Monthly Archives: June 2020

This Is Nuts…Again. Reducing Risk As Tech Goes 1999


In this issue of, “This Is Nuts…Again. Reducing Risk As Tech Goes 1999.”

  • Twice In One Year
  • Fundamentally Detached
  • A Very Narrow Market
  • Portfolio Positioning
  • MacroView: The Fed Has Inflated Another Asset Bubble
  • Sector & Market Analysis
  • 401k Plan Manager

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


Upcoming Event  – CANDID COFFEE

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

July 25th from 8-9 am

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


Catch Up On What You Missed Last Week

Twice In One Year

It is a bit hard to comprehend that twice, in the same year, I would be writing primarily the same article.

In early January, I penned the following:

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

At that time, I tweeted the following chart, which compared the Nasdaq to the S&P 500 index. The bands on both charts are 2-standard deviations of the 200-WEEK moving average. There are a couple of things which should jump out immediately:

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

, This Is Nuts & Why We Reduced Risk On Friday 01-11-20

That was so 6-months ago.

Here is where we are today.

As I warned then, not only has the price of the Nasdaq gone parabolic, this time it is pushing 3-standard deviations of the 200-dma.

Fundamentally Detached

The divergence is particularly notable when you consider the economic and fundamental differences between now and then. (While we are discussing the Nasdaq, to maintain consistency with previous reports, I am using earnings estimates for the S&P 500 to show the relative change.)

When looking at the acceleration in the price of the Nasdaq, and particularly within the small group of stocks driving that advance, you can begin to fathom our concerns. Furthermore, the divergence between the Nasdaq and the S&P 500 index is emulating the late 90’s. (The horizontal red line is where the ratio was last Friday just for perspective.)

Optimism in the Nasdaq 100 has also reached levels of exuberance seen only once previously in the last 25 years. Yep…the late 90’s.

Yes, “This Is Nuts.” 

For the second time in a single year, we have begun the profit-taking process within our most profitable names. Apple, Microsoft, Netflix, Amazon, Costco, PG, and in Communications and Technology ETF’s.

(Note: Taking profits does not mean we sold the entire position. It means we reduced the amount of our holdings to protect our gains.)

As discussed in this week’s #MacroView (below), the “bearish case” does have “teeth” and should not be summarily dismissed. As Doug Kass noted this past Monday:

“Several key labor-intensive industries – education, lodging, entertainment (Broadway events, concerts, movie theaters, sporting events), restaurant, travel, retail, non-residential real estate, etc. – face an existential threat to their core. For these industries, they simply cannot survive the conditions they face. For these gutted industries, we face, at best, an 80% to 85% recovery in the years to come. It should be emphasized that Covid-19 just sped up what was already a secular decline.”

When the market historically becomes this detached from the underlying fundamentals, reversions tend to happen fairly quickly.

A Very Narrow Market

In our subscriber service (RIAPro – 30-Day Free Trial) we recently added a new service with institutional money manager Jeffrey Marcus of Turning Point Analytics (TPA). One of his latest notes to subscribers drove home the point we are discussing now. To wit:

It seems like we have dodged a bullet, yet a look under the surface reveals a much sicker market.  The relative performance chart below shows that while the S&P 500 is still down 1.88%, but TPA’s BIGTECH Index (the top 8 stock in the NASDAQ 100 by market cap)is up an astonishing 48.99% year to date (YTD).

Recovery, TPA Analytics: This Rally Is Impossibly Narrow

The table below shows that these 8-stocks represent $8 trillion in market cap, which is 29% of the market cap of the S&P 500 ($27.3 trillion). TPA ran the numbers to see just what effect these 8 stocks have had on an index of 500 stocks. The BIGTECH effect has been to add 8.71% of performance to the S&P 500 YTD.

Recovery, TPA Analytics: This Rally Is Impossibly Narrow

Just A Handful Of Stocks

At the time of the analysis, the S&P 500 is down 1.88% for the year. Without the BIGTECH stocks, the benchmark would be down 10.5% in 2020.

We have mentioned this before, but a healthy rally is one with broad participation. The current rally is very narrow, historically dependent on less than 2% of the S&P 500 member stocks. Such means the overall performance of the S&P 500 is not representative of the market as a whole. It also means the index performance hinges on a very small group of stocks.

In addition, TPA Canaries in the Coalmine (table below) shows that the 14-day RSI of the ratio of BIGTECH/S&P 500 is also at 70.87. That RSI level denotes that BIGTECH is overbought relative to the S&P 500. At this juncture, one of two things can happen to make the BIGTECH/S&P 500 ratio less overbought:

  1. Stocks other than BIGTECH can rise faster than BIGTECH; or,
  2. BIGTECH can fall. 

Given how much BIGTECH has meant to S&P 500 performance, investors should pray for the former.”

Here is a visual of what Jeff is talking about.

Throughout history, whenever there seems to be a “Can’t Lose Bet” in the financial markets, you are essentially guaranteed to “Lose Money.” 

Updating Risk/Reward Ranges

As noted by Sentiment Trader this past week, the CNN Fear/Greed Proxy has turned down recently from very high readings. While this does NOT suggest stocks will crash, it does indicate over the next few weeks returns will likely be more muted with increased volatility.

With this in mind we can update our risk/reward ranges for next week.

As noted last week:

“The rally reversed much of the short-term oversold condition. While the bulls are in control of the market currently, the upside is somewhat limited. However, the downside risks are reduced with the improvement in the technical underpinnings. Such puts the risk/reward dynamics to a more equally balanced, than opportunistic, positioning. As such, risk controls and hedges should remain for now.”

That advice played out well this past week, given daily swings in the market. While the market was up for the week, it has not reclaimed the June highs. As such, the consolidation continues with risk/reward remaining primarily “neutral” with a “negative” bias.

  • -2.6% to breakout level vs. +1.1% previous rally peak. (Neutral)
  • -4.5 to 5.4% to 50 & 200 dma support vs. +4.0% to January peak (Neutral)
  • -7.9% to previous consolidation peak vs. +5.5% to all-time highs. (Negative)
  • -14.2% to previous consolidation lows vs. +5.5% to all-time highs. (Negative)

Reason To Focus On Risk

It seems appropriate to restate something I wrote the last time we saw these types of divergences.

“Our job as investors is to navigate the waters within which we currently sail, not the waters we think we will sail in later. Higher returns come from the management of ‘risks’ rather than the attempt to create returns by chasing markets. Robert Rubin, former Secretary of the Treasury, defined this philosophy when he stated;

‘As I think back over the years, I have been guided by four principles for decision making. First, the only certainty is that there is no certainty. Second, every decision, as a consequence, is a matter of weighing probabilities. Third, despite uncertainty, we must decide and we must act. And lastly, we need to judge decisions not only on the results but also on how we made them.

Most people are in denial about uncertainty. They assume they’re lucky, and that the unpredictable can be reliably forecasted. Such keeps business brisk for palm readers, psychics, and stockbrokers, but it’s a terrible way to deal with uncertainty. If there are no absolutes, all decisions become matters of judging the probability of different outcomes, and the costs and benefits of each. Then, on that basis, you can make a good decision.'”

An Honest Assessment

It should be evident that an honest assessment of uncertainty leads to better decisions. Still, the benefits of Rubin’s approach, and mine, goes beyond that. For starters, although it may seem contradictory, embracing uncertainty reduces risk, while denial increases it. Another benefit of acknowledged uncertainty is it keeps you honest.

“A healthy respect for uncertainty and focus on probability drives you never to be satisfied with your conclusions.  It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference.” – Robert Rubin

We must be able to recognize and be responsive to changes in underlying market dynamics. If they change for the worse, we must be aware of the inherent risks in portfolio allocation models. The reality is that we can’t control outcomes. The most we can do is influence the probability of specific outcomes. Such is why we manage risk by investing on probabilities rather than possibilities. 

Such is essential not only to capital preservation but to investment success over time.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

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

Sector-by-Sector

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

Previously we noted that Financials moved into the improving quadrant of the rotation model, but will likely be short-lived. That has turned out to be the case as performance has lagged the S&P. Energy and Industrial performance overall remains inadequate with a failure at the 200-dma. Energy is oversold and cheap on a value basis; we hold our exposures for now.

Current Positions: XLE

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

Discretionary, which has gotten very extended, along with Technology, with both sectors very overbought. The upside is limited. We continue to suggest profit-taking, which we did this past week until the overbought condition reverses.

Current Positions: XLK, XLC

Weakening – Healthcare (XLV)

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

Current Position: XLV

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

Our defensive positioning in Staples, Real Estate, and Utilities has lagged. This past week, we exited our Real Estate holdings for the time being. Concerns over the non-payments of rent are becoming a bigger issue particularly as we head into earnings season. Utilities and Staples remain as part of the “risk-off” rotation trade. We see early signs of improvement, suggesting it is the right place to be. If it turns up meaningfully, we will add to our current holdings.

Current Position: XLU, & XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Both of these markets continue to underperform. As earnings season approaches, they seem very susceptible to more pressure from a weak economy. Both markets are sitting on the last line of support. We maintain no holdings currently.

Current Position: None

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

Emerging and International Markets have performed better recently, and have not declined as much as the market. This past week we took on a small trading position in EFA as performance has improved. EEM is too extended and overbought and is due for a correction. The Dollar will be a big driver going forward.

Current Position: EFA

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

Current Position: None

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

Current Position: IAU, UUP

Bonds (TLT) –

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

Current Positions: TLT, MBB, & AGG

Portfolio / Client Update

If you did not receive our Quarterly Client Update for any reason, please contact Karen Roan, and she will send you a copy.

We continue to scratch our heads over the rally in the Nasdaq as performance in the S&P 500 continues to soften. Importantly, the areas of the highest fundamental “value,” are performing the worst as the fundamentally “worst” companies rally the most. Historically, such bifurcated markets tend to have rather nasty outcomes.

As such, we have made changes to portfolios to harvest some gains, raise cash, and reduce our risk to the overall market.

Changes

In the EQUITY model, we trimmed gains in AAPL, MSFT, AMZN, NFLX, PG, and COST, all of which were pushing 3-standard deviations.

In the ETF Portfolio, we took profits in XLK and XLC.

We removed our entire exposures to Real Estate for both portfolios as there continues to be a rising risk of rent and mortgage payment delinquency and defaults. MPW, WELL, and XLRE were sold in their entirety.

We took on a small position in international exposure, using EFA in both models, to offset the risk of a weaker U.S. dollar. Also, global markets are doing better with the virus than the U.S., so there is potential for better economic performance there in the short-term.

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

TPA Analytics: This Rally Is Impossibly Narrow

Note from the RIAPro Team:

We are proud to offer TPA Analytics to you at a deeply discounted price. TPA has been serving institutional clients with their trading ideas and strategies. Now you can add the same strategies and ideas to your portfolio as well.

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

As a subscriber you will receive real-time alerts of trading activity by TPA and a minimum of 2-reports each week.

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


THIS RALLY IS IMPOSSIBLY NARROW

The benchmark S&P 500 is still down 1.88% on the year, but it is up 40.57% from the 3/23 low, and only 7.65% away from the all-time high close of 3386.15 set on 2/19.  It seems like we have dodged a bullet, yet a look under the surface reveals a much sicker market.  The relative performance chart below shows that while the S&P 500 is still down 1.88%, but TPA’s BIGTECH Index (the top 8 stock in the NASDAQ 100 by market cap) is up an astonishing 48.99% year to date (YTD).  The table below shows that these 8 stocks represent $8 trillion in market cap, which is 29% of the market cap of the S&P 500 ($27.3 trillion).

TPA ran the numbers to see just what effect these 8 stocks have had on an index of 500 stocks.  The table below shows the performance of these 8 stocks YTD and the weight of each stock in the S&P500.  The BIGTECH effect has been to add 8.71% of performance to the S&P 500 YTD.  Since the S&P 500 is down 1.88% for the year, without the BIGTECH stocks, the benchmark would be down 10.5% in 2020.

We have mentioned this before, but a healthy rally is one with broad participation. The current rally is very narrow;  historically dependent on less than 2% of the S&P 500 member stocks. This means the overall performance of the S&P 500 is not representative of the market as a whole and it also means the index performance is highly levered to a very small group of stocks.

In addition, TPA Canaries in the Coalmine (table below) shows that the 14-day RSI of the ratio of BIGTECH/S&P 500 is also at 70.87. That RSI level denotes that BIGTECH is overbought relative to the S&P 500. At this juncture, one of two things can happen to make the BIGTECH/S&P 500 ratio less overbought:

  1. Stocks other than BIGTECH can rise faster than BIGTECH; or,
  2. BIGTECH can fall. 

Given how much BIGTECH has meant to S&P 500 performance, investors should pray for the former.

Arete’s Observations 7/10/2020

David Robertson, CFA serves as the CEO and lead Portfolio Manager for Arete Asset Management, LLC. Dave has analyzed stocks for thirty years across a wide variety of sizes and styles. Early in his career, he worked intimately with a sophisticated discounted cash flow valuation model which shaped his skill set and investment philosophy. He has worked at Allied Investment Advisers and Blackrock among other money management firms. He majored in math with extensive studies in economics and philosophy at Grinnell. At Kellogg, Dave majored in finance, marketing, and international business while completing the CFA program concurrently.


Areté’s Observations 7/10/20

Market observations

While the main story of the quarter was the dramatic rebound for stocks from a terrible first quarter, there were several interesting stories playing out under the surface.

First, the rebound in April was substantial but slowed down considerably in May and again in June. For example, the returns of the Russell 1000 index for the three months were 13.21%, 5.28%, and 2.21%, respectively.

Another interesting story was that growth comfortably outperformed value for each month. In fact, the Russell 1000 Value index actually declined in June.

Although returns for major indexes moderated through the quarter, one would hardly know it by just looking at the big tech stocks. Apple rose 44% in the second quarter and Tesla rose over 100%. The huge moves in big tech stocks tended to overshadow some other important happenings.

One of those happenings is simply a math problem. The Russell 1000 was down 20.22% in the first quarter but up 21.82% in the second quarter. That leaves the index down 2.81% for the first half. The key point is that losses are not symmetrical to gains in performance calculations. The key lesson is that it is extremely important to avoid big losses.

Another interesting tidbit is that banks have not joined the recovery. A quick look at the financial sector ETF, XLF, shows a bounce from the lows of late March but pretty much a holding pattern since early April. This is useful because banks tend to be good indicators for the overall health of the economy.

Finally, Lansdowne Partners and John Paulson recently announced important closures. This continues a long string of shutdowns by prominent hedge fund managers and provides a good indication of how hostile markets have become to active management.

