Monthly Archives: October 2020

Empire State Survey Warns of Economic Contraction

The May New York Fed Empire State Manufacturing Survey fell sharply into economic contraction levels at -11.6. Last month the Empire index stood at +24.6. Leading the Empire index lower are New Orders, Unfilled Orders, Inventories, and Shipments. All four sub-indexes point to a normalization of supply lines and reduction of shortages. These readings should bode well for inflation in the coming months. The prices paid and received indexes fell but remained grossly elevated from historical norms. Employment increased despite a broad weakening of activity, and the average workweek held steady.

While the survey is regional and covers a relatively small area, these surveys have a high correlation to national economic activity. Further, they are as close to real-time data as is available. This Empire survey occurred between May 2 and May 9.

empire index

What To Watch Today

Economy

  • 8:30 a.m. ET: Retail Sales Advance, month-over-month, April (1.0% expected, 0.5% during prior month, upwardly revised to 0.7%)
  • 8:30 a.m. ET: Retail Sales excluding autos, month-over-month, April (0.4% expected, 1.1% during prior month, upwardly revised 1.4%)
  • 8:30 a.m. ET: Retail Sales excluding autos and gas, month-over-month, April (0.7% expected, 0.2% during prior month, upwardly revised to 0.7%)
  • 8:30 a.m. ET: Retail Sales Control Group, April (0.8% expected, -0.1% during prior month, upwardly revised to 0.7%)
  • 9:15 a.m. ET: Industrial Production, month-over-month, April (0.5% expected, 0.9% during prior month)
  • 9:15 a.m. ET: Capacity Utilization, April (78.6% expected, 78.3% during prior month)
  • 9:15 a.m. ET: Manufacturing (SIC) Production, April (0.4% expected, 0.9% during prior month)
  • 10:00 a.m. ET: Business Inventories, March (1.9% expected, 1.5% during prior month)
  • 10:00 a.m. ET: NAHB Housing Market Index, May (75 expected, 77 during prior month)

Earnings

Pre-market

  • Walmart (WMT) to report adjusted earnings of $1.48 on revenue of $139.09 billion
  • Home Depot (HD) to report adjusted earnings of $3.71 on revenue of $36.83 billion
  • JD.com (JD) to report adjusted earnings of 1.35 yuan on revenue of 236.73 billion yuan
  • Vodafone (VOD) to report adjusted earnings of €1.01 on revenue of €45.39 billion
  • Trip.com (TCOM) to report adjusted earnings of $0.26 on revenue of $390 million

‌Post-market

  • No notable reports are scheduled for release

Market Trading Update – Timid Buying Keeps Rally Alive

While the Empire Index came in weak, there was still some buying action coming into the market yesterday to build on Friday’s rally. If the market can rally enough to begin to squeeze investors who are short the market, we could see this rally follow through. If not, we will likely retest lows.

For now, the market remains well oversold, and as discussed this morning a rally to the 20-dma seems the most obvious. Any rally to previous resistance should be used as an opportunity to increase cash, reduce risk, and rebalance allocations accordingly.

Market Trading Update 051722

Everybody Is Bearish – Near Record Options Betting AGAINST A Rally

“Small traders are getting awfully nervous. And now they’re willing to pay up for the right to protect against a crash.

For only the 7th time in 22 years, last week, the smallest options traders spent 30% or more of their volume buying put options to open. Between that spike in put buying and an increase in implied volatility, the premiums that small traders paid for protection were more than 10% higher than the premiums they paid for call options.

It’s extremely rare for retail traders to pay more in premiums for put protection than for speculating on rallies. The data shows that the S&P 500 rallied over the next year after every time they did so, averaging a healthy return of 21%. The only precedents are all-out market crashes, so there was a lot of volatility in the short term.” – Sentiment Trader

Sentiment Trader Call Option Premiums

Did the Equity Market Finally Capitulate

Traders and investors often witness a “capitulation” trade at significant bottoms. Capitulation events are sharp declines fueled by panic. Capitulation can be defined using many quantitative and sentiment gauges. Below, we present a popular technical capitulation indicator. The put-call ratio measures the volume of put options versus call options. The dots represent the ratio for each day, and the blue line smooths them into a five-day moving average. Prior capitulation events, as circled, occurred when the moving average approached 1.00. As shown, the ratio is not quite there yet, which doubts whether a sizable bounce has started.

It’s worth considering the 2008/09 experiences. It shows numerous times the ratio neared 1.00 before the market put the final low in place. Bear markets tend to have strong countertrend rallies and periods of sharp declines. If this is a bear market, this indicator can help us assess if a sharp decline is finished and a reflexive bounce is in store.

put call ratio market bottom capitulate

There Is Still Risk In Tech Stocks

While there are plenty of indications suggesting a short-term rally, there is still risk in Technology stocks as noted this weekend by Chartr. To wit:

“We’ve combed through 50 years of daily data on the NASDAQ Composite Index, a tech-heavy index comprised of more than 2,500 companies, to get some perspective on how bad this crash has been… and how bad it could get.

So far the NASDAQ is down 29% from its previous peak. That puts it in bear market territory, but it isn’t even close to the 75-80% drop that was seen during the bursting of the dotcom bubble in 2000 or the depths of the Global Financial Crisis of 2008/09. Things could get a lot worse before they get better as inflation, slowing growth and geopolitical uncertainty take their toll or this could turn out to be one of the many 20-30% drops that markets have lived through over the last 50 years, without turning into a complete capitulation.”

How bad can it get for tech stocks.

No Worries in Corporate Bond Markets

The yield spreads between junk and investment-grade corporate bonds and Treasury bonds remain at relatively low levels. Such tells us that there is not much financial stress in the system. Simply, companies are not having much trouble accessing the capital markets. The graph below compares yield spreads of Junk B-rated corporate bonds to Investment Grade BBB-rated bonds. The orange dots are the 2022 comparisons.

The first takeaway is that yield spreads remain extremely low based on data covering the last 25+ years. Second, given recession odds are increasing, as in the Empire index, we should expect higher spreads and junk spreads to feel the pressure more than investment grade. Most of the orange dots are below the trend line signifying little stress within the corporate bond market.

corporate bond spreads

China’s Economy is Slumping Rapidly

The series of charts below from Pictet Asset Management shows a rapid decline in China’s economic activity. Some of the weaknesses are attributable to a good percentage of the country re-entering Covid lockdown protocols over the last two months. China has a zero Covid policy, and lockdowns are tough on the economy. From an American perspective, the slumping activity is crimping China’s exports which introduces an inflationary bias. Further, China is the second-largest economy in the world. Accordingly, their weakness will negatively affect the U.S. and the global economy.

china industrial production
china retail and care sales
floor space

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

The Disinflationary Impact Of Fed Policy On Equities

The disinflationary impact of Fed policy on equities is coming. There is currently much debate in the mainstream media suggesting investors should ignore Fed rate hikes. To wit:

History suggests U.S. stocks are poised to experience more volatility following the rise in rates. But that doesn’t mean the bull run is over. In fact, in the previous eight hiking cycles the S&P 500 was higher a year after the first increase every single time, according to LPL Financial.” – Bloomberg

Fed rate hikes and equity market performance.

