma to both the 38.2% and 50% Fibonacci retracement levels. From recent peaks, such a correction would entail a 5-8% decline, which is well within the normal range of a market correction within an ongoing bullish trend.”

Chart updated through Monday’s close.

The market failed at the bottom of the broken trend line yesterday, which suggests this “short-term” bounce is likely an opportunity to rebalance risks into.

With the fallout of the “coronavirus” being written off very quickly, under the assumption the outcome will be equivalent to the SARS epidemic in 2003, such is likely a mistake. As I wrote previously:

“Following a nearly 50% decline in asset prices, a mean-reversion in valuations, and an economic recession ending, the impact of the SARS virus was negligible given the bulk of the ‘risk’ was already removed from asset prices and economic growth. Today’s economic environment could not be more opposed.”

With global growth already slow, and the U.S. dragging its feet along at roughly 2% annual growth, there isn’t much room to absorb the impact of an event that potentially curtails consumption. 

Given that China, which is roughly 4x the size of global GDP today versus 2003, it occupies a central place in many supply chains used by other manufacturing countries, including pharmaceuticals, and is a voracious buyer of raw materials and other commodities, including oil, natural gas, and soybeans. That means that any economic hiccups for China this year, coming on the heels of its worst economic performance in 30 years, will have a bigger impact on the rest of the world than during past crises.

The was a point made by Mohamed El-Erian, on Monday, who stated the outbreak was going to take a major toll on the Chinese economy and hurt global growth. 

“For a long time I thought the market sentiment was so strong that we could overcome a mounting list of economic uncertainty. But the coronavirus is different. It is big. It’s going to paralyze China. It’s going to cascade throughout the global economy. Importantly, it cannot be countered by central bank policy. 

Investors ‘need to decide if they want to opt for more of the same, by continuing to implement an investment playbook that has served them well, or if they want to treat the viral outbreak for what it is — a big economic shock that could derail global growth and shake markets out of their ‘buy-the-dip’ conditioning.”Mohamed El-Erian

On Monday, the reflexive bounce was primarily supported by “market chatter” the Fed may be forced to extend their current “Not QE” through June, and/or lower rates. El-Erian is likely correct that this is not an event “monetary band-aids” can fix. 

Furthermore, his comments run similar to our own in that the long-running play of dismissing downbeat fundamentals on expectations central banks will be able to ride to the rescue could prove misguided in the current environment. What the current “bullish bias” is potentially missing is that while the effects of the deadly outbreak are substantial in China, and will cascade not only through the world’s second-largest economy, it will also slow global growth. A weaker China is not only a problem for Europe, but also for the U.S. where exports account for about 40% of corporate profits. 

Importantly, the multi-year gap between elevated asset prices and weaker economic conditions is becoming increasingly unsustainable. This is shown in the chart below:

The problem with pulling forward future consumption, is that it leaves a void which eventually must be filled, which requires more interventions to do so. Ultimately, that void becomes too vast.  

So Goes January…

January was a complete bust. After rocketing higher on “Fed Fuel,” the entire month’s gains were wiped out by January 31st.

It reminded me of January 2018, as the S&P 500 was surging higher following the passage of “tax cuts.” The markets were extrapolating earnings estimates to ridiculous levels in the hopes tax cuts would lead to an earnings and economic recovery. As I wrote then, such was never going to happen:

“The same is true for the myth that tax cuts lead to higher wages. Again, as with economic growth, there is no evidence that cutting taxes increases wage growth for average Americans. This is particularly the case currently as companies are sourcing every accounting gimmick, share repurchase or productivity increasing enhancement possible to increase profit growth.

Not surprisingly, our guess that corporations would utilize the benefits of ‘tax cuts’ to boost bottom line earnings rather than increase wages has turned out to be true. As noted by Axios, in just the first two months of this year companies have already announced over $173 BILLION in stock buybacks.

The chart below shows the run up from October to the January peak in 2018. That rally pushed the S&P 500 to 3-standard deviations above the 200-dma, just as the end of the month was approaching. Then, in just a few short days, the entire gain of January evaporated.