Economy

Companies will start reporting second quarter results soon and hopefully we will start getting some better insight into how much economic harm was caused by the lockdowns and how business looks going into the rest of the year. Until then, a couple of interesting nuggets …

US retail rebound falters as virus infections surge

“After an initial jump in footfall as lockdowns were lifted, the latest figures show that more shoppers are shying away from reopened malls, especially in states such as Texas that had helped drive the initial recovery.”

“Fears about contracting the virus were preventing prospective shoppers from visiting bricks and mortar stores in hard-hit states, said Janine Stichter, retail analyst at Jefferies.”

Early evidence is confirming exactly what I expected: Official policies matter a lot less than whether consumers feel safe or not. If they don’t, they won’t go out and spend.

Huge Political Disconnect Over The State Of The Economy

This graph provides a vivid illustration that economic beauty is in the eyes of the beholder. While it is well known that beliefs and biases taint our perceptions, this relationship may be even more important to perceptions of economic health. This also highlights how crucial it is to remain as objective as possible in order to make the best possible investment decisions.

Politics

In the midst of dealing with the coronavirus and trying to reopen the economy, there has not been much discussion of the election coming up in November. A deeper look into the possibilities for the election reveals this to be an important oversight.

Could this election capsize America?

“A number of academics have been warning of the similarities between today and the

eve of the American civil war. Stress indicators include mutual contempt between a

factionalised elite, the inability of America’s system to address a mounting backlog of

deep-seated problems, and a popular tendency to view the other side as the enemy.

Such conditions make the ordinary compromise of politics almost impossible.”

“Slightly likelier is that Biden either wins narrowly in November, or takes the popular vote but

loses the electoral college. Each case is a recipe for US civil breakdown.”

Ed Luce participated in a “war gaming” exercise for the presidential election and described the scenarios as both “credible and disturbingly plausible”. For instance, “Several states, including Michigan and Wisconsin, sent competing electoral college returns to the US Congress (the Democratic governor one result, the Republican legislature another).”

Most importantly, across various starting points and scenarios, “America was plunged into a constitutional crisis.” In other words, this is not some far out possibility like an asteroid striking the earth. There is a good chance something like this could happen and we ought to prepare for it.

A nation stuck in the worst of all worlds

“The tighter the inspection [of the US], the more numerous the revealed flaws, and the more compromised is America’s ability to command global deference.”

“The world is moving on from American hegemony. It is not moving on from the American spectacle.”

This piece captures two quick points that I think are important to keep in mind. While much of the world is still captivated by what happens in this country, the soft power of the US is diminished in important respects. This will be a limitation to what the country can achieve on a geopolitical platform.

Commercial real estate

Is investors’ love affair with commercial property ending?

One part of the economy that is most vulnerable to adaptations made for Covid-19 is that of commercial real estate. While these companies mostly escaped the severe liquidity problems that emerged in March, it will be important to monitor future developments because the industry is big and because relatively small changes in rents could devastate valuations.

“The global stock of investible commercial property—hotels, shops, offices and warehouses—has quadrupled since 2000, to $32trn.”

“If the net effect [of the pandemic] were a reduction in rented space, it could cause havoc. Victor Calanog of Moody’s, a rating agency, calculates that if tenants in New York gave up even 10% of their space over the next five years, it could result in a halving of rents sought on vacant properties.”

The slowest asset

Grant’s Interest Rate Observer, April 24, 1992

Leave it to Grant’s to reference an article from almost 30 years ago that discusses events from the Great Depression that are relevant today. In recounting the story of the Equitable Building in New York City, Grant’s reveals a key lesson of commercial real estate: “a decline and fall takes time.”

“For those who like to use the stock market as a leading indicator of business activity, the failure occurred some nine years after the Dow Jones Industrial Average made its all-time low.”

“In a deflation, even quality projects will become unprofitable. It’s inevitable.”

To be clear, I am not featuring this story as a means of “forecasting” a big deflationary episode, but nor am I refuting the possibility. The main point is to acclimate investors to the slow-motion nature of decline in commercial real estate. It unfolds over many, many years. As a result, you don’t have one good quarter and then rest assured that you are out of the woods.

Management

What Aircraft Crews Know About Managing High-Pressure Situations

There are several reasons why I find management insights especially interesting. One is because I can apply them to my own life to improve relationships with other people and to make better decisions. Another is that they can be extremely useful as an analyst in evaluating company management teams. Different people and different teams have different ways of working and that has implications for other parts of a company analysis.

Some of my favorite lessons come from situations that regularly involve extreme conditions. This is because such situations, which often involve life and death consequences, are studied and rehearsed so as to minimize negative consequences. Although most of us do not have to confront such extreme situations very often, we do often have to operate under stressful conditions. There are great lessons to be learned. Some managers get this – and some do not.

“The captain’s style of communication had a major impact on crew performance in two ways. First, crews performed consistently better under intense time pressure when the copilot was included in the decision-making process than when the captain analyzed the problem alone and simply gave orders. Second, captains who asked open-ended questions—’How do you assess the situation?’; ‘What options do you see?’; ‘What do you suggest?’— came up with better solutions than captains who asked simple yes-or-no questions.”

Credit

We are all taught that riskier capital costs more than less risky capital. As a result, equity costs more than debt, and lower-rated debt costs more than higher-rated debt. If a business gets dicey, it may have to pay up for additional capital and if it gets too dicey, it may not be able to afford to do so. Capital allocation is commensurate with business quality.

When policymakers intervene in the allocation process, availability can become a greater consideration than cost. This has extremely important implications for businesses and investors. For one, capital decisions go from being linear to non-linear. For another, those decisions go from being market-driven and predictable to politically motivated and unpredictable. This affects both ends of the credit spectrum.

At the top of the spectrum, things couldn’t be better. Just in case there was any doubt about the ability of Apple to support its bonds with its $94 billion in cash $1.6 trillion market cap, the Fed came in to provide assurances by buying its bonds. In addition, Amazon, one of the highly touted success stories from the Covid-19 lockdowns, set a record with the lowest corporate borrowing costs ever with an offering in early June.

Other borrowers are not so lucky. Joe Rennison reported in the FT that weaker credits are struggling to raise money at all.

Riskiest US companies are left behind in rush to buy debt

“The lowest-rated companies in the US are struggling to raise much-needed cash despite a resurgent market for selling bonds, signalling that investors are staying away from borrowers that went into the Covid-19 crisis with the sickliest balance sheets.”

However, if you are just the right kind of lowest-rated company, you might get a break anyway …

US Treasury takes stake in trucking company with $700m bailout

“The US Treasury department has reached a deal to bail out YRC, a struggling US trucking company, with a $700m loan using funds from the $2.2tn stimulus legislation passed in March.”

And, if you are an individual trying to borrow, it is an entirely different game altogether. Good luck trying to get a jumbo mortgage regardless of your credit …

One Weird Sign Of Trouble In The Banking Sector

“Literally every single bank told us, ‘Yeah, we’re just not doing jumbo loans…’”

Topics – inflation

In the 5/15/20 edition of Observations I wrote about Lacy Hunt and his excellent exposition on monetary policy and inflation. One of the key variables in that discussion is the velocity of money. It is also a notoriously enigmatic variable because it is at least partly a function of consumer psychology. As such, the velocity of money often does not get the consideration it deserves.

Investors should prepare for a welcome return of inflation

“In recent years, the capacity of money supply to lift inflation, sometimes called the velocity of money, has been very low. But velocity will need to fall even more sharply to offset today’s growth in money supply. Higher inflation appears more likely.”

While there are some fair points in this FT opinion piece, I also find some glaring problems. Foremost, the author assumes that just because money supply has increased so much, it is unlikely that velocity can fall enough to offset it. Not only is there is no necessary reason for velocity to not fall further, but it’s just not that hard to conceive of plausible causes with just a little bit of reflection.

First, it is important to recognize that when the Fed creates money, it does so by way of banks. The money does not (at least not yet) go directly to consumers. As a result, increased money supply is only inflationary to the extent that opportunities exist for productive investment. If debt is raised purely for consumption and not for productive investment, velocity decreases.

The mechanics of creating inflationary pressure by rapidly increasing money supply are also obstructed by the Fed’s policy of paying interest on excess reserves (IOER). As the July 10, 2020 edition of Grant’s reports, “IOER renders obsolete the formerly simple connection between the Fed’s open-market deeds and inflationary results.” In short, “the dollars it creates lie fallow”.

In addition to these mechanical causes of velocity deterioration, there can by psychological causes as well. Economic hardships caused by the lockdowns, for example, are prompting people to re-evaluate their financial plans. I reported in the 6/26/20 Observations that Covid was crushing personal finances and many people were living on a “knife edge”.

In addition, John Mauldin reports that he is seeing “extraordinarily high savings rates and less spending from those who are uncertain about the economy”. He also makes it clear that this includes a lot of people who are reasonably wealthy. These observations are corroborated by another report …

Americans’ Biggest Financial Regret Is Not Saving Enough Before The Coronavirus Hit

“Among the survey’s key takeaways was the notion that Americans’ biggest financial regret – along every income group, including the wealthy – was not setting aside enough emergency savings, with 23% citing this reason as the biggest source of current anxieties.”

The key points are: Velocity is an important variable in the inflation equation that bears watching, there are indications that the economic shock from Covid-19 is fundamentally changing consumption patterns, and one should never assume something will happen just because it might be hard to imagine.

Liquidity

China’s support for US dollar can no longer be relied upon

“But markets follow money. The coming flood of ECB liquidity and eurozone safe assets, alongside the pressing need for China to diversify, could cause a radical change in capital flows.”

When I discussed Michael Howell’s new book, Capital Wars, in the Observations letter from 6/5/20, I highlighted the phenomenon of liquidity and its impact on capital markets. As Howell points out in this update from the FT, the prospect of increased liquidity from the ECB has the potential to not only affect asset prices, but the balance of geopolitical power as well. This is definitely worth watching.

Investment advisory

Here Are The Thousands Of Investment Advisors And Portfolio Managers Who Received Government Bailouts

“And yet, a casual search through the list of PPP recipients reveals that no less than 1,436 Investment Advisors applied for, and received PPP assistance, in many cases for well over $1 million.”

As data on the Paycheck Protection Program is becoming available, it is clear that at best, it did not work as advertised, and at worst it was a massive transfer of taxpayer money to companies that didn’t need it.

While there is plenty to take issue with if one is so inclined, the single thing that stands out most for me as a wrong is the massive uptake of PPP money by investment advisers. While I have not evaluated each advisor individually and therefore cannot make judgments on any individual case, I can say that in general, there is no good reason why an advisor should participate in this program.

First of all, the program was created with the intent to smooth over business disruptions caused by the lockdowns. There were no significant disruptions to investment advisors. The markets remained open and clients could be contacted in any number of ways. Secondly, advisory businesses are especially amenable to working from home – I have done it for over twelve years.

Finally, and importantly, advisors are supposed to be fiduciaries – people who act in the best interest of their clients. If their inclinations are to chase down government money regardless of how inappropriate that may be in a broader social context, what does that say about their desire to do what is right for you?

Implications for investment strategy

Talking Your Book About Value, Part 3, by Mike Green at Logica Funds

“As we have repeatedly discussed, the widespread transition to index products (both futures and passive mutual funds/ETFs) has changed the behavior of markets. Transactions focused on buying or selling all stocks and profitability derived from index arbitrage (again, both futures and the creation/redemption process of ETFs) rather than security selection have irrevocably changed the incentive structure on Wall Street.”

“We have reached the inevitable conclusion that no one is standing in the way of insanity. We are seeing this in our social lives where Cancel Culture has raised the stakes for anyone willing to stand in the way of the shaming mob, and we are seeing it in our public (and private) markets where any attempt to express rationality is met with underperformance and redemptions.”

Mike Green is one of the smartest and most independent thinkers in the investment world today. The case he makes in his latest research both explains much of what we are observing in terms of market action and guides us to constructive investment approaches.

One of the most difficult things to manage in a market like this – in which stocks keep going up – is to wonder what you are missing. Green makes it clear we aren’t missing anything. Rather, he explains how the incentive structure on Wall Street has changed away from security selection and that there is no longer anyone who is “standing in the way of insanity.”

And insanity it is. Valuations are rising from high to absurd levels even though we know there is going to be a big hit to earnings in the second quarter. At the same time, coronavirus infections are rising again which threatens more lockdowns. The geopolitical skirmish between the US and China is heating up. And oh, the presidential election in November could radically change the business environment.

So why would anyone maintain or increase exposure to risk assets under such conditions? Because “any attempt to express rationality is met with underperformance and redemptions.” This is an important clue. People who manage money for others, i.e., mutual funds managers, pension managers, hedge fund managers, etc. are all subject to redemptions; if they don’t keep up they lose money and maybe even their jobs.

So, it is fair to infer that there are many participants who are very involved in markets because they are compelled to be, not because they want to be. When a disruption comes, and it will, many of these investors will be scrambling to unload as fast as possible.

Fortunately, this is not a game that individual investors and advisors with strong client relationships and fiduciary duty need to participate in. These investors can wait patiently for opportunities that are “sane” and by doing so, substantially increase their chances of hitting their long-term investment goals.

Feedback

This publication is an experiment intended to share some of the ideas I come across regularly that I think might be useful. As a result, I would really appreciate any comments about what works for you, what doesn’t work, and what you might like to see in the future. Please email comments to me at drobertson@areteam.com. Thanks!        – Dave

Principles for Areté’s Observations

  1. All of the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

Relative Value Report 7/10/2020

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

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

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

Commentary

  • There was little surprising in this weeks results. The “go-go” sectors, Tech, Discretionary, and Communications continue to remain well overbought. At the same time, more conservative, value-based sectors are oversold.
  • Utilities and Financials are the most oversold. Many banks will report earnings next week, so if you are tempted to bet on positive earnings reports, they do present some relative value. We have no exposure to banks or XLF, and have no plans to add at the moment primarily due to fundamental and economic concerns.
  • In the Factor/Index (renamed) analysis we added Momentum (MTUM) and Equally Weighted S&P 500 (RSP). Both are assessed as a relative value versus SPY.
  • QQQ and Momentum are grossly overbought. At the same time RSP, Mid-caps and Value are oversold. A market sell-off may likely coincide with a rotation to the more beaten down sectors and factors
  • Mortgages remain the most oversold fixed income sector.
  • The R-squared on the sigma/20 day excess return (Sectors) scatter plot is higher at .51.  XLE is clearly reducing the correlation. Its score is not reflective of its recent performance versus the S&P 500.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

#MacroView: The Threats To The Bullish Thesis Have Grown

Since the March lows, the markets have rallied on optimism of a “V-shaped” economic recovery and constant stimulus from the Fed. So far, that has been the right call. However, in recent weeks, the threats to the bullish thesis have grown.