Such is a pretty compelling argument on the surface to stay the course with portfolios. However, as is always the case, every market cycle is different. Let’s look at a chart of Fed rate hiking cycles from 1980 to the present.

Equity market vs fed funds vs 2-year treasury rate and crisis

Historically, Fed rate hikes have consistently led to poor outcomes for investors. However, since the Fed policy takes about 9-months to impact the economy, LPL’s chart doesn’t show you “what happened next.”

Furthermore, out of the last 8-rate hike cycle, 80% of them occurred during the secular bull market cycle that started in 1980. During that 20-year cycle, the deregulation of the financial industry led to a massive debt-driven consumption boom, combined with consistently falling inflation and interest rates.

Even with those tailwinds, the Fed managed to create crisis after crisis by hiking rates.

QE Is Disinflationary For Stocks

Here is another problem for the “don’t fear Fed rate hikes” thesis.

For the last decade, the primary bullish thesis for chasing equity markets remains “Don’t fight the Fed.” While the “bulls” are adamant that you shouldn’t “fight the Fed” when monetary policy is loose, as evidenced by LPL, they say the same when it reverses. 

However, logic would dictate that outcomes can not be different UNLESS the changes to monetary policy have NO impact on equity pricing. That was a point previously made by Minneapolis Fed President Neel Kashkari once stated that the Fed’s QE program does not affect the financial markets.

“QE conspiracists can say this is all about balance sheet growth. Someone explain how swapping one short-term risk-free instrument (reserves) for another short-term risk-free instrument (t-bills) leads to equity repricing. I don’t see it.”

While he may be “technically correct,” as noted, there is ample evidence of a direct impact on financial markets. As discussed in “Past Performance Is A Guarantee:”

Given the high correlation between the financial markets and the Federal Reserve interventions, there is credence to Minsky’s theory. With an R-Square of nearly 85%, the Fed is impacting financial markets.

Cumulative growth of Fed balance sheet vs equity market.

The inflation of assets was not isolated in the U.S. but globally.

“If you run a simple regression since June 2009, the starting point of the biggest monetary experiment ever, you will find that the G4 Central Banks balance sheet explains 90%(!) of the MSCI AC World Index level.”@TheMarketEar

global central bank balance sheets vs global equity markets.

Given the high correlation to asset prices, logic suggests any contraction of the Fed’s balance sheet is disinflationary.

Fed balance sheet tapering schedule

That contraction is coming, and if correlations hold, the disinflationary impact on equity assets should logically follow.

Selling Rallies

As noted, monetary policy has a lag effect of about 9-months before it becomes evident in the markets and economy. As shown, with market sentiment so extremely negative, a market rally is certainly possible.

AAII INVI Investor sentiment composite
NAAIM equity bulls

However, as my colleague Albert Edwards recently noted:

“Surely all of us working in finance realize by now that something is likely to snap in the financial system and probably quite soon. The rapidity of current market moves and the polarisation of the now extreme Fed (hawkish) and BoJ (dovish) policies almost guarantees that outcome.

Notably, while discussing the disinflationary impact on equities (lower returns), such does not necessarily mean a “bear market.” There is certainly a possibility the U.S. could avoid a major bear market as long as global inflows continue at the current unprecedented pace.

Global equity inflows

Unfortunately, history suggests that such an optimistic outcome is rarely the case, given higher rates, less monetary accommodation, and slower economic growth.

QT Now, QE Later

While many believe the Fed will hike rates in their quest to battle inflation, that fight will end quickly when “financial instability” arises. As Former Dallas Fed President Richard Fisher noted:

“Let’s face it, Joe…the market has worn beer goggles for the longest possible time. They just believe the Fed’s going to bail them out.

I think the strike price on the Fed put has moved significantly [lower]. Unless we have a dramatic turn in the markets, it can infect the real economy.

How would such a dramatic turn occur?

  • At 20%, margin calls will begin to rise, putting pressure on asset and high-yield credit markets. (Such may have already started as witnessed by recent actions.)
  • Yield curves will fully invert as the market declines by 25% and economic growth crashes.
  • At 30%, corporations will lay off workers and move to protect profitability.

I suspect, as noted above that somewhere between a 20-30% decline, we will see the Fed return its focus to “market stability.”

Selling rallies certainly seems to be the prudent course of action at this stage of the equity cycle.

Portfolio Trade Alert – May 16, 2022

Trade Alert For Equity & ETF Model

This morning we added 0.5% to our position in Costco (COST) after its recent decline to oversold conditions. With a Price/Sales ratio of 1, and a steady cash flow stream from membership fees, we like this company long-term and continue to accumulate it on declines.

We also added 1% to our SPDR Healthcare ETF (XLV) increasing that position from 8-9% due to the demographic trends in the U.S. that will continue to support profitability in that sector.

Equity Model

  • Add 0.5% of the portfolio to Costco (COST)

ETF Model

  • Add 1% to XLV increasing the portfolio weight from 8% to 9%.

Viking Analytics: Weekly Gamma Band Update 5/16/2022

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

 

The S&P 500 (SPX) fell all week until the final hour of trading on Thursday, then saw a meaningful recovery rally over the next day.  Our gamma-band model enters the week with a 0% allocation to the SPX and will remain flat as long as the SPX remains below the lower gamma level, which is currently near 4,100.  With monthly options expiration on Friday, we expect to see high volatility during the week.

The Gamma Band model[1] can be viewed as a trend following model that is shows the effectiveness of tracking various “gamma” levels. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level,” the model will reduce the SPX allocation to zero.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

Risk management tools like this have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report). 

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. Rob has deep experience with market data, software and model building in financial markets.  Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.

 


TPA-RRG Report – Relative Rotation Graph scores and rankings

Relative Rotation Graph for Top 20 and Bottom 20 is provided below.

Also, use the following link that shows RRG over time – how stocks move in and out of favor over time: https://vimeo.com/manage/videos/710138044

Sectors:

Social Media and Communication has made a real positive move in the past few weeks. This is a nod to risk coming back into the market and how oversold certain sectors had become. If this relative performance continues, watch for other beaten up areas like TECH and SEMIs to follow.

Top 20 & Bottom 20:

Although the Top 20 still contains a healthy does of Materials and defensive (Utilities and Staples) stocks, Social Media and Retail have crept into the mix.

The Bottom 20 is still predominated with Financial stocks. Russia will continue to weigh on the sector.

Relative Rotation Graph for 27 major sector & subsector ETFs provided below.

Also, use the following link that shows RRG over time – how sectors & subsectors move in and out of favor over time: https://vimeo.com/manage/videos/710132687

TPA-RRG SCORES FOR THE ENTIRE RUSSELL 1000

Click HERE for the entire Russell 1000 TPA-RRG Score and Rank Report.

This Week’s Top 10 and Bottom 10

Strong Finish to a Volatile Week for Stocks

The S&P 500 capped off last week on a positive note with a rally to close above 4000. The index managed to hold on to its gains Friday after failing to do so several times during the volatile week. Friday could be the beginning of a short-term relief rally considering the poor investor sentiment and deeply oversold conditions.

If so, the index may face resistance near 4150, providing a decent opportunity to sell into the rally and reduce risk. Given the low levels of liquidity lately, we could be in store for another volatile week.