The chart below is the S&P 500 from October 2019 to present. Again, we see the market pushing into 3-standard deviation territory, then wiping out the entire gain of January in just a few days.

While I am not suggesting the market will test the 200-dma as it did in 2018, it is a possibility, particularly if the “coronavirus” worsens, or economic impacts begin to become visible. 

However, the reversal of the January gain to a loss does bring up the old Wall Street axiom:

“So goes January…So goes the year.” 

The January barometer was devised by Yale Hirsch in 1972 and has only registered ten major errors since 1950, for an 85.7% accuracy ratio. As noted by StockTraders Almanac:

“Of the ten major errors Vietnam affected 1966 and 1968. 1982 saw the start of a major bull market in August. Two January rate cuts and 9/11 affected 2001. The market in January 2003 was held down by the anticipation of military action in Iraq. The second worst bear market since 1900 ended in March of 2009, and Federal Reserve intervention influenced 2010 and 2014. In 2016, DJIA slipped into an official Ned Davis bear market in January. Including the eight flat years yields a .743 batting average.”

This year’s combination of a positive Santa Claus Rally and First Five Days with a full-month January loss has only occurred 11-times (including this year) since 1950. In the previous 10-occurrences, the S&P 500 was down six times in February with an average loss of 1.5%. However, over the remaining 11 months of the year, S&P 500 advanced 80% of the time with an average gain of 7.4%. Full-year performance was positive 70% of the time, but with an average gain of 2.9%.”

While there are many other factors that could drive the market higher this year, from the election to more Central Bank interventions, there is a growing chorus of indications which suggest we are nearing the end of current cycle. With negative yielding debt back on the rise, numerous yield spreads re-inverting, slower economic growth, and weaker earnings, the ability to sustain high valuations is going to become more challenging. 

Don’t Forget The Super Bowl

The Kansas City Chiefs won “Super Bowl LIV” in a stunning fourth-quarter rally to beat the San Francisco 49ers, which triggered the “Super Bowl Indicator” suggesting a weaker market. (This is a purely coincident indicator, but, given it was the Chiefs’ first Super Bowl championship in 50 years, maybe there is something about odd things happening when everyone else thinks they won’t.)

If you aren’t familiar with the indicator, it says that if the winning team of National Football League’s (NFL) championship game is from the National Football Conference (NFC), then stocks will have a bull market that year. If a team from the American Football Conference (AFC) wins, then it will be a bear market.

The Chiefs are from the AFC, meaning the indicator predicts a bear market this year and the predictor has been right 40 out of 53 games, a 75% success rate. While the last four years have been wrong, statistics suggest odds have increased for the indicator to be correct this year.

Here’s a breakdown of the 20 Super Bowl winners, of the last 53 Super Bowls, and how the S&P 500 has done following their victories:

While investors should never use a “coincident” indicator such as this to manage money, it is interesting nonetheless.

Portfolio Positioning

Yesterday, as we discussed with our RIAPro Subscribers (30-Day Risk-Free Trial) we slightly reduced our holdings in Utilities and Real Estate to raise some cash ahead of what we suspect will be a fairly short-lived rally. The goal is to use a pullback to rebalance exposures and look for a more “washed out” level to take on some “opportunistic” holdings. 

One such area where there is a tremendous amount of “negative sentiment” is in the energy sector. While it isn’t time to start adding exposure, we may be getting a decent “trading setup” here soon. Also, after previously reducing our holdings in some of our Technology, Healthcare, and Communications holdings, we may get the opportunity to rebuild our long-term core holdings at better risk/reward levels. 

While this year could indeed turn out to be a negative year, it doesn’t mean there won’t be some decent trading opportunities along the way. This is portfolio management.

However, make no mistake that we are nearing the end of an exceedingly long bull market cycle, and the eventual “reversion to the mean” will be a brutal event.

While it is easy to dismiss such an outcome under the guise of “this time is different because of the Fed,” every single “bear market” previously came on the heels of similar beliefs. In 1987, it was “Portfolio Insurance.” In 2000, it was the “Internet.”  In 2007, it was the “Goldilocks Economy.” 