We recently discussed the Fed’s inflation of an asset bubble. The crux of the analysis was the unprecedented amount of monetary stimulus to counter the “pandemic.”

The Fed was able to inflate another asset bubble to restore consumer confidence and stabilize the credit markets. The problem is that since the Fed never unwound their previous policies, current policies will have a more muted long-term effect.

However, this time there are 50+ million unemployed, wage growth is declining, and bankruptcies are on the rise. The Fed’s attempt to inflate another bubble to offset the damage from the deflation of the last bubble, will likely not work.”

In the short-term, the Fed’s actions had the intended outcome by providing “stability” to the financial markets.

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

The Paradox

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

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

The problem the Fed, and Global Central banks, currently face is an inability to extract themselves from ongoing monetary policy measures. After the “Financial Crisis,” the Fed had hoped they would be able to reduce their accommodation as economic growth and inflation returned.

Neither ever happened.

A Diminishing Rate Of Return

Instead, as each year passed, more monetary policy was required just to sustain economic growth. Whenever the Fed tightened policy, economic growth weakened, and financial markets declined. The table shows it takes increasingly larger amounts of QE to create an equivalent increase in asset prices.

As with everything, there is a “diminishing rate of return” on QE over time. Since QE requires more debt to be issued, the consequence is slower economic growth over time.

“The relevance of debt growth versus economic growth is all too evident. Debt issuance initially exploded during the Obama administration. It further accelerated under President Trump, and has taken ever-increasing amounts of debt to generate $1 of economic growth.”

In other words, without debt, there has been no organic economic growth.

Importantly, after a decade of unprecedented monetary policy programs in U.S., the risks in the system have been expanded. It is now imperative that everyone continues to “act rationally.”

By not letting the system correct, letting weak companies fail, and allowing valuations to mean revert, the Fed has trapped itself. Such was a point we discussed previously:

“One way to view this problem is by looking at the Nasdaq 100 versus the S&P 500 index. That ratio is now at the highest level ever.”

These levels of extremes rarely exist for extended periods. It currently seems as if “nothing can stop the bullish market.” However, it is always an unexpected, exogenous event, which pops the bubble. 

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

The Bear Case

My colleague Doug Kass recently penned an interesting post on this issue:

“In aggregate terms, COVID -19 will likely have a sustained impact on the domestic economy. Such will be seen in reduced production and profitability for several years and forever in some industries.

At the core of my concerns:

  • Important Industries Gutted: Several key labor-intensive industries, such as education, lodging, entertainment, restaurant, travel, retail, and non-residential real estate, all face an existential threat. For these industries, they simply cannot survive the conditions they face. For these gutted industries, we face, at best, an 80% to 85% recovery in the years to come. In the case of some of these sectors like retail, Covid-19 only sped up what was already a secular decline. 
  • A Negative Knock-On Effect: Tangential industries, like food and other services surrounding less utilized offices, malls, and other spaces, will also get hit. They, too, face at best, an 80% recovery.
  • Widening Income and Wealth Inequality: The combined unemployment impact will run deep and cause adverse economic ramifications and intensified social imbalances.
  • A Battered Public Sector: With a lower revenue base, the Federal government and municipalities will cut services (and employment).
  • Rising Tax Rates and Redistribution: To fund the revenue shortfall tax rates will steadily increase. Such will exacerbate the disruption described above, and create a less than virtuous cycle.

Negative Impact To Stocks

As Doug also notes, there are substantial impacts to companies individually, which will eventually manifest in lower asset prices.

  • Weak Capital Spending: With a large output gap and higher debt loads ($2.5 trillion of Federal Debt and $16 trillion of non-financial debt), the outlook for capital spending is weak over the next several years.
  • Higher Costs And Lower Profit Margins: The surviving companies in a post-virus world will face higher costs of doing business. 
  • The Competitive Influence of Zombie Companies Exacerbate Lower Profitability: Corporations will face further pressure on profit margins from “zombie companies.” These companies compete aggressively on cost, and take longer to die due to low interest rates and weak loan covenants. 
  • Small Businesses Gutted: The greatest brunt from the pandemic is faced by small businesses that historically account for the largest job creators.
  • The Specter of a Secular Erosion in Unemployment: Permanent job losses will be surprisingly large, ultimately killing consumption. 
  • More Cautious Business Confidence and Spending: The surviving companies were ill-prepared operationally and financially, in early 2020 for the disruptive impact of COVID- 19. Such will force companies to maintain a “buffer” of additional capital (and cash) in the event of another unforeseen event or tragedy. In all likelihood, this will make for less ambitious capital spending and expansion plans relative to the past. 
  • Financial Repression Holds Multiple Risks: A sustained period of low-interest rates, necessary (by some) to offset reduced economic growth, could backfire. Repressing interest rates runs the risk of a pension fund crisis, and intransigence on the part of businesses to expand and may impair the U.S. banking system.
  • A Political Stasis: Political divisiveness and partisanship could intensify – dimming the probability of effective, pro-growth fiscal policy necessary in a low growth economy.

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

Overly Bullish

When reading through Doug’s list, the immediate response from readers who have a “bullish bias,” is “yeah…but what about the Fed?”

In the short-term, the Fed’s monetary interventions can certainly lift asset prices. As noted in the table above, the biggest “bang for the buck” is when asset markets are profoundly depressed, and negative sentiment is exceptionally high.

Such is not the case currently with retail investors chasing momentum in the markets with reckless disregard of the underlying investment risk. The sharp rise in the Russell 2000 index, as noted by Sentiment Trader, supports this view:

“Below is the percentage of Russell 2000 firms that have negative operating earnings over the trailing-12 months. It just moved above 30%, the most in over a decade. Only twice before in 20 years have such a high proportion of these small companies lost money. Those two periods were in April 2002 and December 2009 through February 2010.”

Furthermore, you have a near-record number of small traders speculating on asset prices through the use of options.

As noted previously, investors are also using 24-month forward estimates to justify overpaying for assets.

But, by nearly any metric, stocks are extremely expensive. There is only so much “future growth” that can be pulled forward. Eventually, “the piper must be paid.” 

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

The Risks Of Being Bullish

At the moment, none of these risks seem to matter.

What is vital to understand none of these issues will “cause” the “bear market.”

They are just the “fuel” that will exacerbate an eventual decline when the right catalyst is applied. Much like a can of gasoline stored in your garage, gas is inert until introducing the proper catalyst (a match.)

Concerning the financial markets, it will most likely not be a resurgence of the virus, weak economic data, or even a dismal earnings season. Such has already been “priced in” by the market. However, as stated, it will require an unexpected, exogenous event to ignite the fuel. At the point, it will become hard to contain the flames.

From an investment standpoint, it is critical to understand the “risk” under which you deploy capital into overvalued and extended assets.

While it may seem like a “no-lose” scenario due to the Fed’s liquidity programs, mean reversions can, and have previously, occurred.

As Doug concluded:

“While the Federal Reserve can provide the necessary ammunition (and liquidity) to stabilize activity briefly – it is unlikely a longer-term solution.

As we pass another Independence Day, the downcast prospects will impact the markets in the coming weeks and months

These are not an ingredient for a “Bull Market” or rising valuations. Instead, the above factors may be an ingredient to:

  1. Increased market volatility.
  2. Increasing economic uncertainty and cautiousness in the C-suite.
  3. An irregular period of growth.
  4. Lower price-earnings ratios.
  5. More social unrest.

The U.S. economy and our financial markets now face a crossroad – they are once again decoupling. The test of economic aspiration and market optimism will come in the years ahead.”

Navigating The Risk

Whenever I write an article that discusses a “bearish view” on the financial markets, readers construe it to mean I am sitting in cash, or short the “bull market.”

Nothing could be further from the truth. As stated over the last few weeks, we are currently “uncomfortably long” the market on our portfolios’ equity side. While we continue to hedge our risks to some degree through our bond, gold, and cash holdings, we are still well exposed to potential downside risks.

Having a thorough understanding of the “risk” is to have better control over long-term outcomes. While it is essential to make money while markets are rising, it is even more critical to control the losses. Spending a bulk of your time getting “back to even” is not a long-term investment strategy.

In January and February of this year, we discussed taking profits in stocks like AAPL, MSFT, AMZN, and others. The reason was not some prediction about the impact of the virus, but rather the gross deviation and extension of these positions from long-term means.

That risk reduction benefited us much when the crash came in March.

On Wednesday, we took profits in AAPL, MSFT, NFLX, and AMZN. (Taking profits does not mean we sold the entire position.)

I don’t know what might cause the next correction, or if there will even be one. But what I do know is that when stocks are this extended, overbought, and deviated above long-term means, bad things tend to happen.

#WhatYouMissed On RIA This Week: 07-10-20

What You Missed On RIA This Week.

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

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

Webinar: Candid Coffee

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

Got a question you want us to answer? CLICK HERE

Join Us: Saturday, July 25th from 8-9 am.

The Week In Blogs

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

________________________________________________________________________________

Our Latest Newsletter

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

________________________________________________________________________________

What You Missed: RIA Pro On Investing

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

________________________________________________________________________________

The Best Of “The Real Investment Show”

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

________________________________________________________________________________

What You Missed: Video Of The Week

The Fed’s Intervention In Markets

Mike Lebowitz and I discuss the Fed’s intervention into the market and the distortion to “value” investing caused by the “passive ETF” indexing problem.

________________________________________________________________________________

What You Missed: Our Best Tweets

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

See you next week!

Depression Or Roaring 20’s. Everybody Is Wrong.

I’ve been pondering all the “analysis” out there on the current economic and investment landscape and can only shake my head. That’s SMH, for you youngsters. What I see are coexisting comments for a Depression and the Roaring ‘20s at the same time. Again, for you youngsters, I am making a convenient comparison to the economic boom time of the 1920s, yes, before even I was born. Everybody is wrong.

Economists Are Wrong

Let’s start with the economic downturn, which led to the stock market collapse. Such is rated “1 duh,” because the stock market, at the onset of the economic shutdown, was looking ahead to a period of low earnings. Of course, shuttered companies are going to earn less.

What is rather sad is that the “experts” said that most businesses would not recover. Really? Indeed, some will never return because bills continued while revenue disappeared. Thinking there will never be a bar, or a concert or even a catered wedding in an event hall again, is ludicrous.

Never is a long time. What do they think will happen when there is a vaccine to prevent COVID, medicines to treat it, and herd immunity to mitigate it? Do we still have mass scale chickenpox? Rubella? Polio? Even AIDS, while there is still no cure, is mostly under control and no longer inflicting full-blown panic on society. I was single and living in NYC in the 1980s when AIDS became a crisis, so I know a little from the panic side.

So why is everyone so shocked when the stock market rockets higher? Again, it is looking ahead, not to a cure, but to people returning to work, masks, Purell, toilet paper, and all. Most of the jobs are still there, waiting for the ruling overlord politicians to allow them to get back in gear.
Such was not an economic downturn that started with an uptick in inflation or the desire by consumers to cut back. It was not rising inventories that told producers to cut back and, in turn, buy less from suppliers. The slowdown ripples through the economy until labor reverses back and voila, the stock market is falling.

Politicians are Wrong

In many areas, this was a government-mandated shutdown. Yes, nobody wanted to fly commercial airliners anymore, but Mom and Pop were not allowed to sell greeting cards. Where is the danger there? And that gets me started on the arbitrary nature of the shutdown.

Walmart is essential because they sell food? But you could still buy a toilet paper cozy and flowers there. Sally’s florist down the block was mandated closed.

Even a local plant nursery was allowed to be open because they sold tomato plants, which are food, and therefore essential. You can buy flowers there, too. And mulch, because we all know how important it is to have nice looking shrub beds during a pandemic.

Why was it OK to physically go into Stop and Shop but not into Macy’s? We were wearing masks – and gloves – to buy our Cap’n Crunch, so what is the big deal? And if you want to argue that Macy’s was not essential enough for that, why not allow curbside? You could get a rack of ribs delivered contactless to your car, so why not a fresh set of sweatpants?

I am not arguing with the concept of a mandated shutdown but rather the arbitrary nature of how it was done. The governor (any state) had dictatorial discretion.

Fundamental Analysts are Wrong

What makes me laugh is how the pundits compare year-over-year, and month-over-month sales results in a mandated closed economy. Why don’t they compare the tree climbing speeds of spider monkeys and goldfish? Analysts get 2-duhs.

How does it make sense to compare an open economy to a closed economy?

Don’t forget the overlap with Economists on recession calls. Yes, we could see two-quarters of contracted growth, so officially, that would be a recession. But again, they are comparing a chicken to its egg. Guess which one can run faster? Open things up (safely), and there will be growth.

For the May jobs report, the experts were looking for 7.5 million jobs to be lost, but there were actually 2.5 million jobs. Such goes to show that economists are non-essential workers.

In June, there were 4.8 million jobs gained, more than a million over the estimate. The analysts touted the numbers as the largest monthly gain in history. Another 2-duhs. Of course, it was huge in relation to normal times, but it was entirely in line with what was lost and why. Headline writers do not like to put things in context, do they?`

Technical Analysts are Wrong

You did not think that just because I have a CMT, that I won’t skewer technicians. Please do me a favor and stop comparing the price to any moving average that captures data before March 23. That’s right, the market’s low. The intermediate-term analysis is skewed by what happened. Look at long-term trends that show the bull run from the 2009 low, but please don’t think the 200-day average has any validity. Know your tools. You get only 1-duh because I like you.

If you read this far, I thank you and suggest you get outside more (wear a mask). I am not afraid to get a haircut in a salon that takes care to keep me safe. There is little worry about walking into a store, my doctor’s office or even flying to a resort. However, as long as I know the establishment’s policy to operate safely in the current environment. I am more afraid of who is preparing my food because I cannot see the chef in a mask, but then again, when was it ever a good idea to peek into the kitchen?

Educate yourself on this virus. Believe the emergency room workers when they tell you this is a serious disease. But we are passed the stage where the only answer is self-isolation and an Amazon account.

The Survival of Millions of Small Businesses Is Threatened

The Survival of Millions of Small Businesses Is Threatened: Let’s Support Them!

“I can’t throw everything I worked for under the bridge. I’m sitting in my retirement.”