Intraday SPY Chart

What To Watch Today

Economy

  • 8:30 a.m. ET: Empire Manufacturing, May (15.0 expected, 24.6 during prior month)
  • 4:00 p.m. ET: Net Long-Term TIC Outflows, March ($141.7 billion during prior month)
  • 4:00 p.m. ET: Total Net TIC Outflows, March (162.6 billion during prior month)

Earnings

Before Market Open:

  • • Warby Parker (WRBY) to report adjusted earnings of $0.00 on revenue of $154.5 million
  • Weber (WEBR) to report adjusted earnings of $0.19 on revenue of $660.25 million

After Market Close

  • Take-Two Interactive (TTWO) to report adjusted earnings of $1.04 on revenue of $870.05 million

Market Trading Update

Are we near the bottom? That is the question we will explore this week. However, the market is as oversold, deviated, and negatively biased from a technical viewpoint since both the 2018 and 2020 lows.

Market update weekly chart

With the market pushing 3-standard deviations below the 1-year moving average, and all technical indicators testing weekly lows, such is historically consistent with reflexive rallies. While such was what we said last week, the selling pressure continued this week as investors panicked over the latest inflation print.

With inflation, earnings, and the Fed behind us temporarily, maybe the “lack of news” will be enough to allow for the bulls to reenter the market.

Technically Speaking

Our composite technical gauge which is a weekly measure of Williams %R, Stochastics, RSI, and several other measures combined has now reached its lowest level since March 2020. While technical measures can stay extremely oversold for quite some time, it is rare for all technical measures to be at these levels. Historical, such extremes don’t last long.

Technical gauge

If you are a SimpleVisor.com subscriber (try FREE for 30-days) you can find a live version of all of our sentiment gauges here.

Earnings Season in the Rearview

Earnings season is almost behind us, with 91% of companies in the S&P 500 having reported results. The table below, via Refinitiv, shows that 78% of reported companies beat earnings estimates. Consumer discretionary had the worst beat rate (56%) while industrials had the highest beat rate (90%). As measured by the return from 1 day before to 1 day after reporting, on average, companies were punished for missing earnings estimates but were not rewarded for beating them.

Earnings season

Is a Freight Recession Looming?

The Cass Transportation Index Report for April points to a possible weakening in the freight cycle going forward. We have included a few of the key points below:

  • “While truckload rates have had an extraordinary cycle, the key leading indicators have fallen sharply over the past few months, which we expect to limit further upside in the Cass Truckload Linehaul Index and change its trajectory over the course of the year.”
  • “Normal contract timing would suggest there’s room for this index to continue to rise for a little longer after the peak in spot rates, but the clock is ticking.”
  • “The combination of inflation, Fed monetary tightening, war in Europe, and substitution back to services from goods are all leading to a downshift in the freight cycle. And consistent with the fundamental reason for cyclicality in the freight sector, the capacity response is occurring just as the surge in demand is ebbing.”

The last bullet refers to the chart below. Shipping capacity tends to lag freight rates as new entrants come when times are good and exit when rates fade. If we enter a freight recession, freight rates will decrease until either enough capacity leaves the market or freight demand picks up meaningfully enough. On the bright side, deflation in freight rates would ease inflationary pressures on consumers and shippers alike.

Freight Supply-Demand

The Week Ahead

Investors face another light week of economic data this week with several appearances by Fed speakers. Retail sales data for April will be released tomorrow. Expectations are for an increase of 0.8% MoM after gaining 0.5% MoM in March. The industrial production index will also be released tomorrow. On Wednesday, we will be watching April’s housing starts and permits data for indications of whether homebuilders are shifting course amid rising mortgage rates and record prices. Existing home sales for April will be released on Thursday. Expectations are for another decrease from 5.77M in March to 5.62M in April as rising mortgage rates crimp demand. We may face another volatile period in the markets this week unless we see an improvement in liquidity.

Factor Performance Update

Through Thursday’s close the S&P 500 has given up 17% YTD as investors sort out rising rates, inflation, and geopolitical uncertainty. The table below shows how relative factor performance trends have evolved over the last 245 trading days. Value-oriented factors are still outperforming YTD, with high dividend yield in the lead. The low volatility factor is picking up steam as volatile trading increases, however. It has gained 8.4% on SPY since March 10th versus 5.5% for high dividend yield. Aside from the ARKK “disruptive tech” basket, the areas underperforming most YTD are small-cap growth, semiconductors, and mega-cap growth.

Factor Performance

Consumer Sentiment Reaches its Lowest Point Since 2011

The University of Michigan Consumer Sentiment Index reached its lowest point since 2011 in the preliminary results for May. The reading of 59.1 came in well below estimates of 63.7 and last month’s 65.2. It’s no secret that skyrocketing food and energy prices are negatively impacting the consumer. The correction in asset prices YTD has further worked to reduce the “wealth effect” felt by consumers, which also is likely dragging on sentiment. We are creeping on levels of sentiment that existed during the GFC. Notably, the message from this survey is quite contradictory to the Fed’s messaging on the strength of the economy.

Consumer sentiment

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Selected Portfolio Position Review – May 16, 2022

The selected portfolio position review is something we will produce regularly on alternating weeks along with a sector review and major market review. Each report will contain a chartbook of either major financial markets, market sectors, or individual equities to review the underlying technical conditions for potential opportunities and risk management. This helps refine not only decision making about what to own and when, but what to overweight or underweight to achieve better performance.

HOW TO READ THE CHARTS

There are five primary components to each chart if you want to recreate them yourself in the CHARTING application under the RESEARCH tab.

  • The candlestick price chart is bounded by two Bollinger Band studies set at a 50-dma with 2- and 3-standard deviations. The 200-dma is also shown for support and resistance levels.
  • Below the price chart is a Williams %R indicator set at 14 periods.
  • The Stochastic indicator at the bottom is set at 14 %K periods, 3 %K smoothing, and 3 %D periods.

When the indicators are at the TOP of their respective charts, there is typically more risk and less reward available. In other words, the best time to BUY is when the majority of the indicators are at the BOTTOM of their respective channels.

With this basic tutorial let’s get to the portfolio position review analysis.