Today will not be different, but the eventual outcome will be the same.

Cartography Corner – February 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


January 2020 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESH0) during January 2020. In our January 2020 edition of The Cartography Corner, we wrote the following:

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

  • M4                 3475.00
  • M1                 3353.00
  • M3                 3318.25
  • PMH              3254.00
  • Close             3231.00     
  • M2                 3106.00
  • MTrend        3092.44     
  • PML               3069.50    
  • M5                 2984.00

Active traders can use 3254.00 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for January 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first four trading sessions of January saw the market price exhibit “choppiness”, reflecting market participants’ indecision as to directional bias.  Early into the fifth trading session, January 8th, the geopolitical event emanating from Iran caused the market price to achieve its low price for the month at 3181.00.  However, by the end of the day, the market price had recovered and settled back above our isolated pivot at PMH: 3254.00.     

Over the following six trading sessions, the market price ascended to our isolated resistance level at M3: 3318.25.  The ensuing four sessions saw the market price lose its upward momentum, straddling either side of M3: 3318.25.  On January 22nd the high price for the month was realized at 3337.50, in between our resistance levels at M3: 3318.25 and M1: 3353.00.

From January 24th through the end of the month, the market price action was dominated by market participants’ reaction-to and anticipation-of the effects of the Wuhan Coronavirus.  The trading sessions of January 24th and 27th saw the market price decline a total of 86.50 points on a settlement basis.  The final four trading sessions were spent with the market price oscillating around our isolated pivot at PMH: 3254.00.

Conservatively, active traders following our analysis had the opportunity to monetize a 1.78% profit.

  

Figure 1:

Japanese Yen Futures

We continue with a review of Japanese Yen Futures (6JH0) during January 2020.  In our January 2020 edition of The Cartography Corner, we wrote the following:

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

  • M4         0.94068
  • M3         0.93445
  • PMH       0.92659
  • Close      0.92455
  • M1           0.92403
  • MTrend   0.92330
  • PML        0.91195           
  • M2         0.91140                       
  • M5           0.89475

Active traders can use 0.92659 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 0.92330 as the downside pivot, whereby they maintain a flat or short position below that level.

As you read this, recall that we wrote in January that the annual correlation of daily returns between Japanese Yen Futures and E-Mini S&P 500 Futures is -0.53.  January’s price action in those markets were mirror images of one another.

Figure 2 below displays the daily price action for January 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first four trading sessions of January saw the market price exhibit “choppiness”, reflecting market participants’ indecision as to directional bias.  Early into the fifth trading session, January 8th, the geopolitical event emanating from Iran caused the market price to achieve its high price for the month at 0.93235.  However, by the end of the day, the market price had recovered and settled back below our isolated downside pivot at MTrend: 0.92330.

Over the following six trading sessions, the market price descended to and settled below, our clustered support levels at PML: 0.91195 and M2: 0.91140.  On January 17th the low price for the month was realized at 0.90935.

From January 18th through the end of the month, the market price action was dominated by market participants’ reaction-to and anticipation-of the effects of the Wuhan Coronavirus.  The market price rallied back to, and settled slightly above, our clustered support levels at MTrend: 0.92330 and M1: 0.92403, now acting as resistance.

Conservatively, active traders following our analysis had the opportunity to monetize a 0.81% profit.

Figure 2:

February 2020 Analysis

E-Mini S&P 500 Futures

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESH0).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Weekly Trend         3285.17       
  • Daily Trend             3265.61
  • Current Settle         3224.00       
  • Monthly Trend        3180.97       
  • Quarterly Trend      2974.00

In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures have been “Trend Up” for four quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures have been “Trend Up” for eight months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”, after having been “Trend Up” for sixteen weeks.  The relative positioning of the Trend Levels is beginning to lose its bullish posture.