Dennis Dreibelbis – owner of the G Bridge Lodge, in a restaurant he purchased in 1984 investing long term to support his retirement –  6/10/20

Mr. Dreibelbis is 69 years old. In mid–March he shut down his Pennsylvania restaurant. He quickly fell behind in payments to vendors, rent, utilities, and payroll. He hopes to see a return of customers when he reopens this summer.  He received a Payroll Protection Program loan which goes mostly to pay his staff. He still has insurance, maintenance, and other unpaid bills pilling up. Dreibelbis does not want to close the business and lose his investment or be forced to sell in a weak economy.

David Deeds, a professor of entrepreneurship at the University of St. Thomas says, “Their (retirees) time horizon is short.” He estimates that revenues for most small businesses revenues will fall up to 50% and will need to be ready for reduced income for up to three years.  Dreibelbis’s situation is typical of 40% of 31 million small business owners who are age 55 or older. Prospective retirees face a major crisis keeping their business operating and running up debts while looking to retire in the near future.

Four Major Factors

Millions of small businesses are struggling to survive due to lockdowns, delayed reopening, and now reversed openings. To understand the dynamic transformation small businesses are experiencing we’ll look at four factors:

  • Pandemic Impact – Review of three of some of the hardest hit industries: restaurants, lodging, and creative services.
  • The Outlook for Small Businesses – Examine the present “Great Depression” state of small businesses and prospect of a U-shaped cycle of contraction, with an extended trough and recovery.
  • Federal Relief Programs Fall Short– Evaluate how well federal financial assistance to small businesses is working and where it is fails to meet the needs of small businesses.
  • Investment Opportunities – Present several investment alternatives to take an active role in supporting small businesses.

Pandemic Impact

Restaurants

There are 1 million restaurants across the U.S. with 70% of them run by small businesses owners.  The restaurant industry has been hard hit by the pandemic with a loss of $82 billion of total restaurant sales from March through May:

Sources: U.S. Census, National Restaurant Association – 6/16/20

The National Restaurant Association estimates that 3%, or 30,000 of total restaurant locations have already closed permanently. As the financial squeeze of Mr. Dreibelbis typifies, many restaurants are hanging on by a financial thread with curbside pickup, delivery or outside dining at 50 % capacity.

Sources: Open Table, Bloomberg – 6/17/20

Restaurants have seen an increase in business since states have reopened yet sales are falling back. A recent analysis of Open Table reservations shows a slow rise as reopening activity began across the country but was followed by an 18% fall.  This decline maybe the result of a rise in COVID-19 cases in 21 states causing prospective diners to be concerned about their safety.

Open Table predicts that 25% or 250,000 of all restaurants will permanently close which includes 175,000 small business operated locations. Other research of major concern comes from Yelp. Yelp reports for the week of June 15th that 53% of website listed restaurants have posted ‘permanently closed’ notices with highest rates of closure in Los Angeles, New York and San Francisco.

Hotels

The American Hotel and Lodging Association (AHLA) estimates that 8 of 10 hotel rooms were empty in April.  AHLA forecasts a 50% or more decline in revenue for the year of 2020. Over 70% of all hotel employees have been laid off or about 1.6M employees and a loss of $2.4B per week. Oxford Economics estimates that at total of 3.9M jobs that support the hotel industry will be lost over the next two years.

Source: AHLA, Oxford Economics – 6/16/20

The AHLA expects a slow recovery process as travellers become more confident in staying at a hotels. There are 33,000 small businesses operating hotels in the U.S. with projected occupancy rate of 20% or lower.  At a 35% occupancy rate these small businesses are at risk of closing their locations permanently.  Thus, most of these small business run locations are in danger of closing. Airbnb competing with the mainstream hotel industry has experienced a devasting impact in their bookings as well. IPX 1031 reports that 64 % of guests cancelled their bookings. Airbnb expects a 44% loss in revenue from June thru August. About 70% of guests say they are fearful about the safety of staying at host location.  Bookings are beginning to pick up as reopening of the economy begins with 26% of guests say they will rebook for this summer.  However, hosts face a financial challenge as 16% have already delayed a mortgage payment and 50% expect to be out of business if the pandemic lasts for 6 months or longer.

Creative Services

The gig economy is huge segment of our workforce. In 2019, 33% of the labor force or 55M contract workers were in the labor force, according to McKinsey & Company. Since the pandemic hit the U.S., thousands of gig economy workers were laid off as they are often the first to be let go in any recession. Creative services is a major segment of the gig economy.  The highly skilled creative services workforce includes: writers, actors, producers, directors, studio crews, artists, video and audio professionals. Los Angeles has the second largest creative services workforce second to New York.  The Los Angeles economy has been hard hit by the mid-March shutdown with an unemployment rate of 21%.  The heart of the local economy is in entertainment production. Media production is a project based business using ad hoc teams. Thus, when production was shutdown contractors were laid off without major company benefits like health insurance, retirement matching funds or stock options. The creative services industry while concentrated in New York and Los Angeles employs thousands of workers across the U.S.

Source: The Wall Street Journal, 6/30/20

Other skilled independent service workers include technical workers like software developers and IT staff, and professional services which include attorneys, marketing support staff, and management consultants.  As the entertainment industry shutdown it depended on technical services workers to quickly shift production to Zoom shows and at home programs. This production shift provided a bridge during the shelter-in-place situation while providing program content for advertising.  California has announced a partial reopening of the economy. However, there are many issues in shifting to in studio production. New virus control regulations call for six foot social distancing, masks and disinfecting that are difficult to implement in an indoor studio team environment.   New Zealand with a good virus containment record is already taking advantage of the Los Angeles film industry predicament by offering incentives to move production activity to their studios. In Europe, the UK and Germany are also promoting their contained virus facilities for media development. In addition, Los Angeles is likely to have a slow recovery due to increasing virus infections in the Southern California area. Due to increasing infections creatives services workers enrolled in the Pandemic Unemployment Assistance program are likely to need continued benefit payments.

The Outlook for Small Businesses

This is a small business Great Depression

Nicholas Colas, Co-Founder, DataTrek Research

The small businesses sector is the jobs engine of the U.S. economy. In 2019 small businesses created 1.5M jobs for 64% of total business new hires. Plus, small businesses provided 50% of all economic output and 60M jobs accounting for 47% of the total labor force (chart below). Many businesses are just hanging on as only 40 % of small businesses under 500 employees are profitable.  The other 60% are either breaking even or losing money.  Most small businesses have only 30 days of free cash flow.

Sources: The U.S Census, Heather Long, Washington Post – 6/5/20

Prior to the pandemic, small businesses have been directly targeted by big businesses which caused business closures and a forced reduction in workers noted in the chart above.  For example, in the Dallas metro area Walmart has located ‘neighborhood’ grocery stores in locations next to locally owned food stores triggering the closing of many locally operated grocery stores. Amazon purchased Whole Foods, providing financial and marketing power to take market share from local organic food businesses that had established separate niche market positions from Safeway and Albertson’s.  As the pandemic has forced consumers to stay home, major players like Amazon and Walmart have cranked up their curbside pick-up and home food delivery services. Thus, further eroding market share of local groceries that have not been able to offer online delivery services.

In the retail sector, Amazon has built a huge e-commerce online business which has continued to whittle away at market share of small retail businesses.  Small businesses try to differentiate their business by offering sales, support and expertise not available on the internet.  For example, a California sewing machine and fabric retailer, experienced a 90% decline in fabric sales from the lockdown. Yet, just one day after the lockdown they had 45 people come in for sewing machine repairs. As people were sheltering-in-place there was renewed interest in sewing. Small businesses that are innovative, adaptive, and have sufficient funding will likely be the businesses that survive this recession.

As the pandemic hit, lockdowns were instituted in both rich and poor neighborhoods triggering reduced consumer spending.  However, a Harvard study showed that consumers in affluent ZIP codes cut their spending by 70% while spending in lower income ZIP codes saw only a 30% dip.  Of major concern, even after states opened their economies for business spending in the affluent neighborhoods did not return to pre-pandemic baseline spending levels.  The decline in affluent area spending forced small businesses in those ZIP codes to lay off 65% of their workers, versus businesses in low income areas which laid off 30% of their staff.  The affluent consumers had higher discretionary income so when they stopped spending there was a greater spending decline.  Small businesses catering to these affluent consumers had strong businesses but when discretionary purchases stopped their business income dropped significantly. In lower income neighborhoods small businesses were providing more essential goods and services so workers continued to buy.  Also, some affluent consumers left core city neighborhoods. Nicholas Colas, cofounder, DataTrek Research has observed a drop in income for small businesses near his Midtown Manhattan home. He notes, “(my) neighbors have fled to their second homes or rented homes. The small businesses that depend on their physical presence in the city have seen business dry up.” The implication is that virus safety concerns of high income consumers were more of a critical factor in local spending than states opening their economies.

The impact of the economic decline has hit minority owned small businesses harder than white owned firms.

Source: Bloomberg – 6/8/20

By April, there was a 41% decline in black owned businesses or nearly three times the loss of white owned businesses.  Lockdowns forced many minority businesses to close in already low income neighborhoods forcing increased unemployment while threatening their limited financial security.

In addition, the small business sector faces a major headwind in new business creation. The following chart from the Kauffman Foundation shows the predicted trend for new business applications which include forecasts for hiring or wages planned.  There is a 37 % decline in the April – May timeframe from the predicted number of applications likely to be filed compared to 2019.  Small businesses are a major job creation segment of our economy so the decline of the creation of new businesses is a concern.

Source: The Kauffman Foundation – 5/2020

We expect four waves of economic activity that fit within a standard U-shaped recession model consisting of contraction, trough and recovery phases. Today, we are in the early stages of the contraction phase of the overall economic cycle. (Please see our post, COVID-19 Triggers Transformation Into A New Economy – Part 1 on a U-Shaped economic cycle and indicators to watch).   The first and second waves outlined below complete the contraction phase. Wave three is a trough phase of low economic activity. Finally, wave four emerges in the recovery phase where ‘green shoots’ begin to appear as business models that are working turn profitable and begin to take hold across the economy.

Wave 1 – Shock – Today, there is financial relief for some small businesses from the Payroll Protection Program (PPP), $1200 checks to consumers, Fed bond buying, Fed Main Street Loan Program which has been slow getting started,  48% of small businesses report not making their full June rent payment, and retail foot traffic is slowly returning.  But, retail sales are still 16% below pre-pandemic levels (chart below):

Sources: Google, Macrobond, ANZ Research, The Wall Street Journal, The Daily Shot – 6/23/20

COVID-19 infections are rising in 23 states which account for 25% to 33% of national GDP. Goldman Sachs rates the R0 (or rate of one person infecting another) factor at 1.1 nationally or doubling of infections every 59 days. The rise in infections will likely cause a significant economic disruption. A high vulnerable group, Baby Boomers account for 30% to 35% of consumer spending. They are likely to be concerned about their safety. Thus, they will be reluctant to leave home causing reduced consumer spending, according to Deutsche Bank.

  • The weakest small businesses are not financially viable  – 100k – 250k small businesses close (Harvard Business School Study, May 2020)

Wave 2 – Relief Runs Out– In the near term future, due to lack of bipartisanship in Congress, PPP relief funding is renewed for only five weeks, relief checks will stop to consumers, there will be limited major company hiring due to lack of demand, some creative small businesses will adapt, others do not, but demand is capped by 25% permanent layoffs by small businesses by January, 2021.

  • COVID -19 second wave will hit many states causing significant economic disruption, – 2M – 3M small businesses close

Wave 3 – Economic Feedback Loop Sets In –  In the intermediate future, permanent layoffs will continue, many more mortgages will go into default, consumer confidence will continue to decline based on fear of layoffs even for those with jobs. A COVID-19 vaccine, or Herd Immunity will take hold, for those consumers with money and jobs spending will begin to rise yet below pre-pandemic levels due to uncertainty.

  • So many workers will be jobless that the economy is stuck at a depressed level. 3M – 4M small businesses close

To mitigate a deep economic Wave 3, we look for state and local governments, private equity firms and corporations to invest in the economy. The federal government must implement a national strategic program of testing, tracing and treatment to control the COVID-19 virus.  Only when consumers feel comfortable resuming their pre-pandemic activities will the economy be able to build on a solid economic foundation necessary for recovery. Wave 3 will last longer and have a tighter grip unless significant government investments are made in infrastructure, job training for new types of work to match labor better to job openings, and climate change solution job opportunities.

Wave 4 – Recovery Begins – innovative small businesses with solid business models and good cash flow begin to grow from increased consumer spending.  The federal government begins to focus on investment initiatives like infrastructure spending.  Longer term focused business development programs finally take hold as suggested in Wave 3 above on how to mitigate a deeper Wave 3 trough.

  • Renewing economic activities will begin to take hold – 400k -500K new small businesses open

Federal Relief Programs Fall Short

Many small business owners fault the federal funding programs for not being flexible enough to pay for services, product maintenance, insurance, vendors and other essential needs that are not payroll related. Let’s look at where the federal programs worked to provide relief to small businesses and where they did not meet the financial needs of small business owners.

In early April, Phase One of the PPP was quickly funded by Congress. The CARES Act in implementing the PPP focused on providing funding to small businesses who would keep employees on staff.  Thus, a key provision to receive funds was companies had to use 75% of the funds for payroll and only 25% for other expenses if the loan was to be forgiven at the end of the June 30th period.  Subsequently, Congress a few weeks ago passed a set of changes to the PPP law which extend the payroll funding time frame from 8 weeks to 24 weeks, hiring for the forgivable loan to December 31, 2020, and unforgiven part of the loan time frame for payback was extended from 2 years to 5 years. The funds available for payroll was lowered to 60% with 40% to other essential costs like rent and utilities. Many small businesses did not have an opportunity to receive Phase One funds as the money went to existing large bank customers and many major corporations. A major benefit of the PPP program was conversion of the loan to a grant if funds were used primarily for keeping employees on payroll. Congress passed a second law providing an additional $484 billion for PPP funding. Banks began taking applications on April 30th, focusing their loan underwriting activity on those small businesses left out of the Phase One. 

The National Federation of Independent Businesses (NFIB) reports that 77% of its members have applied for PPP loans and 93 % of those have been approved. Thus, it is estimated that 22M small businesses have temporary funding to survive for the next 6 months. Yet, most small businesses are still in tight financial situation. Many small businesses that received funds in the first round spent the funds to keep employees off unemployment but their business has not reopened.  Now, business owners face consumers not coming back due to the virus infections increasing thereby running out of funds to survive until customers return. For example, the accommodation and food services sector was hit from March through May with 33 % of the job losses in the U.S. but only received 8% of PPP loans. There are 9M total businesses without grants or loans from the federal government who must turn to other financial sources.  Owners will need to tap their own savings, retirement, angel investors or family and friends to keep operating.