Abbott Laboratories (ABT)

ABT Abbott Labs
  • ABT has come under a lot of price pressure as of late over baby formula disruptions. The company should have production back up by the end of July.
  • Currently, ABT is on a very deep sell signal (bottom panels)
  • ABT recently traded well into 3-standard deviation territory giving us a reasonable entry point.
  • Short-Term Positioning: Added to the portfolio.
    • Buy with a target of $118
    • Stop-loss is currently $105
  • Long-Term Positioning: Neutral

AbbVie (ABBV)

Abbvie ABBV
  • ABBV sold off very quickly with the market. However, this has been a very strong stock over the last several years.
  • ABBV bounced off the 2-standard deviation zone and the oversold condition is getting reversed.
  • The position is heading back into short-term overbought conditions and the 50-dma may provide short-term resistance.
  • Short-Term Positioning: Holding our position in the portfolio.
    • Hold with a target of $155
    • Stop-loss is currently $143
  • Long-Term Positioning: Neutral

Apple (AAPL)

Apple AAPL
  • With the Nasdaq under tremendous pressure, AAPL finally gave way to the selling. The company remains fundamentally very strong, however, it is no longer the growth company it once was.
  • The 50-dma will likely cross below the 200-dma which will provide additional downside pressure.
  • Apple is very oversold currently and 3-standard deviations below the mean. A reflexive rally in the next few days would not be surprising.
  • Short-Term Positioning: Holding our position in the portfolio.
    • Hold with a target of $160
    • Stop-loss is currently $140
  • Long-Term Positioning: Neutral

AMD (AMD)

AMD
  • AMD had terrific earnings and rallied but gave up those gains last week before bouncing on Friday.
  • Support is holding at the May lows for now. However, the stock is not nearly as oversold as it was previously.
  • We are looking to reduce the position further (weight-wise) in the portfolio on a rally.
  • Short-Term Positioning: Hold And Reflex Rally To Reduce Risk
    • Hold with a target of $102
    • Stop-loss is currently $84
  • Long-Term Positioning: Neutral / Bearish

CostCo (COST)

Costco Stores
  • One of my favorite long-term stocks is Costco. This company literally prints money with its membership fees.
  • The recent selling pressure in the whole market has pulled Costco back to a very oversold level.
  • Both lower indicators are very oversold and COST is trading 3-standard deviations below its mean.
  • We are looking to increase the current weighting in our portfolio.
  • Short-Term Positioning: Bullish – Look to add.
    • Buy with a target of $550
    • Stop-loss is currently $490
  • Long-Term Positioning: Bullish

United Health Care (UNH)

United healthcare UNH
  • UNH has a great demographic story. Millions of “baby boomers” aging in retirement guarantee UNH a long runway of profitability.
  • The long-term trends remains very positive.
  • UNH remains deeply oversold and is sitting just above support at the 200-dma.
  • Short-Term Positioning: Added to the portfolio
    • Buy with a target of $520
    • Stop-loss is currently $480
  • Long-Term Positioning: Bullish

Verizon (VZ)

Verizon VZ
  • With a 5% yield and strong fundamentals, I could resist adding VZ to our portfolio for a bit of defensive hedge in a volatile market.
  • Both oversold signals are starting to improve after the recent plunge to 3-standard deviations below the 50-dma just recently.
  • The sharp plunge lower gives VZ a decent risk/reward profile for a trade.
  • Short-Term Positioning: Added to the portfolio.
    • Buy with a target of $51
    • Stop-loss is currently $46
  • Long-Term Positioning: Neutrol

Exxon Mobil (XOM)

Exxon Mobil XOM
  • I would be remiss not to cover one of our energy holdings given the sharp advance in these companies over the last year.
  • The trend is very positive and the 50-dma is trading well above the 200-dma.
  • Short-term overbought and oversold conditions are not extreme and XOM has some room to retest recent highs.
  • The current setup is still very positive but an entry point to add exposure is not evident.
  • Short-Term Positioning: Holding a slightly reduced position in the portfolio.
    • Hold with a target of $92
    • Stop-loss is currently $78
  • Long-Term Positioning: Bullish

Five Energy Stocks to Sell

If we presented you with a year-to-date chart of the S&P 500 with no other context and asked which sector has defied gravity and is up over 30%, what would you say? Maybe, traditionally conservate sectors like Utilities, Staples, or Health care? If you picked one of those you may be surprised to learn that Energy has significantly outperformed the S&P 500 this year.

Supply chain challenges and geopolitical conflict sparked a substantial increase in energy prices giving way to massive capital flows into Energy companies as investors chase returns. As shown below, most sectors are deeply oversold but XLE still remains nearly 1.5 standard deviations above its 200dma.

With the U.S. Dollar at its strongest point in decades and energy prices well above historical norms, we question whether the energy trade has become too crowded. Relief on the geopolitical front and or signs of demand destruction could send shares of energy companies lower towards long term norms. Such is why we are screening for five energy stocks that remain vulnerable to a pullback.

Screening Criteria

We used the following screening criteria:

  • Energy Sector
  • Market Cap >$300M
  • YTD Performance >30%
  • Price 20%+ above 200dma
  • RSI not oversold (>50)
  • % Insider ownership decreased by >15% in last 6 months. (Insider selling occurred)

Company Summaries (all summaries courtesy of Zacks)

ConocoPhillips (COP)

ConocoPhillips is primarily involved in the exploration and production of oil and natural gas. Considering proved reserves and production, the company is the largest explorer and producer in the world. The company, founded in 1875, has strong presence across conventional and unconventional plays in 16 countries. ConocoPhillips low risk and cost-effective operations spread across North America, Asia, Australia and Europe. The upstream energy player also has foothold in Canadas oil sand resources and has exposure to developments related to liquefied natural gas (LNG).

Like most of the stocks in the scan COP is up over 30% year to date. It sits 25% above its 200dma. Some of its technical measures are back close to fair value but the stock price remains extremely elevated.

Chevron Corporation (CVX)

Chevron Corporation is one of the worlds leading integrated energy companies. Through its subsidiaries that conduct business worldwide, the company is involved in virtually every facet of the energy industry. Chevron explores for, produces and transports crude oil and natural gas; refines, markets and distributes transportation fuels and lubricants; manufactures and sells petrochemicals and additives; generates power; and develops and deploys technologies that enhance business value in every aspect of the company s operations.

CVX is up nearly 40% year to date and well above its 200dma. Like COP, its technical measures are moderating but the stock price has yet to weaken. This has been a function of some price consolidation, not declining prices.

Hess Corporation (HES)

Hess Corporation is a global integrated energy company. The company engages in exploration, production, development, transportation, purchase and sale of crude oil, natural gas liquids, and natural gas. It has gathering, compressing and processing operations of natural gas as well as fractionating natural gas liquids (NGLs). Additionally, Hess provides gathering, terminaling, loading and transporting operations for both crude oil and NGLs. The company also provides water handling services mainly in the Bakken and Three Forks Shale plays in North Dakota s Williston Basin area. Currently, the company has two operating segments, Exploration and Production (E&P) and Midstream.

HES is trading at its 50dma which has been good support. Like the other stocks in this screen, it is well above its 200dma. HES is up over 40% for the year but as shown below, it is showing some bearish signals.

Dorian LPG (LPG)

Dorian LPG Ltd is a liquefied petroleum gas shipping company. It is primarily focused on owning and operating Very Large Gas Carriers (VLGCs). The Company offers its services worldwide. Dorian LPG Ltd is headquartered in the United States.

LPG has the highest RSI on this screen at 70 and is the most bullish of the group. LPG is trading over 50% above its 200dma and 20% above its 50dma. The stock is up 20% in the last five trading days. Thus, most technical measures are extremely overbought as shown below. 

Exxon Mobil Corporation (XOM)

Exxon Mobil Corporation is the largest publicly traded international energy company, uses technology and innovation to help meet the worlds growing energy needs. Its principal business is energy, involving exploration for, and production of, crude oil and natural gas, manufacturing of petroleum products and transportation and sale of crude oil and natural gas, natural gas and petroleum products. Exxon Mobil is a major manufacturer and marketer of basic petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics and a wide variety of specialty products. ExxonMobil holds an industry leading inventory of resources, is one of the largest refiners and marketers of petroleum products and its chemical company is one of the largest in the world.