We wrote in January, “The first indication of weakness will be a weekly settlement under Weekly Trend”.  We now have that indication.  The next event that needs to occur to strengthen the case of a possible Trend Reversal is a monthly settlement under Monthly Trend.  As noted above, Monthly Trend for February is at 3180.97.

Astute readers will notice that January’s low coincided with February’s Monthly Trend level.  Hmmm…

Support/Resistance:

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

  • M4                 3605.50
  • M1                 3421.00
  • PMH              3337.50
  • M2                 3292.50
  • Close             3224.00     
  • M3                 3217.00
  • PML               3181.00     
  • MTrend         3180.97     
  • M5                3108.00

Active traders can use 3217.00 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Bitcoin Futures

For the month of February, we focus on Bitcoin Futures.  We provide a monthly time-period analysis of BTG0.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Daily Trend           9,489             
  • Current Settle       9,440
  • Quarterly Trend    9,239             
  • Weekly Trend       8,830             
  • Monthly Trend      7,982

As can be seen in the quarterly chart below, Bitcoin is in “Consolidation”.  Stepping down one time-period, the monthly chart shows that Bitcoin is in “Consolidation”, after having been “Trend Down” for five months.  Stepping down to the weekly time-period, the chart shows that Bitcoin has been “Trend Up” for five weeks.

With the weekly, monthly, and quarterly trend levels having quietly slipped beneath the market price, it is worth considering that the rally in Bitcoin that began five weeks ago may be just the beginning of a substantial move higher in price.

Support/Resistance:

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

  • M4         13,070
  • M3         11,670
  • M1         11,520
  • PMH       9,745
  • Close        9,440
  • MTrend   7,982
  • M2         7,300  
  • PML        6,860              
  • M5           5,750

Active traders can use 9,745 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Summary

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

Major Market Buy/Sell Review: 02-03-20

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

Over the last 3-weeks we have been warning of a pending correction due to the extreme overbought, extended, and overly bullish condition. All that was needed was a “catalyst” to trigger the correction which came in the form of a “Coronavirus.” This is a common theme in this week’s market update.

S&P 500 Index

  • As noted last week: “With the market now trading 12% above its 200-dma, and well into 3-standard deviations of the mean, a correction is coming.” That correction started last Friday and continued this week.
  • Even with the sell-off on Friday, it barely registered in terms of reducing the overbought or extended levels of the market. There is likely a bit more correction to come to buy into.
  • As noted we took profits in both the ETF and Equity Model (See Portfolio Commentary). We will likely have a much better entry point to buy into on a longer-term basis.
  • We may add a short-term trading position after we see where the market trades on Monday.
  • Short-Term Positioning: Neutral Due To Extension
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $300
    • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

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

Nasdaq Composite

  • Again, like SPY, the sell-off on Friday barely registered. Nasdaq remains “extremely” extended currently. As noted last week, “With QQQ now pushing towards a 4-standard deviation event. A correction is inevitable, it is just a function of time now.”
  • The Nasdaq “buy signal” is also back to extremely overbought levels so look for a correction to add exposure. As with SPY we may pick up a short-term trading position for a reflex rally but this will be trade, not an investment.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $195
  • Long-Term Positioning: Neutral due to valuations

S&P 600 Index (Small-Cap)

  • Small caps corrected more than the major markets, but they also haven’t moved as much.
  • The buy signal remains extremely extended, but the index has corrected some of the short-term overbought.
  • Th correction needs to hold the previous breakout levels with a stop moved up to the 200-dma.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop loss moved up to $68
  • Long-Term Positioning: Neutral

S&P 400 Index (Mid-Cap)

  • Like SLY, MDY also started to correct this past week.
  • MDY remains extremely extended above the 200-dma, so more corrective action is likely. MDY is getting oversold short-term so a bounce is likely.
  • The previous breakout level needs to hold while the overbought condition is reversed.
  • Short-Term Positioning: Neutral due to extensions.
    • Last Week: No holding
    • This Week: No holding/May add a trading position for a reflex rally.
  • Long-Term Positioning: Bullish