Congress authorized $600B for a new Federal Reserve Main Street loan program for businesses who were not interested in the PPP program or could not qualify.  The name of the program is a bit of a misnomer as corporations up to 15,000 employees and up to $5B in sales are eligible. The program was to start in early May, yet only two weeks ago did banks start to take applications. Interest from banks and businesses has been tepid due to certain provisions which are not attractive to borrowers. Provisions such as large loan sizes beginning at $500k to $10M and begin payments at 1 year.  Small businesses need loans ranging from $100k to $250k. Major banks are not interested in the program as well.  At first the Fed required banks to take 15% of the loan collateral with the Fed providing 85%.  The Fed since has changed loan provisions to offer loans starting at $250k, and extending the time frame out to 2 years to begin paying principal and interest only beginning after the 1st year.  Banks would only have to take 5% of the loan on their books, with the Fed taking 95% of the loan value on its books.  Business have found the paper work to be too complicated, and major banks are not interested in actively marketing the program. The Main Street initiative was well intended but falls short and comes too late to meet the needs of business owners already short on cash. It seems in retrospect that involving community banks that are closest to small businesses in the development of a fast track focused loan program on the unique needs of small businesses would have been more effective.

The result of these federal programs time limits and relief orientation is that they don’t begin to take on the huge small business development challenge for the real possibility that 30 – 40 % of the non PPP relief businesses or 3M will face insolvency by January 2021.

The PPP and other relief programs will likely need to be extended beyond the five weeks now anticipated by Congress. However, what is really needed is a long term solution to small business development.  In our post, COVID-19 Triggers Transformation Into A New Economy – Part 2, we propose the idea of building a self-renewing economic ecosystem of venture capitalists, angel investors, company incubators, universities and local government to build small businesses. Areas that have successfully used the self-renewing economic model include:  Portland, Oregon with their Silicon Forest, and Salt Lake City has their Silicon Slope.

We need an imaginative vision for America that includes workers at all income levels and makes labor’s role in the economy a partnership with capital.  We will pull out of the recession faster with a longer expansion if we build an economy that works for all.

Investment Opportunities

Now is a good time for investors to review their investments and consider new investments while rebalancing portfolios.  Rebalancing portfolios based on considering both return and the financial needs of small businesses is crucial to our economy and communities. Outlined below are a set of investments to review. Investors will want to conduct more in depth research to assess how these types of investments will meet their portfolio objectives.

Community Banks

Local banks provide the cash life blood of many small businesses.  Most small businesses do not have accounts at major banks but instead rely on their local banker for loans and credit accounts.  Moving funds from a big five bank to a local bank will provide more financial support for local businesses. On a national level investors can invest in indexes that focus on community and small banks in the U.S., for example: KBWB

Non-Bank PPP Providers

These companies serve millions of small business owners, many of whom are sole proprietorships and mom and pop stores. They have the AI and advanced technology to process these loans, as well as strong relationships with many borrowers who regularly use their concierge-type services. Plus, they are certified PPP loan providers to small businesses that use their services.  Examples of Non-bank PPP providers are Intuit, Square and PayPal

Community Development Financial Institutions – CDFIs

CDFIs are mission-driven financial institutions that have been certified by the U.S. Department of the Treasury. CDFIs include credit unions, banks, loan funds, and venture capital funds that operate with a primary mission of serving small businesses and low-income communities. Over the past 35 years, CDFIs have made $74B in loans to support over 400,000 small businesses with about 58% going to minority owners. The Treasury Department has funded the CDFI program for $250M this year, seeding additional investments by foundations, investors and banks.  Many small businesses were successful obtaining PPP loans with their local CDFI. There are 1120 certified financial institutions participating which includes 300 credit unions.  CDFIs offer not just capital to small businesses but provide coaching on how to write business plans, write a loan proposal to a bank or learn how to tighten accounting practices. Mark Ivancie, Director of Growth and Partnership for CNote, a software platform provider for CDFI investing, observes that investors “can gain a competitive return, support small businesses and have a social impact.”  Some CDFI investments offer returns from 2.25% to 4.00% depending on the term. 

Investors can allocate funds to CDFIs in two ways, directly and indirectly.  One example of a way to directly invest is with the Reinvestment Fund.  The fund has $1.5B in assets under management and focuses on small businesses, housing projects, access to health care, educational programs, and job initiatives.  Indirectly, funds can be placed via an innovative software platform like CNote to a nationally diverse set of CDFIs. CNote qualifies, monitors and manages all the details of investing in CDFIs. Both the Reinvestment Fund and CNote have taken steps to insure investors receive repayment of both principal and interest based on CDFI agreements, loan loss reserves and quality audits.

For a directory of local CDFIs in your community there is a Treasury site to download a spreadsheet, and then click on the city and state tabs to find a CDFI near you.

Patronage

A wider perspective on ‘investment’ may include patronage.  It would be helpful to pause and think of all the locally owned businesses we patronize. We suggest getting to know the owner, maybe there is a loan or some financial assistance that you can provide.  As a customer you know the quality of their product or service so you can assess the likelihood of the risk in your investment.  We often take local boutiques for granted as we drive by to buy a gift at Target for a birthday. Worse yet we just buy the birthday gift online from Amazon. At the least make sure you continue to go to their store for a curbside pickup of your purchase.  We depend on local services like barbershops, nail salons, laundries and many more that provide essential services. Consider making an advance payment on an upcoming service appointment to help the owner make ends meet until reopening.

Increasingly, younger generations are concerned with what types of businesses they spend their money. Barbara Kahn, professor of marketing at Wharton has observed a shift in purchase patterns of young shoppers. “We see Gen Z and the young people put their money where their mouths is. Now people think of the entire transaction of what they’re paying for. That there’s value in sustainable transactions, in supporting the local community, that’s over and above the value of the goods.”

Summary

Small businesses in our neighborhoods create a unique and rich culture for our communities or where we visit.  What would a New England seaport town be without local clam chowder or lobster roll?  Or New Orleans be without a Cajun blackened shrimp?  Or Southern California be without a Balboa Bar of a scoop of ice cream coated with chocolate and toppings on a stick. Beyond food we may like to shop for a local beach shirt, woven handbag, or table built of wood from indigenous trees.  All these things and experiences create a wonderful culture we enjoy, but many could be gone.

Community small businesses need our investment and patronage today more than ever. It is time to examine where we allocate our investments to make a difference in our community. In addition to impacting our health and economy, the virus is attacking the small business cultural fabric of our country. The survival of many small businesses is threatened. We have an opportunity to support their products and services to ensure they are open to provide jobs and enrich our communities.  

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

Selected Portfolio Positions Review: 07-08-20

In this week’s selected portfolio positions review (07-08-20), we want to review a few of the trades we made recently. We also want to discuss a couple of positions we make take action on soon.


AAPL – Apple, Inc. (Looking To Take Profits)

  • Over the last couple of years, we have bought AAPL, taken profits, added more on dips or breakouts.
  • With AAPL pushing into the 3-standard deviation overbought zone, like many of the market sectors, we are looking to reduce our position slightly to take in some of the gains. 
  • We will look for a pullback to add back to the position. 
  • Stop loss is at $310

NFLX – Netflix (Looking To Take Profits)

  • Like AAPL, we added to our holdings of NFLX previously.
  • Like AAPL the recent surge has taken the stock into an extreme overbought condition.
  • We are looking to reduce our position slightly and wait for a correction or consolidation to work off the extreme conditions to rebuild the holding. 
  • Stop set at $385

AMZN – Amazon, Inc.

  • Also, like AAPL, after adding to AMZN previously, the near vertical spike in the AMZN suggests that profit taking is prudent. 
  • We will look for an opportunity to rebuild the position on a pullback or consolidation.
  • Stop set at $2350.

AEP – American Electric Power (Reduced Holding)

  • AEP and DUK have both been good holdings for us in the past, but defensive positioning has lagged as of late weighing on overall portfolio performance.
  • We still like both of our holdings and suspect they will perform better during a market correction. However, in then meantime we reduce our positioning in both DUK and AEP by 1/3rd. 

CLX – Clorox Co.

  • CLX has been a stellar performer since we added the position earlier this year. 
  • The COVID trades have been in favor, but with the extreme overbought condition we took profits in CLX recently and rebalanced the position in portfolios.

CMCSA – Comcast Corp.

  • In the same vane of the “work at home,” “COVID,” trades we added to our holdings in CMCSA.
  • We continue to like the position although it has underperformed the market as of late.
  • With the resurgence in the “virus” we suspect we will begin to see better performance as the rotation to these types of companies continues.

CSCO – Cisco Systems

  • As with CMCSA, we also added to our position in CSCO recently for virus play. 
  • CSCO is a bit overbought, but holding support at the 200-dma. 
  • We have a stop on the position at $40.

MSFT – Microsoft Corp. (Looking To Take Profits)

  • As with AAPL, AMZN, and NFLX, we are looking to take profits in MSFT at some point soon. 
  • The position is extremely overbought and extended, so a correction is likely. 
  • We like the position long-term, but valuations are very stretched currently. 

INTC – Intel Corp.

  • After adding INTC, we were unable to gain traction on the position and we were stopped out.

BLL – Ball Corp.

  • BLL is an industrial company, which makes aluminum cans.
  • With the virus gaining traction, individuals are consuming more at home, and channel checks show that BLL has been running at near capacity to meet demand. 
  • They are also considered an “essential business” so the threat of a shutdown is eliminated. 
  • We have added a small position to start, with a stop at $67.5

Tesla’s Moonshot, How High Can It Go?

Tesla’s Moonshot, How High Can It Go?

Since the beginning of 2020, the aggregate market cap of the twelve largest automakers is up 9.30% to $803 billion. Quite an increase considering the COVID pandemic is causing a global recession and weak auto sales. 

The obvious question is, why is the auto sector doing so well amid such uncertainty?

It’s not!

The optics are “driven” by one stock, Tesla (TSLA). TSLA’s stock price continues its moonshot while other automakers languish. The gross divergence of fortunes in the industry is worth exploring. 

As has always been the mandate of our articles, we look at data on auto sales, industry trends, and demographics to help you come to your conclusion about Tesla and the auto industry. This, in turn, allows you to assess Tesla better independently.  

Auto Industry

According to the International Organization of Motor Vehicle Manufacturers, global vehicle sales have grown annually at 0.37% over the last five years. Sales over the previous 15 years are quite a bit stronger at 2.20%.

The graph below highlights total global auto sales broken down by passenger and commercial vehicles.

The following table shows growth rates and the percentage of global sales for the four largest auto markets.

Bottom line: auto sales over the last five years are tepid at best.

To put sales into a different context, it’s worth comparing them to economic activity. Over the last 15 years and five years, global GDP has grown annually 4.17% and 3.14%, respectively. Auto sales are not keeping up with global growth.

China has increased car ownership significantly and is the bright light for the industry. However, as shown below, sales of vehicles in China are leveling off. With China’s economic growth slowing considerably, and auto ownership more saturated, China’s appetite for autos will remain weak.

Without an obvious geographic region to replace China, the industry must rely on changes in consumer behaviors and preferences.

Demographics

Baby Boomers are retiring in droves and need fewer automobiles. Can the newest drivers, Millennials and Generation Z pick up the slack?

The Atlantic wrote an article in March 2012 entitled Why Don’t Young Americans Buy Cars? While the article is dated is still rings true. Here are some key quotes about the Millennial generation’s desire to buy cars: 

Kids these days. They don’t get married. They don’t buy homes. And, much to the dismay of the world’s auto makers, they apparently don’t feel a deep and abiding urge to own a car. 

The Times notes that less than half of potential drivers age 19 or younger had a license in 2008, down from nearly two-thirds in 1998. The fraction of 20-to-24-year-olds with a license has also dropped. And according to CNW research, adults between the ages of 21 and 34 buy just 27 percent of all new vehicles sold in America, a far cry from the peak of 38 percent in 1985. 

At a major conference last year, Toyota USA President Jim Lentz offered up a fairly doleful summary of the industry’s challenge. 

“We have to face the growing reality that today young people don’t seem to be as interested in cars as previous generations,” Lentz said. “Many young people care more about buying the latest smart phone or gaming console than getting their driver’s license.”

The next generation, Gen Z, currently aged 5-25 are starting to buy cars. As such, it is early to define Generation Z’s car buying preferences. However, they are being shown to be frugal with big-ticket items. Data shows that their buying habits are similar to the millennial generation. This seems to make sense given their existing student debt obligations and relatively low wages.

For an in-depth discussion of generational tendencies we highly recommend Generations and The Fourth Turning by Howe and Strauss (LINK).

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

Ridesharing

As if generational shifts are not enough trouble for the industry, ridesharing companies may be worse. Uber and Lyft make it easy to avoid car ownership.

What taxis did for car ownership in New York City, ride-sharing services are doing in many urban and suburban regions. (In Manhattan, less than a quarter of households own a car. That compares to an average of 1.88 vehicles per U.S. household.)

The cost/benefit analysis of owning a car has changed, and it’s not to the benefit of the auto manufacturers. Autonomous ridesharing services in the future will only make this problem more acute.

Why Are Valuations Rising?

The recent pace of car sales is weak and below economic trends. Global economics argues there is no clear replacement for China’s growth of years past. Demographics do not favor the industry. So, why is the aggregate value of auto companies rising during a recession?

As shown below, Tesla’s market cap has risen 244% this year. The market cap of the industry, excluding Tesla, is down 17%.

The table leads to a straightforward question. Is Tesla becoming an automotive behemoth and leaving its competition in the dust?

The graph below comparing sales and market cap puts context around that question.

As shown, Tesla’s sales are a fraction of every other major manufacturer. By default, investors must think their future sales trajectory is enormous. Meanwhile, deliveries have been flat since the third quarter of 2018.

Courtesy @teslacharts

If Tesla shareholders are correct, Tesla must garner at least 25-30% of the market share.

Can TSLA justify the combined market cap of GM, Fiat/Chrysler, Honda, BMW, Nissan, Hyundai, Mercedes, and Ford? Before you answer, understand they currently make only about 2% of the cars as those other manufacturers.

Tesla’s Advantage… For Now

Tesla certainly has a valuable first starter advantage in the electric vehicle (EV) category. Notably, however, they do not have patents. 