XOM is trading over 30% above its 200dma and has risen 37% year to date. It is sitting near its 50dma which has proven good support this year. A break of said support could result in a break toward its 200dma.   

We currently hold a 2% stake of XOM in our 60/40 equity model. While we are very cognizant it is overbought, its has proven a good hedge against the broader market. We have trimmed our holdings on numerous occasions to lock profits in.

Disclosure

This report is not a recommendation to buy or sell the named securities. We intend to elicit ideas about stocks meeting specific criteria and investment themes. Please read our disclosures carefully and do your own research before investing.

Portfolio Trade Alert – May 13, 2022

Trade Alert For Equity Model Only

While we are waiting on a reflexive rally to take hold so that we can reduce high beta volatility and adjust weightings, we are continuing with our process of a “runnng rebalance.” Our goal, as we head toward a recession, remains to tilt the portfolio more heavily towards value and defense as the economy slows. As such we have been taking advantage of beaten-down prices in companies like Verizon (VZ), Public Storage (PSA), and United Healthcare (UNH.)

Today we are rebalancing our holding of Abbott Laboratories (ABT) back to target model weights of 2% of the portfolio following the sell-off over baby formula concerns.

  • Rebalance ABT to 2% of the portfolio.

PPI and CPI: Are They Peaking?

Producer prices (PPI) for April met expectations rising .5%. While .5% is a big monthly increase, it pales compared to March’s +1.6% PPI. Core PPI, excluding food and energy, rose 0.4%, well below expectations for +0.8%. Inflation is still running hot, but PPI and CPI show the momentum of price changes might have peaked.

PPI data was generally lower than expectations, while CPI was higher. Forming expectations given the wild volatility in prices and supply line problems is challenging. Given the circumstances, beating or missing expectations by .1 or .2% is meaningless. What really matters is the trend. Is the trend for CPI and PPI starting to decline? One month does not make a trend, but this week’s inflation data, combined with weakening economic activity and much higher interest rates, leaves us hopeful.

ppi cpi inflation

What To Watch Today

Economy

  • 8:30 a.m. ET: Import Price Index, month-over-month, April (0.6% expected, 2.6% in March)
  • 8:30 a.m. ET: Import Price Index, year-over-year, April (12.2% expected, 12.5% in March)
  • 8:30 a.m. ET: Export Price Index, month-over-month, April (0.7% expected, 4.5% in March)
  • 8:30 a.m. ET: Export Price Index, year-over-year, April (18.8% in March)
  • 10:00 a.m. ET: University of Michigan sentiment, May preliminary (64.0 expected, 65.2 in April)

Earnings

  • No notable reports are scheduled for release

Market Trading Update – The Selling Continues

No relief for traders through Thursday as the selling continued unabated. As noted yesterday, the market did bounce off the extreme of 3-standard deviations below the 50-dma and closed about where the market finished yesterday at the 138% Fibonacci retracement level. With inflation data, earnings, and the Fed behind us for now, I would not be surprised to finally see a bit of a relief rally. However, even if we do, there are MANY investors caught on the wrong side of this market, so any rally will likely be met with more selling. We continue to suggest using any rally to reduce risk and rebalance portfolios.

Panic Button Getting Pressed

“This week, investors truly started to panic. In March, despite losses in stocks, credit conditions were relatively calm. The biggest panics – not grinding bear markets, but actual panics – always see wholesale selling pressure in credit markets.

That is starting to change, and the Panic Button has been pressed. It has risen above 1.0 for the first time in almost two years.” – Sentiment Trader

Seasonality Argues Bond Yields Might Have Peaked

The graph below from Sentimentrader shows that bond prices typically perform poorly until the 90th trading day of the year. May 10th was the 90th trading day. After the 90th day, they tend to rise. This year has been no exception, with bond prices plummeting from January to April. Recently bond prices have ticked up right on schedule. Might the graph below accurately portray the trend of bonds for the year? Also of interest, if the direction does turn up, was it Wednesday’s CPI report that might have shown a peak in inflation that is the culprit?

bond seasonality yields

ARKK vs. Energy

The ARKK Innovation ETF, managed by Cathie Wood, has been in the financial media limelight. Shares of ARKK have gotten crushed, down over 60% year to date. At the same time, the energy sector has been on fire, up over 40% year to date. One would think that investors would follow the returns and move from funds like ARKK to the energy sector. The graph below shows that is not happening. The two lines show the stunning differential in 2022 performance. The box shows XLE has experienced a slight outflow of funds, while over $1.1 billion has moved into ARKK.

arkk xle

What Are Homebuilders Drinking?

Sharply higher mortgage rates have radically changed the purchasing power of many potential homebuyers. For example, the first graph below from Redfin shows the average mortgage payment on a median-priced house has risen from approximately $1,650 to $2,400 in just four months. At the same time, house prices continue higher, making the plight of the homebuyer even more difficult.

The second graph below shows these concerns are weighing on homebuyer sentiment. Homebuyer sentiment is now way below any level seen since at least 1990, including 2007/08. Despite the horrendous sentiment, homebuilders’ sentiment is at 30-year highs. Something has to give, and barring a sharp drop in mortgage rates, it appears homebuilder sentiment is due for a steep decline. If so, reduced home construction will weigh on the economy. We will closely follow Housing Starts and Building Permits over the next few months to see if homebuilders start to slow their activity.

homebuilders homebuyers sentiment
homebuilder mortgage

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

The Biggest Crash In History Is Coming? Kiyosaki Says So.

Robert Kiyosaki recently tweeted, “The best time to prepare for a crash is before the crash. The biggest crash in world history is coming. The good news is the best time to get rich is during a crash. The bad news is the next crash will be a long one.”

Is Kiyosaki just being hyperbolic, or should investors prepare for the worst?

Importantly, I received Kiyosaki’s comment in an email that I could find out more by just clicking on the link to get a “free” report.

I can save you time, and future spam emails, by telling you that Kiyosaki will be correct.

Eventually.

However, the problem, as always, is “timing.”

As discussed previously, going to cash too early can be as detrimental to your financial outcome as the crash itself.

Over the past decade, I have met with numerous individuals who “went to cash” in 2008 before the crash. They felt confident in their actions at the time. However, that “confidence” gave way to “confirmation bias” after the market bottomed in 2009. They remained convinced the “bear market” was not yet over, and sought out confirming information.

As a consequence, they remained in cash. The cost of “sitting out” on a market advance is evident.

As the market turned from “bearish” to “bullish,” many individuals remained in cash worrying they had missed the opportunity to get in. Even when there were decent pullbacks, the “fear of being wrong” outweighed the necessity of getting capital invested.

Analysis showing the cost of "sitting out" on a market advance

The email I received noted:

“If such a disaster could be in the making, your assets are at risk and this requires your immediate attention! And if you believe that now isn’t the time to protect yourself and your family, when will it be?”

Let’s start with that last sentence.

Advertisement that you can click to schedule a consultation with RIA Advisors.

The Biggest Crash In History Is Coming

As I stated, Kiyosaki is right. The biggest crash in world history is coming, and it will be due to the most powerful financial force in the financial markets – mean reversions. The chart below shows the deviation of the inflation-adjusted S&P 500 index (using Shiller data) from its exponential growth trend.