Emerging Markets

  • EEM was more deeply impacted by the potential impact of the “Coronavirus.”
  • As noted previously, with the “buy signal” extremely extended, a correction is coming so be patient to add exposure assuming stop levels are not violated.”
  • Initial support failed and stop loss levels are coming quickly into focus. If there is good news on the virus front, EEM will bounce sharply. We will likely use that to sell our positions into.
  • The Dollar (Last chart) is the key to our international positioning. The dollar looks to have reversed its move lower which isn’t beneficial for international exposure.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $43
  • Long-Term Positioning: Neutral

International Markets

  • Like EEM, EFA also sold off last week, and is testing important support.
  • Any good news with the virus and international exposure should rally. EFA looks better than EEM, so we will likely revisit our holding on a rally.
  • As with EEM, the key to our positioning is the US Dollar.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss set at $67
  • Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

  • Oil completely broke down last week, and collapsed below all of the important levels. Oil is now testing critical support at $51. A failure there and a break into the low $40’s is probable.
  • As noted last week: “With oil prices falling back below $60/bbl, it is imperative that oil maintains the 200-dma support level which it is currently testing.” That level failed and prices plunged back towards recent lows.
  • This keeps us on hold for now from adding to positions and stops are close to being triggered.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Hold positions
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • As noted last week, Gold had rallied sharply and broke out to new highs, suggesting there was something amiss with the stock market exuberance.
  • That was confirmed last week with the onset of the “Coronavirus” and the fall in the market.
  • On Friday, gold rallied to new highs once again as money sought safety from stocks. As noted last week: “If gold can muster a rally and break above recent highs, it is likely we will see a further advance.”
  • Our positioning looks good particularly since gold has registered a new “buy signal.”
  • We used the recent weakness to add to our GDX and IAU positions taking them back to full weightings.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for whole position adjusted to $137
    • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

  • As noted two weeks ago: “I suspect we are going to get some economic turmoil sooner, rather than later, which will lead to a correction in the equity markets and an uptick in bond prices.”
  • That occurred as bonds broke out of their declining trend sending yields lower. That breakout was a decent entry point to add exposure to bonds if you need it. However, that opportunity has now passed.
  • Take profits and rebalance holdings and look for a trade on the equity side short-term.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Take profits and rebalance holdings.
    • Stop-loss is moved up to $132
  • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously, we noted the dollar broke down below both the 200-dma and the bullish trend line. It then retested, and failed, at that previous support level which confirms a breakdown in the dollar from its previous bullish channel.
  • As noted previously: “The dollar has rallied back to that all important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle. It may be too early for a sharper dollar decline currently, as the U.S. economy is still the “cleanest shirt in the dirty laundry.”
  • That is exactly what happened last week and the dollar appears to be back in a bullish trend. Oil has collapsed, along with international exposures. We are close to triggering stops on all those positions.
  • The “sell” signal has began to reverse. Pay attention.

The Rotation To Value Is Inevitable

In late 1999, it was stated that “investing like Warren Buffett was the same as driving ‘Dad’s ole’ Pontiac.” The suggestion, of course, was that “value” investing was no longer a viable investment strategy in the new “dot.com” economy where “growth” was all that mattered. After all, in the “new world,” it was indeed “different this time.” 

Less than a year later, investors wished they had adhered to Warren Buffett’s strategy of buying value as the “Dot.com dream” emerged as a nightmare for many unwitting individuals.

However, it wasn’t just stocks either. In 2007, individuals were chasing the “momentum” in the real estate market as individuals left their jobs to pursue riches in housing and were willing to “pay any price” under the assumption they would be able to sell higher. Of course, it was long after then Fed Chairman Ben Bernanke uttered the words “the subprime market is contained,” the dreams of riches evaporated like a “morning mist.” 

As Warren Buffett once quipped, “price is what you pay, value is what you get.”  

Throughout market history, investors have repeatedly abandoned this simple principle during periods where bull market advances seemed to defy logic. Ultimately, those investors paid a dear price for their speculation as the reality of “overpaying for value” led to poor financial outcomes.