Its advantage exists because other manufacturers have been slow to release EV cars. The technology is easy to replicate.  Whether they are waiting for costs to decline, longer battery life, persistently higher gas prices, or more robust demand, we don’t know. Nonetheless, the wait will not be much longer.  

Most auto manufacturers have lines of EVs due out this year and next. Many will come at prices cheaper than those Tesla offers. Unlike Tesla, they offer their clients service shops and trade ins. Tesla’s first mover advantage is slipping away quickly.

For Tesla’s market cap to be correct, the following must be true:

  • They must continue to dominate the EV space
  • EVs must gain significantly in popularity
  • Other manufacturers must be incapable of producing competitive EVs

That a tall order!

Summary – Momentum Rules

TSLA’s stock may run higher. We believe its stock price is in the grips of speculative fervor and passive investing momentum. These conditions may last longer.

We do not know when Tesla’s moonshot will end. However, as we learned in 2001, the end is unusually swift and vicious. Afterward, it can take years and even decades before an investor breaks even. Just consider it took Microsoft 15 years to regain the record highs of 2000. At that time, Microsoft had strong fundamentals and a dominant market position.  

Tesla?

Not so much.

TPA Analytics: Using Historic Price/Book Value

Like this analysis on Price/Book value? Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. 

Add TPA Analytics to your current membership plan for additional market, and trading, insights. You can see an overview under RIAPro+

TPA defines each stock as Trend or Range to identify actionable inflection points. Trade specific commentary and portfolios are available now.

__________________

WHAT IN THE WORLD IS OVERBOUGHT USING HISTORIC PRICE/BOOK VALUE (5, 10, & 15 years)

TPA uses Price/Book Value to determine what areas of the market are historically overbought and oversold.

Book Value is the worth of a company if it liquidated its assets and paid back its liabilities. Since book value represents the intrinsic net worth of a company, Price/Book Value (P/BV) is a helpful tool for investors looking to determine if a company is underpriced, or overpriced. P/BV can also be determined for indexes and so it is helpful to determine the value of broad market categories, sectors, and even countries. Even if clients do not like using P/BV as a measuring stick, looking at P/BV historically can give clients an idea of how overbought or oversold certain areas of the market are on a relative basis.

The tables below calculate the average P/BV and standard deviation of P/BV for U.S. broad market, major U.S. sectors and countries for ALL (15-year), 10-year, and 5-year periods. TPA then calculates how many standard deviations the current P/BV is away from the period average. The more standard deviations away from the average, the more likely the recent direction has to reverse course (revert to the mean).

TPA has highlighted several areas of the market that are at long term statistical extremes. Ranking them based on the standard deviation distance from the mean on a 10-year basis, they are:

  1. Large Cap Growth (+4.26 STD DEV)
  2. Technology (+3.42 STD DEV)
  3. Consumer Discretionary (+2.61 STD DEV)
  4. Healthcare (+1.93 STD DEV)
  5. Large Cap (+1.93 STD DEV)
  6. Small Cap Growth (+1.92 STD DEV)
Globally, the most overbought Countries on a 10-year basis using relative P/BV are:
  1. Denmark (+2.42 STD DEV)
  2. U.S. (+1.84 STD DEV)
  3. Brazil (+1.40 STD DEV)
  4. Taiwan (+1.40 STD DEV)

Clearly, we are living in extreme times and the overbought areas of the world indicate expectations and relative expectations for potential earnings and for safety. Regardless of the reasons, however, these areas are clearly statistically overbought and crowded on a historic basis and clients should be wary of being the last one out the door.

Sector Buy/Sell Review: 07-07-20

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

HOW TO READ THE SECTOR BUY/SELL REVIEW CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

  • As noted last week, XLB held support at $54, but remains very overbought short-term, however, trading positions could be added with a tight stop at $54. 
  • XLB is too overbought currently to chase the sector further, but hold trading positions for now.
  • Target for trade is $60-61
  • The sector looks weak overall so caution is advised as we head into earnings season.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
  • Stop-Loss set at $54
  • Long-Term Positioning: Bearish

Communications

  • XLC has resumed its rally and is looking to breakout to new highs after holding support. 
  • The sector is VERY overbought so hold current positions, but I would not suggest chasing the sector at this juncture.
  • With the virus resurging, the more defensive quality of the sector is attracting flows.
  • We moved our stop to $52.
    • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Neutral

Energy

  • The pullback in energy stocks has moved the sector back to oversold. We were a bit early adding to our holdings but we were close to the short-term bottom.
  • If support can hold here, our positions should play out.
  • We maintaining fairly close stops however.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Stop loss adjusted to $35.00
  • Long-Term Positioning: Bearish

Financials

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

Industrials

  • Industrials bounced of support at the 50% retracement level and triggered a buy signal. Sector performance has improved as well.
  • The sector has triggered a “buy signal” but is short-term overbought. 
  • Positions can be added with a stop at $56
  • Short-Term Positioning: Bullish
    • Last week: No position.
    • This week: No position.
  • Long-Term Positioning: Bearish

Technology

  • Technology continues push higher as the “virus trade” is back on. 
  • Technology stocks, and the Nasdaq, are extremely overbought. 
  • We are holding our positions currently, but would not add further to the sector until you get a correction. 
  • The deviation above the moving averages will be resolved likely sooner than later. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Staples

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

Real Estate

  • Like XLP, XLRE has triggered a buy signal.
  • The sector is not grossly overbought and a further defensive rotation in the market should see this sector rally. 
  • XLRE is looking to test the 200-dma, and a break above that level would be bullish short-term.
  • We have moved our stop to $33.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions.
    • Long-Term Positioning: Bullish

Utilities

  • XLU has been lagging but is working off its previous sell signal.
  • The sector is currently underperforming the market as a hole, but there is some relative value and dividends in the sector.
  • XLU held support on the recent pullback, and looks set to move higher in the short-term.
  • We have an alert set at $54
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV continues to consolidate. With a buy signal in place, a defensive rotation in the market could push the sector higher.
  • The consolidation was needed following the massive rally from the lows. So, if the market begins to look for areas with better fundamentals for a catch up trade, XLV will likely be it.
  • The 200-dma is now important support and needs to hold, along with the previous tops going back to 2018. 
  • We have an alert set at $95 as a stop.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • AMZN is still driving this sector. The overall retail sector looks terrible from an earnings standpoint, but for now, the sector is AMZN. 
  • Hold current positions but maintain your stop levels.
  • Stop loss is set at $122.50
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

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

The Death Of Fundamentals & The Future Of Low Returns

Over the last quarter, the “Death of Fundamentals” has become apparent as investors ignore earnings to chase market momentum. However, throughout history, such large divergences between fundamentals and price have resulted in low future returns.

This time is unlikely to be different.

What you missed, #WhatYouMissed On RIA This Week: 07-03-20

Biggest Decline In Earnings…Ever

As discussed previously: 

“During the second quarter, analysts lowered earnings estimates for companies in the S&P 500 for the quarter. The Q2 bottom-up EPS estimate (which is an aggregation of the median Q2 EPS estimates for all the companies in the index,) declined by 37.0% (to $23.25 from $36.93) during this period. How significant is a 37.0% decrease in the bottom-up EPS estimate during a quarter? How does this decrease compare to recent quarters?

During the past five years (20 quarters), the average decline in the bottom-up EPS estimate has been 3.2%. Over the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate has been 3.4%. During the past fifteen years, (60 quarters), the average decline in the bottom-up EPS estimate has been 4.6%. Thus, the decline in the bottom-up EPS estimate recorded during the second quarter was much larger than the 5-year average, the 10-year average, and the 15-year average. 

In fact, this marked the largest decline in the quarterly EPS estimate during a quarter since FactSet began tracking this data in Q1 2002. The previous record was -34.3%, which occurred in Q4 2008.” – FactSet

Wishing For A Hockey Stick

The chart above is telling. Investors continue to bet on a “hockey stick” recovery in earnings to justify overpaying for stocks with the highest price momentum. As discussed in “The Bullish Test Comes:” 

“Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”

Earnings, The Bullish Test Comes As Earnings Season Begins 07-03-20

Importantly, earnings estimates did not decline due to just the onset of the “pandemic.” Earnings began to decline in earnest in late 2018 as economic growth had started to weaken. 

As we warned in mid-2019, the inversion of the yield curve had also set the stage for an economic contraction:

Despite commentary to the contrary, the yield curve is a ‘leading indicator’ of what is happening in the economy currently, as opposed to economic data, which is ‘lagging’ and subject to massive revisions.”

All that was needed was an unexpected, exogenous catalyst to trigger the actual event. 

The important point is that investors have been overpaying for earnings by more than 2.5x since the peak in earnings in 2018. Slower economic and wage growth and a widening of the “wealth gap,” has stalled revenue growth. Such has forced companies to engage in a wide variety of accounting “gimmickry” to manufacture earnings to support higher asset prices.

Overpaying For Value

Since 2009, investors have bid up stock prices by more than 368%. Yet, cumulative operating earnings and revenue have only grown by 93% and 50%, respectively.

Even if the expected “hockey stick recovery” in earnings occurs, earnings will only return to the same level as they were in 2018.

If we assume analysts are correct, and historically they overly estimate by 33%, investors have vastly overpaid for earnings. Such has historically guaranteed investors disappointing investment outcomes.

However, as we enter “earnings season,” we are again seeing analysts and companies adjusting their numbers to win the “beat the estimate” game. Such is why I call it Millennial Soccer.” Earnings season is now a “game” where no one keeps score, the media cheers, and everyone gets a “participation trophy” just to show up.

What you missed, #WhatYouMissed On RIA This Week: 07-03-20

Wall Street Analysis Isn’t For You

When it comes to earnings season, the media will be complicit in pushing Wall Street’s recommendations. However, those “buy, sell and hold” recommendations aren’t for you. Those recommendations are the “bait” to camouflage the “hook.”

I will let you in on a “dirty little secret.” 

Wall Street doesn’t care about you or your money. Such is because their profits don’t come from servicing “Mom and Pop” retail clients trying to save their way into retirement. Wall Street is not “invested” along with you, but “uses you” to generate income for their “real” clients.

Such is why “buy and hold” investment strategies are so widely promoted. As long as your dollars are invested, the mutual funds, stocks, ETF’s, etc, the Wall Street firms collect their fees. These strategies are certainly in their best interest – just not necessarily yours.

However, those retail management fees are a “rounding error” compared to the really big money.

Wall Street’s real clients are multi-million and billion-dollar investment banking transactions. These deals include public offerings, mergers, acquisitions, and debt offerings, which generate hundreds of millions to billions of dollars in fees for Wall Street each year.

You know, companies like Uber, Lyft, Snapchat, Tesla, and Shopify.

Buy, Sell or Hold

For Wall Street firms to “win” that very lucrative business, they must cater to their prospective clients. Not surprisingly, it is difficult for a firm to gain investment banking business from a company with a “sell” rating. 

Such is why “buy” ratings are so prevalent versus “hold” or “sell,” as it keeps the client happy. I have compiled a chart of 4644 rated stocks ranked by the number of “Buy”, “Hold” or “Sell” recommendations.

There are just 2.97% of all stocks with a “sell” rating.

Do you believe that out of 4644 rated companies, only 138 should be “sold?”

You shouldn’t.

But for Wall Street, a “sell” rating is not good for business.

The conflict doesn’t end just at Wall Street’s pocketbook. Companies depend on their stock prices rising as it is a huge part of executive compensation packages.

Corporations apply pressure on Wall Street firms, and analysts, to ensure positive research reports with the threat they will take their business to a “friendlier” firm. The goal of boosting share prices for compensation is also why roughly 40% of corporate earnings reports are “fudged” to produce better outcomes.

As the Associated Press exposed in “Experts Worry That Phony Numbers Are Misleading Investors:”

“Those record profits that companies are reporting may not be all they’re cracked up to be.

As the stock market climbs ever higher, professional investors are warning that companies are presenting misleading versions of their results that ignore a wide variety of normal costs of running a business to make it seem like they’re doing better than they really are.

What’s worse, the financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they’re largely passing along the rosy numbers in reports recommending stocks to investors.

What you missed, #WhatYouMissed On RIA This Week: 07-03-20

You Have To Do Your Own Homework

So, what can you do? 

You have two choices. 

You can do your homework using a research tool like “RIAPro.Net” (Try Risk-Free for 30-days) where you can screen for fundamental value.

Or, you can hire an independent, fee-only advisor who knows how to do the work for you.

Let me show you the difference between Wall Street’s “buy, sell, hold” analysis versus how we break the universe of stocks we screen at RIA Advisors.

As an independent money manager, I use valuation analysis to determine what equities should be bought, sold or held in client’s portfolios. While there are many valuation measures, two of my favorites are Price-to-Sales and the Piotroski f-score. For this example, I sorted the entire Zacks Research equity universe of 5028 issues. I ranked them by just these two measures.

See the difference. Not surprisingly, there are far fewer “buy” rated, and far more “sell” rated, companies than what is suggested by Wall Street analysts.

What you missed, #WhatYouMissed On RIA This Week: 07-03-20

Price-To-Sales Sends A Warning

Here is something even more alarming.

Just after the “dot.com” bust, I wrote a valuation article quoting Scott McNeely. He was the CEO of Sun Microsystems at the time. At its peak, the stock was trading at 10x its sales. (Price-to-Sales ratio) In a Bloomberg interview, Scott made the following point.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. It also assumes I have zero cost of goods sold, which is very hard for a computer company.

That assumes zero expenses, which is really hard with 39,000 employees.That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10-years, I can maintain the current revenue run rate.

Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes.

What were you thinking?

What’s In Your Portfolio

How many of the following “Buy” rated companies do you own carrying price-to-sales valuations above 9 or 10 times?

So, what are you thinking?

As an increasing number of “baby boomers” head into retirement, the need for independent, organic research and analysis, which is in the client’s best interest, is more critical now, than ever. 

Independent advice can help remove those emotional biases from the investing process that lead to poor investment outcomes. There are many great advisors with the right team, tools, and data, who can manage portfolios, monitor trends, adjust allocations, and protect capital through risk management.

The next time someone tells you that you can’t “risk-manage” your portfolio and just have to “ride things out,” just remember, you don’t.

TPA Analytics: Top 10 Buys & Sells

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

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

TPA Top 10 Buys & Top 10 Sells.   

TPA will begin publishing its Top 10 Buys and Top 10 Sells every week.  The report is an overview of recent recommendations.  The report will include the last price, the action price, and the distance to action.  The action price is the optional Buy or Sell level.  The distance to action is the percent difference between the last price and the action price.