Note that the market reverted to or beyond its exponential growth trend in every case, without exception.

Market deviation from long-term exponential growth trend.

(Usually, when charting long-term stock market prices, I would use a log-scale to minimize the impact of large numbers on the whole. However, in this instance, such is not appropriate as we examine the historical deviations from the underlying growth trend.)

Importantly, this time is not different. There has always been some “new thing” that elicited speculative interest. Over the last 500 years, there have been speculative bubbles involving everything from Tulip Bulbs to Railways, Real Estate to Technology, Emerging Markets (5 times) to Automobiles, Commodities, and Bitcoin.

List of speculative bubbles

Jeremy Grantham posted the following chart of 40-years of price bubbles in the markets. During the inflation phase, each period got rationalized as “this time is different.” 

Grantham 40-years of market bubbles

Again, every financial bubble, regardless of the underlying drivers, had several things in common:

  1. Tremendous amounts of speculative interest by retail investors.
  2. A sincere belief “this time was different:” and,
  3. A tragic ending that devastated financial fortunes.

This time is likely no different.

Timing Is Everything

So, yes, a crash is coming.

However, the problem is the “when.”

A crash could come at any time, next month, next year, or another decade.

In the meantime, as noted, sitting in cash or some other asset that vastly underperforms either inflation or the market impedes the progress in achieving your financial goals.

Notably, crashes require an event that changes investor psychology from the “Fear Of Missing Out” to the “Fear Of Being In.” As noted previously, this is where the current lack of liquidity becomes extremely problematic.

The stock market is a function of buyers and sellers agreeing to a transaction at a specific price. Or rather, “for every seller, there must be a buyer.”

Such is an important point. Every transaction in the market requires both a buyer and a seller, with the only differentiating factor being at what PRICE the transaction occurs. When the selling begins in earnest, buyers will vanish, and prices will fall lower. Such is why the correction in March 2020 was so swift. There were indeed people willing to buy from panicking sellers. They were just 35% lower than the previous peak.

What could cause such a shift in psychology?

No one knows. However, historically speaking, crashes have always resulted from just a few issues.

  1. An unexpected, exogencous event that changes economic outlooks (Geopolitical Crisis, War, Pandemic)
  2. A rapid increase in interest rates.
  3. A sudden surge in inflation.
  4. Credit-related events that impact the financial system (Bankruptcies, Real Estate foreclosures, defaults)
  5. Monetary event (currency crisis)

Almost every financial crisis in history boils down ultimately to one of those five factors and mainly a credit-related event. Importantly, the event is always unexpected. Such is what causes the rapid change in sentiment from “greed” to “fear.”

Advertisement that you can click to subscribe to the Real Investment Report, a weekly newsletter for market updates.

Preparing For The Crash

As investors, we should never discount “risk” under the assumption some force, such as the Fed, has eliminated it.

Every era of speculation brings forth a crop of theories designed to justify the speculation, and the speculative slogans are easily seized upon. The term ‘new era’ was the slogan for the 1927-1929 period. We were in a new era in which old economic laws were suspended.” –Dr. Benjamin Anderson – Economics and the Public Welfare

So, we know two things with certainty:

  1. Robert Kiosaki will be correct about the next crash; and,
  2. We have no idea when it will happen.

Fortunately, we can take certain actions to protect portfolios from a crash without sacrificing financial goals. However, such actions are not “free” of cost.

  1. Properly sizing portfolio positions to mitigate the risk of concentrated positions.
  2. Rebalancing portfolio alllocations
  3. Take profits from extremely overbought and extended positions.
  4. Sell laggards
  5. When you are not sure what to do, do nothing. Cash is a great hedge against risk.
  6. Don’t dismiss the value of bonds in a portfolio.
  7. Look for non-correlated assets to mitigate risk.

As noted, there is a “cost.” Adding any strategy to a portfolio to mitigate or diversify risk will create underperformance relative to an all-equity benchmark index.

However, as investors, our job is not to beat some random benchmark index but to make sure our investments meet just two goals:

  1. Exceed the rate of inflation
  2. Meet the rate of return required to meet our long-term financial goals.

Any objective that exceeds those two goals requires an undertaking of increased risk and ultimately increases losses.

So, if you are afraid of the next crash, click here for a FREE REPORT.

Okay, I don’t actually have one.

However, you can certainly take some actions today to mitigate the risk of catastrophic losses tomorrow.

Bill Dudley Bashes The Fed

Ex-New York Fed President Bill Dudley seems to have it out for the Fed. Despite spending a decade at the Fed, Bill Dudley has some strong words about what his ex-colleagues are doing. As he claims:

“…..Worse, the Fed’s sugarcoating could undermine its credibility, and hence its ability to do its job.

While most Fed members think that inflation will slowly fall, Bill Dudley is raising his forecast. Per the interview:

I think it’s 4%-5% or higher. I was at 3%-4% maybe six months ago… Wouldn’t shock me if I’m 5%-6% a few months from now.”

Click on the picture below for a snippet from Bill Dudley’s interview on Bloomberg.

bill dudley fed

What To Watch Today

Economy

  • 8:30 a.m. ET: Producer Price Index, month-over-month, April (0.5% expected, 1.4% in March)
  • 8:30 a.m. ET: Producer Price Index excluding food and energy, month-over-month, April (0.6% expected, 1.0% in March)
  • 8:30 a.m. ET: Producer Price Index excluding food, energy, trade, month-over-month, April (0.6% expected, 1.0% in March)
  • 8:30 a.m. ET: Producer Price Index, year-over-year, April (10.7% expected, 11.2% in March)
  • 8:30 a.m. ET: Producer Price Index excluding food and energy, year-over-year, April (8.9% expected, 9.2% in March)
  • 8:30 a.m. ET: Producer Price Index excluding food, energy, trade, year-over-year, April (6.5% expected, 7.0% in March)
  • 8:30 a.m. ET: Initial jobless claims, week ended May 7 (192,000 expected, 200,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended April 30 (1.368 million expected, 1.384 million during prior week)

Earnings

Pre-market

  • WeWork (WE) to report an adjusted loss of $0.72 on revenue of $768 million
  • Six Flags Entertainment (SIX) to report an adjusted loss of $1.04 on revenue of $122.54 million

Post-market

  • Affirm (AFRM) to report an adjusted loss of $0.48 on revenue of $344.33 million
  • Figs Inc. (FIGS) to report adjusted earnings of $0.06 on revenue of $117.33 million
  • Toast Inc. (TOST) to report an adjusted loss of $0.16 on revenue of $491.94 million

Market Trading Update – Selling Continues

Bill Dudley’s hawkish commentary, and a higher than expected inflation print, kept selling pressure on the market pushing it well into 3-standard deviation territory below the 50-dma. Furthermore, all measures of overbought/oversold conditions are at extremes. While we have been suggesting a tradeable bounce is likely, that hasn’t happened yet which is frustrating. However, current conditions are rare and markets don’t stay at such oversold conditions for long.