As we have noted in a series of articles posted at RIAPRO.net, we believe the market is on the precipice of another monumental shift from “growth” to “value,” and as repeatedly seen in the past will blindside most investors.

Value vs. Growth

The market’s surge higher since the financial crisis, which has been driven by massive fiscal and monetary policies, have been nothing short of extraordinary. Currently, the S&P 500 is trading at the greatest deviation from its long-term exponential growth trend in history.

This is occurring at a time where market prices are advancing while corporate profitability has been flat since 2014.

While we have previously discussed the unparalleled use of monetary policy to push markets higher, massive fiscal spending designed to keep economic growth positive, and how corporations have shunned future growth with a preference for the short-term incentive of “share repurchases.”

As Michael Lebowitz, CFA previously noted:

“As a result of these behaviors and actions, we have witnessed an anomaly in what has historically spelled success for investors. Stronger companies with predictable income generation and solid balance sheets have grossly underperformed companies with unreliable earnings and over-burdened balance sheets. The prospect of majestic future growth has trumped dependable growth. Companies with little to no income and massive debts have been the winners.”

This was much the same as we saw in late 1999 as companies with no earnings, no revenue, and no real strategy for growth exploded higher in a speculation fueled buying frenzy.

This underperformance of “value” relative to “growth” is not unique. What is unique is the current duration and magnitude of that underperformance. To say unprecedented is almost an understatement.

The graph below charts ten-year annualized total returns (dividends included) for value stocks versus growth stocks. The most recent data point representing 2018, covering the years 2009 through 2018, stands at negative 2.86%. This indicates value stocks have underperformed growth stocks by 2.86% on average in each of the last ten years.

The data for this analysis comes from Kenneth French and Dartmouth University.

There are two important takeaways from the graph above:

  • Over the last 90 years, value stocks have outperformed growth stocks by an average of 4.44% per year (orange dotted line).
  • There have only been eight ten-year periods over the last 90 years (total of 90 ten-year periods) when value stocks underperformed growth stocks. Two of these occurred during the Great Depression and one spanned the 1990s leading into the Tech bust of 2001. The other five are recent, representing the years 2014 through 2018.

It is important to understand that it is “investor speculation” which drives these deviations in returns between growth and value. Of course, when things ultimately go “pear-shaped,” the return to value tends to be a swift event. The chart below overlays important periods in market history where “value” became “valued.”

The chart below shows the difference in the performance of the “value vs growth” index versus a pure growth index. Both are based on a $100 investment. While value investing will always provide consistent returns, there are times when growth outperforms value and vice versa. What is important to note are the periods when “value investing” has the greatest outperformance as noted by the “blue shaded” areas.

Given that we are statistically, and logically, very likely nearing the end of the current cycle, it is even more crucial to grasp what decades of investment experience tells us about the future.

When the cycle turns, we have little doubt the value-growth relationship will revert back to its long-term mean. Importantly, seldom do such reversions stop at the mean.

“To better understand why this is so important, consider what happens if the investment cycle turns and the relationship of value versus growth returns to the average over the next two years. In such a case, value would outperform growth by nearly 30% in just two years. Anything beyond the average would increase the outperformance even more.”Michael Lebowitz

History Doesn’t Repeat

It is often noted that history doesn’t repeat, but it often rhymes, particularly when it comes to financial markets. It is not a question of if the rotation to value will occur, it is only a function of when.

However, this is the risk that investors take on currently in the market. Chasing markets is the purest form of speculation. Ultimately, it is a pure bet on prices going higher rather than determining if the price being paid for those assets are selling at a discount to fair value.

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

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

There is also a 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 someday be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.”

While the current market advance seems to be unstoppable, this was the attitude seen by investors at every prior market in history. As Howard Marks once stated:

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

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

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

The rotation from “growth” to “value” is inevitable. It will occur against a backdrop of devastation for the majority of investors quietly lulled into the extreme sense of complacency years of monetary interventions have provided.

The only question is whether you will be the buyer of “value” at a time when everyone else is selling “growth?”