TPA TOP 10 BUYS AND TOP 10 SELLS

TPA MARKETSCOPE

CLICK ON LINKS BELOW FOR TECHNICAL INDICATOR EXPLANATIONS:

ASCENDING – DESCENDING TRIANGLE

BASING-TOPPING-CONSOLIDATION

BREAKOUT (Breakdown)

CHANNEL & RANGE

DIRECTIONAL MOVEMENT INDEX (DMI)

DOUBLE BOTTOM or DOUBLE TOP

MACD-MOVING AVERAGE CONVERGENCE-DIVERGENCE

MOVING AVERAGES

RELATIVE STRENGTH & PEER STOCK PERFORMANCE

REPEATING PATTERNS

RSI-RELATIVE_STRENGTH

SUPPORT, RESISTANCE, BREAKOUT, BREAKDOWN

TREND

Major Market Buy/Sell Review: 07-06-20

HOW TO READ THE MAJOR MARKET BUY/SELL CHARTS FOR THE WEEK OF 07-06-20.

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

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

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

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

Market Buy/Sell 07-06-20

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

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

S&P 500 Index

  • As noted last week “That correction happened over the last two weeks with the SPY bouncing off support at the 200-dma and retesting it again on Friday. It is critical the market holds support into next week. “
  • The market did hold support and bounced above the short-term downtrend.
  • As noted last time, we added a small trading position with a stop at the 200-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No core position
    • This Week: 2.5% Trading position
    • Stop-loss set at $300 for trading positions.
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • We noted last week, that we had added a 5% trading position in the Dow for a catchup trade, but it had violated the stop.
  • Specifically we stated: “As always, by the time a stop is triggered, markets are short-term oversold. We will look for bounce to clear the position.”
  • We sold 1/2 of the position last week on the bounce. We will sell the other 1/2 position on any rally this week.  
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: Sold 1/2 of position.
    • Stop-loss violated, will sell on a bounce.
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • QQQ’s outperformance of SPY continues. 
  • The QQQ’s broke out to all-time highs last week after a brief consolidation. 
  • The QQQ’s are overbought and the buy signal is extended so consolidation or a correction is still possible so maintain stops accordingly and take profits and rebalance as needed.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss moved up to $235
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The correction in small-caps continues with small caps back to underperforming large caps.
  • With small-caps very susceptible to weak economic growth, we are still avoiding this area of the market. 
  • The previous stop-loss at $58 was violated.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $56
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. MDY also failed its breakout above the 200-dma resistance. 
  • We are also avoiding mid-caps for the time being until relative performance improves.
  • The $320 stop-loss was violated. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $310
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets performed much better on a relative basis this past week. However, I suspect it will be short-lived as the virus resurfaces globally. 
  • EEM is very overbought short-term, look for a correction that does not violate the 200-dma to add a trading position. 
  • There is dollar risk to international markets so pay attention to it for clues as to when to leave the emerging markets trade.
  • Short-Term Positioning: Bearish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $38 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Overall, like EEM, EFA is holding up better this past week. 
  • Unlike EEM, EFA has been unable to climb above the 200-dma. 
  • As with EEM, EFA is dollar sensitive, so watch it for clues as to when to exit positions.
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss reset at $60
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

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

Gold

  • We remain long our current position in IAU. 
  • This past week Gold rallied and broke out to new highs. However, the position is extremely overbought and pushing 3-standard deviations above the 50-dma. 
  • We suggest taking some profits for now and look for a pullback to increase our sizing. We noted previously that gold would likely rise with a correction is stocks.
  • We believe downside risk is fairly limited, but as always maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss remains at $155
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • The previous correction in stocks pushed the “risk off ” trade and pushed TLT back towards overbought.
  • With TLT wrestling with the 50-dma and not grossly extended, there is more room for TLT to rally this next week. 
  • We noted that we had added to both TLT in our portfolios to hedge against our increases in equity risk. We have also swapped IEF and SHY for MBB and AGG to increase duration and yield.
  • That hedge worked well this past week. There is still more upside potential in rates if volatility continues this week.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously we stated, “While the dollar has sold off, and helped fuel a rather torrid stock and commodity rally, we are likely closer to a bottom. With the USD still oversold, there is potential for a further rally in the dollar. (This won’t play well with EEM and EFA)
  • The dollar is struggling to move higher but remains oversold. Trading positions can be added to hedge portfolios but there is not a huge move available currently given the current market dynamics. 
  • Stop-loss adjusted to $95

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

If you missed Part-1 of our series on the “Theory Of MMT Falls Flat When Faced With Reality,” start there. In Part-2, we complete our analysis of the theory and the potential ramifications. The premise of our discussion was this recent explanation of “Modern Monetary Theory” by Stephanie Kelton.

As discussed previously, economic theory always sounds much better than how it works out in reality. The reason is that in “theory,” supply and demand imbalances always revert to previous norms. However, in “reality,” humans rarely act or react, according to theory.

We left off in Part-1, discussing the similarities between the U.S. and Japan. Most importantly, while MMT suggests that debt and deficits don’t matter in theory, economic realities have been vastly different.

The Productive Debt Of WWII

Let’s pick up with Ms. Kelton’s views on this issue.

“Think about what happened after World War Two when the U.S. national debt went in excess of 100% –close to 125% of GDP. The way we talk about it today as burdening future generations, as posing a grave national security risk, we would have to scratch our heads. Did our grandparents worry about the next generation with all those bonds sold during World War Two to win the war, build the strongest middle class, and produce the longest period of peacetime prosperity? 

The Golden age of capital, all of that followed in the wake of fighting World War Two, increasing deficits massively, increasing the size of the national debt. And, of course, the next generation inherits those bonds. They don’t become burdens to the next generation; they become their assets.”

We must address several issues in Ms. Kelton’s recollection of WWII.

The first issue is the amount of deficit. If you take a look at a long-term history of our debts, deficits, and economic growth, we can immediately gain some perspective.

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

The Golden Age

As the U.S. headed into WWII, the Government ran a deficit, which in hindsight is barely visible. Most importantly, the Government did expand its debt burden by selling “War Bonds” to the public. These “War Bonds” were bought by citizens an “investment” to fund the “war effort.” These bonds were a “productive use” of debt. They funded manufacturing and construction projects with every manufacturing facility converted to “war-time” production.

Ms. Kelton conveniently forgot to mention that during this period, the 10-year average economic growth ran nearly 15% annualized. Such was not surprising with an entire population with a singular focus of the war effort. While the men signed up to fight overseas, the women left their homes to build planes, trucks, tanks, and jeeps. There was no “excess” consumption as everything from gasoline, to tires, to cheese, was rationed to the general public with everything consumed to feed, clothe, and arm the troops abroad.

Ms. Kelton is correct that our grandparents didn’t “squabble” over the debt. There was no need, as the focus of every single worker in the U.S. was “winning the war.” They also knew that when the war was over, the Government would reduce the debts and deficits as it returned to more fiscally responsible measures.

Then came the “Golden Age” as the “boys of war” returned home. Following World War II, America became the “last man standing.” After the war, the devastation of France, England, Russia, Germany, Poland, Japan, and others, left them crippled. It was here America found its strongest run of economic growth in history as the “boys of war” returned home to start rebuilding a war-ravaged Europe.

But that was just the start of it.

The Leap Into Space

In the late ’50s, America embarked upon its greatest quest in human history as humankind took its first steps into space. The space race, which lasted nearly two decades, led to leaps in innovation and technology that paved the wave for the future of America.

These advances, combined with the industrial and manufacturing backdrop, and low debt ratios, fostered high levels of economic growth, increased savings rates, and capital investment. 

Currently, the U.S. is no longer the manufacturing powerhouse it once was, globalization has sent jobs to the cheapest sources of labor. Technological advances continue to reduce the need for human labor and suppress wages by increasing productivity. Most importantly, households are highly indebted, and use that debt primarily for non-productive uses.

While Stephanie certainly makes a case of running deficits, the evidence is abundantly clear the approach is misguided. Still, the abuse of debt is economically destructive.

Where The Theory Falls Apart

The types of inflation that have been important in the U.S. have almost always come on the cost side: what we call cost-push inflation. They come about because of things like oil price shocks. You might see increases in headline inflation rates because of the housing component or healthcare. So when you think about how to fight inflation, if inflation is resulting from energy price increases, you will probably not have the Fed raise interest rates or Congress raise taxes. You got to do something else that’s going to work, so I reject the idea that MMT is about using taxes to fight inflation. That’s a mischaracterization of everything we’ve written, but people say it all the time.” – Kelton

Such is the entire problem with MMT in a nutshell. On the one hand, as noted in Part-1, under the MMT theory, you can run debts and deficits as long as “inflation” is not a problem. However, for the theory to work, you must have a measure of inflation, which is both accurate and not subject to manipulation.

Currently, we have neither.

Mind The Gap

However, where Ms. Kelton, and almost all economic theories are misguided, is there is a vast difference between “economic theories of inflation” and “actual inflation.” With economic theories continuing to weigh on the economic prosperity of the masses, their ability to absorb higher “costs” has continued to erode over the last 30-years. 

“The ‘gap’ between the ‘standard of living’ and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the ‘gap.’ However, following the ‘financial crisis,’ even the combined levels of income and debt no longer fill the gap. Currently, consumers cannot fill the record $2654 annual deficit to maintain their lifestyle without more debt.”

retail sales, #MacroView: Retail Sales Bounce, But Consumers Are Tapped Out.

MMT Is Already Here

Then, as with all economic theories, you need an “out clause” to continue to justify “socialistic spending.” In this case, Kelton completely contradicts her theory by stating that in the pursuit of your spending goal, “inflation” doesn’t matter.

The reality is that MMT is already here.

Breadlines In The Mail

During the “Great Depression,” the economically devastated masses would form “breadlines.” Today, the economic devastation is just as real, it is just that the “breadlines” are at the mailbox as the rise of “Social Assistance” skyrockets.

“The declines in real income are evident. The burgeoning ‘real’ labor pool, and demand for higher-wage work is suppressing wages. Companies further opt for increasing productivity, outsourcing, and streamlining employment boost profit margins. However, the cost of living continues to increase from rising food, energy, and health care prices. Without a compensatory increase in incomes – more families are forced to turn to assistance just to survive.”

Without government largesse, many individuals would be living on the street. The chart above shows all the government “welfare” programs and current levels to date. The black line represents the sum of the underlying sub-components. Since the onset of the “pandemic,” both unemployment insurance and “other benefits” have surged by $3 trillion along with continued rises in all other benefits, like social security, Medicaid, and Veterans’ benefits.

Importantly, for the average person, these social benefits are critical to their survival. Government assistance now makes up ~38% of real disposable personal incomes. With more than 1/3rd of incomes dependent on Federal assistance, it should not be surprising the economy continues to struggle. Recycled tax dollars used for consumptive purposes, has virtually no impact on increasing economic activity.

Time To Wake Up

MMT is not a free lunch. Individuals pay for it through a reduced value of the dollar and ergo your purchasing power. MMT is a hidden tax paid for by everyone holding dollars. As Michael Lebowitz outlined in Two Percent for the One Percent, inflation tends to harm the poor and middle class while benefiting the wealthy.

The inflation problem is masked by the inability to calculate inflation in one meaningful number accurately. Even if you believe everything about MMT, how can you practice it without an accurate reading on its most crucial gauge, inflation?

For the last 30 years, each Administration and the Federal Reserve have continued to operate under Keynesian monetary and fiscal policies believing the model worked. However, the reality has been most of the aggregate growth in the economy has been financed by deficit spending, credit expansion, and a reduction in savings. In turn, the reduction of productive investment into the economy has led to slowing output. As the economy slowed and wages fell, it forced the consumer to take on more leverage, which also decreased savings. As a result of the increased leverage, it diverted more of their income into servicing the debt.

Without debt, there has been no actual organic growth since the 1970’s.

, Economic Theories & Debt Driven Realities

Secondly, most of the government spending programs redistribute income from workers to the unemployed. Such, as Keynesians argue, increases the welfare of the many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment.

MMT Sounds Great In Theory

In its essential framework, MMT correctly suggests debts and deficits don’t matter as long as the money borrowed is spent for productive purposes. Such means that the investments made create a return higher than the carrying cost of the debt used to finance the projects.

Again, this is where MMT supporters go astray. Free healthcare, education, childcare, living wages, etc., are NOT productive investments that have a return higher than the carrying cost of the debt. In actuality, history suggests these welfare supports have a negative multiplier effect in the economy.

Most telling is the inability of the current economists, who maintain our monetary and fiscal policies, to realize the problem of trying to “cure a debt problem with more debt.”

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 30 years.

Conclusion

MMT supporters believe that if the Government hands out money, it will create more robust economic growth. No evidence supports such is the case.

We fear that MMT, which promises “free everything” with no consequences, instead delivers inflation, generates further income inequality, and ultimately higher social instability and populism. Such was the result in every other country which has run such programs of unbridled debts and deficits.

While MMT sounds excellent at the conversational level, so does “communism” and “socialism.” In practice, the outcomes have been vastly different than the theory.

As Dr. Brock suggests:

“It is truly ‘American Gridlock’ as the real crisis lies between the choices of ‘austerity’ and continued government ‘largesse.’ One choice leads to long-term economic prosperity for all; the other doesn’t.”

The Bullish Test Comes As Earnings Season Begins


In this issue of, “The Bullish Test Comes As Earnings Season Begins:”

  • A Breakout Of Consolidation
  • Updated Estimates As Earnings Begin
  • A Quick Note On The Jobs Report
  • Portfolio Positioning
  • MacroView: The Fed Has Inflated Another Asset Bubble
  • Sector & Market Analysis
  • 401k Plan Manager

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


Upcoming Event  – CANDID COFFEE

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

July 25th from 8-9 am

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


Catch Up On What You Missed Last Week


Note:

I am on vacation this week for a quick break. However, I did want to post a short market and portfolio positioning update.

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

A Breakout Of Consolidation

Over the last few week’s we have noted the continuing consolidation of the market since the June peak.  When markets are overbought short-term, that condition is resolved through a correction or consolidation process. Such is what occurred during the last part of June and completed last week.

As shown below, the market broke out of that consolidation and triggered a “buy signals” across multiple measures. This breakout will give the “bulls” an advantage in the short-term with a retest of the June highs becoming highly probable.

The bulls will also gain some additional support from the “Golden Cross” (when the 50-dma crosses above the 200-dma). That “bullish signal” will likely occur over the next week or two depending on market action.