The chart below is a WEEKLY chart of the S&P 500 index ETF (SPY). As noted, SPY is pushing levels of oversold not seen since the March 2020 lows. Also, SPY is near a 38.2% Fibonacci retracement level of the entire rally and is 3-standard deviations below the 1-year moving average. That only happened in 2018 and 2020 near the lows.

CPI Inflation Report

The good news in the CPI report is that the upward trend in prices may have peaked. The monthly inflation rate was +0.3%, equating to +3.6% on an annualized basis. +0.3% compares favorably to +1.2% last month. But the bad news is the market was hoping it would only be up +0.2%. The same story holds for all aspects of the report. All indicators were lower than last month which is positive as it possibly points to a change in momentum. However, they were all higher than expectations.

The year-over-year CPI rate fell from 8.5% to 8.3%. That was the first decline since August 2021. The data does not warrant the Fed to take a step back from its aggressive Fed Funds or QT forecasts. Of importance to the Fed, the monthly core rate (excluding food and energy) rose 0.6%. That was greater than all 67 economic forecasts in a Bloomberg survey.

cpi inflation

The Rise And Fall Of Ipod

It’s the end of an era and Apple pulls the plug on iPod. From Chartr:

“The iPod, and other MP3 players, offered an alternative to the mostly-linear way that albums used to be listened to on CD or vinyl — and they were just so much more convenient. ‘1,000 songs in your pocket’ was a powerful slogan that quickly became 2,000, then 4,000, and 16,000 as storage capacity expanded. The fact that most people only had a few hundred songs to fill their iPods with was irrelevant.

Of course, nothing lasts forever in tech, and this week Apple announced it was going to discontinue the product line, marking the official end of the iPod era. iPod sales peaked with Apple selling more than 50 million units every year. Indeed, before the rise of the iPhone, the iPod was the company’s crown jewel alongside the Mac — in 2006 the iPod was roughly 40% of Apple’s revenue.”

TPA Calls For a Rally

The following market call is from Jeffery Marcus of Turning Point Analytics (TPA). His excellent research can be found on SimpleVisor for those interested to learn more about what Jeff offers subscribers.

The TPA Marketscope has identified an intermediate-term extreme for stocks. The percent of stocks in the Russell 1000 that are trading above their 50DMA hit 13% yesterday. Since TPA was founded in 2009, 13 years ago, we have found that this signal has marked a low extreme for the market. This signal has been correct on a consistent basis, although not 100% of the time. When the percent of stocks trading above their 50DMA goes below 15%, the market is oversold and there has been a very consistent move higher for the intermediate-term.

Clients should expect stocks to be more positive for the intermediate-term. TPA defines the intermediate-term as 50 trading days or approximately 2.3 months.

tpa market rally

Investor Psychology

Over the past six to nine months, we have seen many SPACs, meme stocks, high-growth technology stocks, and cryptocurrencies form a traditional bubble/bubble popping pattern. The “A” shape in the graph below shows this pattern. Further, it shows the typical investor feelings that appear at various stages in the bubble and its downfall. The critical takeaway as we see many examples of the pattern is to realize where we are in the cycle. There are many stocks now entering the “Anger” phase. As shown, the Anger phase is near the lows of the process but, it takes a long time for trust to return to the stock. As such, there are a series of fits and starts before it starts rising. The bottom line is that prices may seem cheap, but they can stay cheap for much longer than you think.

market investor psychology

New Risks In Crypto

Coinbase (COIN) released its earnings yesterday. COIN fell over 10% on Wednesday after reporting a first-quarter loss of $429 million. In addition to a much larger than expected loss, its revenue fell well short of expectations. COIN stock is down nearly 90% since peaking in November.

Buried within their SEC 10-Q filing is some new legal language worth considering if you have a Coinbase account or possibly a cryptocurrency account at another custodian. Essentially, the new legalese states that if COIN goes bankrupt, its clients could see some or all of their assets lost to the company’s creditors. SPIC insurance, which covers stock investors at firms like Fidelity, TD, and Charles Schwab, does not apply to cryptocurrency custodians.

“Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”

coinbase crypto

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Portfolio Trade Alert – May 11, 2022

Trade Alert For Equity Model Only

In our process of shifting to a bit more defensive posture in our portfolio, we are adding a “start position” in United Healthcare (UNH.) The demographic story bolds well fundamentally, and healthcare will continue to be a defensive trade in a slowing economic environment. We will look to add to our position opportunistically.

UNH has shown good stability and tends to trade with the value grouping. Our intention is to add some value, lower beta now, and assuming we get the bounce we expect, shed some of the higher growth, higher beta names as the market peaks. Call it a running rebalance.  

Technically the stock is very oversold and near the bottom of its bullish uptrend channel.

  • Initiate a 1.5% weighting of UNH to the portfolio.

STOCKS HIT AN INTERMEDIATE-TERM EXTREME LOW

STOCKS HIT AN INTERMEDIATE-TERM EXTREME LOW

The TPA Marketscope has identified an intermediate-term extreme for stocks. The percent of stocks in the Russell 1000 that are trading above their 50DMA hit 13% yesterday. Since TPA was founded in 2009, 13 years ago, we have found that this signal has marked a low extreme for the market. This signal has been correct on a consistent basis, although not 100% of the time. When the percent of stocks trading above their 50DMA goes below 15%, the market is oversold and there has been a very consistent move higher for the intermediate-term.

Clients should expect stocks to be more positive for the intermediate-term. TPA defines the intermediate-term as 50 trading days or approximately 2.3 months.

Investor Sentiment Is Horrendous- Is That A Bullish Sign?

Often markets bottom when investor sentiment is poor and peak when it’s high. As they say, the markets like to catch as many people offside as possible. Currently, investor sentiment is at 30-year lows. In the past, such weak sentiment would provide a spark, even if temporary, to the markets.

While investors are talking the bearish talk, they are not walking the bearish walk. Institutional portfolio allocations to equities have barely declined. Despite uber bearish opinions, institutional investors are not selling. The graphs below highlight this odd divergence. Sentiment argues for a sizeable rally, but investor allocations warn there is plenty of downside if investors decide to sell.

sentiment investor

For more on Investor Sentiment read yesterday’s blog post.

What To Watch Today

Economy

  • 7:00 a.m. ET: MBA mortgage applications, week ended May 6 (2.5% during prior week)
  • 8:30 a.m. ET: Consumer Price Index, month-over-month, April (0.2% expected, 1.2% in March)
  • 8:30 a.m. ET: Consumer Price Index excluding food and energy, month-over-month, April (0.4% expected, 0.3% in March)
  • 8:30 a.m. ET: Consumer Price Index, year-over-year (8.1% expected, 8.5% in March)
  • 8:30 a.m. ET: Consumer Price Index excluding food and energy, year-over-year, April (6.0% expected, 6.5% in March)
  • 2:00 p.m. ET: Monthly Budget Statement, April ($260.0 billion expected,, -$225.6 billion in March)

Earnings

Pre-market

  • Yeti Holdings (YETI) to report adjusted earnings of 32 cents on revenue of $290.6 million
  • Olaplex (OLPX) to report adjusted earnings of 11 cents on revenue of $172.44 million
  • Krispy Kreme (DNUT) to report adjusted earnings of 7 cents on revenue of $367.86 million

‌Post-market

  • Disney (DIS) to report adjusted earnings of $1.18 on revenue of $20.11 billion
  • Bumble (BMBL) to report adjusted earnings of 2 cents on revenue of $208.27 million
  • Sonos Inc. (SONO) to report adjusted earnings of 17 cents on revenue of $351.67 million
  • Beyond Meat (BYND) to report adjusted losses of 98 cents on revenue of $112.17 million
  • Dutch Bros. (BROS) to report adjusted earnings of 1 cent on revenue of $145.9 million
  • Rivian Automotive (RIVN) to report adjusted losses of $1.45 on revenue of $131.2 million

Market Trading Update – No Progress Ahead Of Inflation Print

The market made no real progress yesterday with investors anxiously awaiting the April inflation data. While we expect the print to be on the lighter side, suggesting a peak of inflation, there is still a risk of a hotter than expected number. Regardless, the market is sitting on support and while it tried to rally yesterday, it failed to do so. The market needs to get back above $400 on SPY today if we are going to see a further reflexive rally short-term.