The “bullish supports” for the market are currently in play. Such keeps our portfolio allocations weighted towards equity risk. However, there are many fundamental and economic headwinds that could quickly derail the bullish thesis.

Seasonality In Play

In the short-term, the bulls remain in charge currently, and as such, we must be mindful of those trends. Also, the month of July tends to be one of the better performing months of the year.

As noted last week:

“With the sell-off on Friday, the short-term oversold condition, a reflexive rally next week would not be surprising.”

That rally reversed much of the short-term oversold condition. While the bulls are in control of the market currently, the upside is somewhat limited. However, the downside risks are reduced with the improvement in the technical underpinnings. Such puts the risk/reward dynamics to a more equally balanced, than opportunistic, positioning. As such, risk controls and hedges should remain for now.

  • -1.4% to breakout level vs. +2.4% previous rally peak. (Neutral)
  • -5% to 50/200 dma support vs. +4.9% to January peak (Neutral)
  • -7% to previous consolidation peak vs. +6.5% to all-time highs. (Neutral)
  • -13.4% to previous consolidation lows vs. +6.5% to all-time highs. (Negative)

Earnings Estimates Update

Over the next two weeks, we will enter the earnings season for all publicly traded corporations. Of course, we will mostly hear about those companies which comprise the S&P 500 index. I am writing a more comprehensive report on the earnings estimates for Tuesday’s “Technically Speaking.” Still, I did want to make a quick comment about what is coming.

As with every quarter, we are about to play “Millennial Soccer.” Such is where Wall Street analysts continually lower earnings estimates for the quarter until companies can beat them. When you see the analysis that 70% of companies beat their estimates, just remember analysts lowered the bar to a point where “everybody gets a trophy.” 

What will be important to pay attention to is “revenue,” which happens at the top of the income statement. Companies can do a lot to fudge bottom-line earnings by using accruals, “cookie jar” reserves, share buybacks, and a variety of other accounting gimmicks. It is much more difficult to manipulate revenue.

However, the market will focus on reported earnings. As stated, the estimates have fallen sharply over recent weeks, and are far lower than where they were set previously.

Importantly, while Wall Street has dramatically lowered estimates for the coming quarter, expectations remain for a rapid recovery in the economy. Given the rise in COVID-19 cases as of late, states pausing reopening, and depressionary levels of unemployment, it is highly likely those future estimates will ratchet sharply lower.

Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today even riskier.

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

A Quick Note On The Jobs Report

While the BLS reported a massive 4.8 million in employment for June and a drop in the unemployment rate to 11.1%, these numbers remain distorted by bad data gathering and analysis.

As Mish Shedlock noted on Thursday:

“I question both the strength of the rise in jobs and the decline in the unemployment rate based on claims data and the reference week.”

I agree.

It’s hard to reconcile a 4.8 million increase in jobs in a month where you added over 4-million to initial jobless claims and continuing claims continued to remain near the highest levels on record.

All Continued Claims in 2020 July 1

More importantly, as noted by Zerohedge, there is a problem in the data when you have more people getting unemployment benefits than there are unemployed workers.

“As the DOL reported todaythere were 19.29 million workers receiving unemployment insurance. And yet, somehow, at the same time, the BLS also represented that the total number of unemployed workers is, drumroll, 17.75 million.

If you said this makes no sense, and pointed out that the unemployment insurance number has to be smaller than the total unemployed number, you are right. And indeed, for 50 years of data, that was precisely the case.”

The main point here is that employment is what drives earnings, corporate profits, and GDP. Given the exceedingly high level of unemployment, in real terms, the recovery to earnings will much slower than expected.

Such suggests that expectations for the bull market to continue “to infinity and beyond,” will likely prove disappointing.

Portfolio Positioning Update

Let me restate our position from last week:

“With our portfolios almost entirely allocated towards equity risk in the short-term, we remain incredibly uncomfortable.”

Such remains the case this week.

As noted last week, with the market having gotten very oversold short-term, the reflexive rally off of support came as expected and achieved our first rally target.

Given that we are not yet to more extreme short-term overbought conditions and expectations of future earnings, the market can still retest the June highs. 

As noted last week, we used the counter-trend bounce to rebalance exposures. We took profits in CLX and UPS and rebalanced our “core positions” by reducing DIA and adding SPY. Our focus remains on capital preservation for the next couple of months, so our hedges in fixed income remain.

With the virus resurfacing, the potential risk of disappointment to the earnings and economic recovery story has risen. Our job remains the same, protect our client’s capital, reduce risk, and try to come out on the other side in one piece.

While we are certainly more bullish on markets currently, as momentum is still in play, it doesn’t mean we aren’t keenly aware of the risk.

Pay attention to what you own, and how much risk you are taking to generate returns. Going forward, this market will likely have a nasty habit of biting you when you least expect it.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

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

Sector-by-Sector

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

Last week, Financials moved into the improving quadrant of the rotation model, but will likely be short-lived. However, performance in the sector is weak. Energy and Industrial performance overall remains inadequate with a failure at the 200-dma. Energy is oversold and cheap on a value basis; we hold our exposures for now.

Current Positions: XLE

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

Discretionary, which had gotten very extended, corrected, and rallied this past week again. The sector is back to very overbought so that upside may be limited. After suggesting profit-taking previously, Communications has corrected a bit, reducing the overbought condition. Communications may provide an opportunity to add to the position. Technology remains short-term overbought. The opportunity may be to reduce Technology and add to Communications and Discretionary.

Current Positions: XLC, XLK, XLC

Weakening – Healthcare (XLV)

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

Current Position: XLV

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

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

Current Position: XLRE, XLU, & XLP

Market By Market

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

Current Position: None

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

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

Current Position: None

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

Current Position: None

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

Current Position: IAU, UUP

Bonds (TLT) –

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

Current Positions: TLT, MBB, & AGG

Sector / Market Recommendations

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

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

Portfolio / Client Update

As noted last week, we used this week’s rally to rebalance portfolios a bit. Over the next couple of weeks, we will enter into earnings season where volatility will likely pick up a good bit.

We currently remained focused on protecting capital first, but we also want to mindful of performance. While our performance did drag in the during the last quarter, that drag came from the conscious choice of maintaining our fundamental discipline and not chasing bankrupt and fundamentally unsound companies. In the short-term, we did sacrifice some performance. Still, we believe that you will appreciate our attention to our discipline in the long-term and focus on fundamentals.

Changes

Last week we trimmed gains in both CLX and UPS. We were also overweight energy in the ETF Portfolio, so we sold XLE but are maintaining our holdings of XOM and CVX in both portfolios.

With States now starting to reverse reopening procedures, there is a risk to corporate outlooks as we enter earnings season. Also, with Congress not returning from break until the 20th of July, there is a chance of not getting an extension to unemployment benefits passed promptly. Such could cause a pick up in volatility in the short-term.

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

#WhatYouMissed On RIA This Week: 07-03-20

What You Missed On RIA This Week.

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

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

Webinar: Candid Coffee

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

Got a question you want us to answer? CLICK HERE

Join Us: Saturday, July 25th from 8-9 am.

The Week In Blogs

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

________________________________________________________________________________

Our Latest Newsletter

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

________________________________________________________________________________

What You Missed: RIA Pro On Investing

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

________________________________________________________________________________

The Best Of “The Real Investment Show”

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

I was on vacation last week – The Real Investment Show returns on MONDAY

________________________________________________________________________________

What You Missed: Video Of The Week

Interview With Jim Mosquera

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

________________________________________________________________________________

What You Missed: Our Best Tweets

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

See you next week!

Relative Value Report 7/02/2020

Relative Value Report 7/2/2020

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

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

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

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

Commentary

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

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

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

TPA Analytics: Introducing The TPA Marketscope

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

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

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

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

 

INTRODUCING THE TPA MARKETSCOPE

 

TPA MARKETSCOPE EXPLAINED

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

TPA MARKETSCOPE

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

Indicators explained:

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

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

 

CLICK ON LINKS BELOW FOR TECHNICAL INDICATOR EXPLANATIONS:

ASCENDING – DESCENDING TRIANGLE

BASING-TOPPING-CONSOLIDATION

BREAKOUT (Breakdown)

CHANNEL & RANGE

DIRECTIONAL MOVEMENT INDEX (DMI)

DOUBLE BOTTOM or DOUBLE TOP

MACD-MOVING AVERAGE CONVERGENCE-DIVERGENCE

MOVING AVERAGES

RELATIVE STRENGTH & PEER STOCK PERFORMANCE

REPEATING PATTERNS

RSI-RELATIVE_STRENGTH

SUPPORT, RESISTANCE, BREAKOUT, BREAKDOWN

TREND

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

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

 

Turning Point Analytics Disclaimer

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

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

S&P 500 Monthly Valuation & Analysis Review


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

Cartography Corner – July 2020

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

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

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

GTA Users Guide


June 2020 Review

E-Mini S&P 500 Futures

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Figure 1:

Natural Gas Futures

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

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

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

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

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

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

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

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

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

Figure 2:


July 2020 Analysis

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

Trends:

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

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

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

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

Support/Resistance:

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

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

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

Silver Futures

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

Trends:

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

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

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

Support/Resistance:

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

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

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

Summary

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


The Decade Long Path Ahead To Recovery- Part 1 Debt

The Decade Long Path Ahead To Recovery – Part 1 Debt

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

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

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

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

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

Yardeni et al.

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

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

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

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

Planning Ahead

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

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

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

The real catalysts include the following:

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

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

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

Past Experience

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

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

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

A New Trajectory for U.S. Growth

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

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

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

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

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

The Culprit

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

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

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

The New Order

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

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

  1. Growth in the labor force
  2. Productivity gains

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

A Fine Mess

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

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

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

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

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

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

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

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

Evidence

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

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

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

Summary

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

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

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

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

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

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

10 Dividend Stocks We Like Now

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

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

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

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

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

The Screen

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

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

The criteria for our Dividend screen are:

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

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

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

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

The Results

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

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

The Need

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

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

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

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

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

Conclusion

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


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

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

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

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

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

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

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

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

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

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

Unemotionalism

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

How do you avoid getting trapped by the devil?

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

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

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

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

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

Greed & Fear

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

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

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

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

Do I make mistakes? Absolutely.

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

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

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

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

The 15-Rules

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

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

The Bull Trend Still Lives

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

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

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

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

Conclusion

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

How long it can last is anyone’s guess. However, importantly, it should be remembered that all good things do come to an end. Sometimes, those endings can be very disastrous to long-term investing objectives. This is why focusing on “risk controls” in the short-term, and avoiding subsequent major draw-downs, will allow the long-term returns to take care of themselves.

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

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

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

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

I hope you find something useful in it.

Sector Buy/Sell Review: 06-30-20

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

HOW TO READ THE SECTOR BUY/SELL REVIEW CHARTS

There are three primary components to each chart:

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

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

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

Basic Materials

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

Communications

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

Energy

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

Financials

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

Industrials

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

Technology

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

Staples

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

Real Estate

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

Utilities

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

Health Care

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

Discretionary

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

Transportation

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

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

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

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

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

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

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

Market Buy/Sell 06-22-20

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

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

S&P 500 Index

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

Dow Jones Industrial Average

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

Nasdaq Composite

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

S&P 600 Index (Small-Cap)

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

S&P 400 Index (Mid-Cap)

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

Emerging Markets

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

International Markets

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

West Texas Intermediate Crude (Oil)

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

Gold

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

Bonds (Inverse Of Interest Rates)

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

U.S. Dollar

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

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

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

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

The Government Isn’t A Household

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

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

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

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

American Gridlock

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

“The word ‘deficit’ has no real meaning. 

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

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

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

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

MMT’s Root Problem

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

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

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

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

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

Measuring With The Wrong Yardstick

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

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

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

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

How Should MMT Measure Inflation?

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

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

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

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

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

It currently isn’t.

Deficits Are Others Surpluses

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

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

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

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

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

Economy Can’t Grow Faster Than Debt

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

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

However, merely looking at Federal debt levels is misleading.

It is the total debt that weighs on the economy.

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

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

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

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

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

Such is why MMT will ultimately fails. 

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

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

Productivity Loss

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

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

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

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

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

, MMT Sounds Great In Theory&#8230;But

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

, MMT Sounds Great In Theory&#8230;But

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

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

Let’s Be Like Japan

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

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

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

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

There Is More To The Story

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

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

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

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

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

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

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

Japan Is A Template

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

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

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

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

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

Such is a key point.

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

At some point, you simply have to stop digging.

Market Corrects As COVID Cases Surge


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

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

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


Upcoming Event  – CANDID COFFEE

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

July 25th from 8-9 am

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


Catch Up On What You Missed Last Week


Note:

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

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

Market Corrects As COVID Cases Surge

Three overriding catalysts were driving the correction this past week:

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

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

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

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

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

The Market Is Well Ahead Of Fundamentals

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

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

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

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

6-Downside Risks

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

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

Six Downside Risks 

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

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

COVID Makes A Second Appearance

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

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

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

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

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

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

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

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

Timing Couldn’t Be Worse

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

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

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

End Of The Quarter Rebalancing

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

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

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

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

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

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

Portfolio Positioning Update

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

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

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

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

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

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

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

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

Sometimes, however, it just gets messy.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

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


Sector & Market Analysis:

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

Sector-by-Sector

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

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

Current Positions: XLE

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

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

Current Positions: XLC, XLK, XLC

Weakening – Healthcare (XLV)

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

Current Position: XLV

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

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

Current Position: XLRE, XLU, & XLP

Market By Market

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

Current Position: None

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

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

Current Position: None

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

Current Position: None

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

Current Position: IAU, UUP

Bonds (TLT) –

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

Current Positions: TLT, MBB, & AGG

Sector / Market Recommendations

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

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

Portfolio / Client Update

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

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

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

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

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

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

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

Sometimes, however, it just gets messy.

Changes

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

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

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

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

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

#MacroView: The Fed Has Inflated Another Asset Bubble

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

Another Bubble

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

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

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

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

Don’t Blame The Pandemic

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

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

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

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

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

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

Reliance On Debt To Solve A Debt Problem

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

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

The Problem Of Debt

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

Such is a point made previously:

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

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

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

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

Bubbles, Bubbles, Bubbles

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

As previously stated:

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

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

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

“Stocks have reached a permanently high plateau.”

Instability

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

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

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

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

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

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

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

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

Bubbles Aren’t About Price

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

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

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

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

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

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

It’s Elementary

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

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

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

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

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

That is what started in March.

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

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

The 4th-Bubble

Our previous prediction:

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

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

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

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

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

Problems QE Can’t Fix

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

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

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

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

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

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

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