Market trading update

Percentage Of Nasdaq Stocks Above 200-DMA

“As SoFi’s Liz Young points out, as of Tuesday, only about 16% of Nasdaq Composite stocks were trading above their 200-day moving averages, or a key technical indicator of a stock’s price trends. That’s nearing the ultra-low percentages seen at the market bottoms over the past two decades, including in 2020 (about 6%), 2018 (9%) and 2009 (4%).” – Yahoo

Trouble In Cryptoland?

Stablecoins are crypto tokens that serve as the cash or the money market of cryptocurrency markets. Think of these as the conduit-like role money market funds serve the stock or bond markets. When we sell a stock, the proceeds are moved to a money market fund at our brokerage account. The money can sit in the fund as a cash surrogate, buy another stock, or be redeemed for cash. Money market funds are never expected to lose value, aka breaking the buck.

Stablecoins are similar conduits that link crypto to crypto trading or crypto to cash transactions. When you sell a crypto, you first convert it to a stablecoin instead of a money market fund. Assuming the stable coin is at or very close to $1.00 your value is stable. There are many kinds of stablecoins and they are differentiated by numerous factors. The most important factor is what backs the stablecoins. Some, such as tether claim cash and government bonds ensure the price will be $1.00. Others use algorithms. Today, those backed by algorithms are experiencing trouble.

The graph below is the $18 billion algorithm-based Terra stablecoin (UST), supporting the Luna cryptocurrency. As shown below, it has broken the buck (<$1.00). As expected a lack of stability of stable coins is leading to liquidity concerns in cryptocurrencies. That said, Tether stablecoin supports the largest crpyto, Bitcoin. Because cash and Treasury bonds collateralize Tether, its value is not fluctuating like other stable coins.

Matt Levine from Bloomberg has an excellent article describing how algorithmic stablecoins work. Given the strong correlation of the Nasdaq to crypto, this is a story worth following even for those with no interest in crypto.

crpyto stable coins

Lowered Expectations

On Thursday morning, we wrote the following:

The 92.7% probability of the Fed Fund rates increasing to 1.50%-1.75% at the June meeting is based on Fed Funds futures trading on the Wednesday morning before the Fed’s announcement.

The purpose of sharing the odds of a 75bps June rate hike last week was to compare it in the future. Here we are a few days out from the Fed meeting, and the market has certainly changed. The graph below shows that the odds for 75bps have fallen to only 13.5%. It certainly helps that Jerome Powell ruled out a 75bps rate hike. Further, we have yet to hear a Fed member pushing for 75bps.

fed funds expectations

Energy Stocks Defying Statistics

As we often find in markets, asset price changes often defy what should be expected by a normally distributed statistics bell curve. On Monday, energy stocks (XLE) reminded us of that. XLE fell over 8% on Monday, which is a 4.5 standard deviation move. We should expect such an occurrence once every 125 years. XLE has been trading for about 24 years and there have been 12 other trading days in those 24 years in which the standard deviation decline was worse. The graph below shows the price and daily standard deviation change for XLE. We highlighted Monday’s standard deviation in red. It was undoubtedly a large decline, but there were days in 2020 and 2008/09 that were much worse.

xle energy

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Liquidity and Volatility- Decoding Market Jargon

“Liquidity” and “volatility” are constantly thrown around by the financial media and Wall Street as if everyone fully understands them and their importance. These terms are vital, but regrettably, not many investment professionals take the time to help investors fully appreciate them.

Mea culpa! We also use the terms extensively in our writings and podcasts, yet we fail to impress upon our followers their importance.

With volatility spiking and the Fed removing liquidity, we think it is an excellent time to discuss the two terms and their dependency on each other. We hope this broader understanding of volatility and liquidity may help you better appreciate risk conditions.

Liquidity

  • Fed Pumps $70.2 Billion in Short-Term Liquidity Into Markets.” – WSJ December 2019
  • Is this a Liquidity Crisis or a Solvency Crisis? It Matters to the Fed.” WSJ April 2020
  • Liquidity Shocks: Lessons Learned from the Global Financial Crisis.” NYT August 2021

Those headlines are just a few of the many ways the media use the word liquidity.

Liquidity is the fuel that keeps the financial market’s engine running. As such, without enough liquidity, the motor seizes, and financial crises erupt.

Liquidity refers to the amount of money investors are willing to use to buy and sell assets now. As you might surmise, the more investors willing to bid and offer assets, the more liquid the market. We cannot underline or highlight the word “AND” enough. Liquid markets must have both many willing bidders and offerors of an asset.

Let’s consider markets in which only one side of the market offered good liquidity.

In 2008, everyone was a seller of sub-prime mortgages, while buyers were few and far between. In late 2020 and early 2021, buyers of SPACs, meme stocks, cryptocurrencies, and an assortment of high-growth tech stocks dwarfed the number of sellers.

The 2008 example highlights a surplus of sellers with limited buyers. The more recent example is the opposite. In hindsight, we know how both illiquid conditions ultimately ended up. That is why it is vital for a liquid market to have ample buyers and sellers.  

Liquidity is in the Eye of the Transactor

As we write this article, the price of Apple stock is 160.12. Currently, 350 shares are offered at 160.13, and 500 are bid at 160.11. Within five cents of the current price, well over 7,500 shares are bid and offered. Accordingly, for a retail investor looking to buy or sell 20 shares, the market for Apple is incredibly liquid. A 20-share transaction will occur at the market price and have no effect on the market.

Warren Buffett’s Berkshire Hathaway has approximately 1 billion shares of Apple. If Buffett has a hankering to sell even a small portion of his billion shares asap, he might have a different opinion of Apple’s liquidity.

The point of comparing these two opinions on liquidity is to stress the importance of assessing how current liquidity conditions affect your trading, but equally important to understand broader liquidity. The Warren Buffetts of the investment world dictates the price of Apple, not our 20-share trader! Therefore, if Mr. Buffett is desperate to sell, he will likely have to rely on bidders at lower prices. Then the amount of price concession is a function of how much liquidity exists.

Liquidity defines risk!

Schedule an appointment now

Volatility

Volatility is often quoted in two ways, realized and implied.

Realized, or historical, volatility is backward-looking. It is a statistical measure of an asset’s price movement over a prior period.

Implied volatility is derived from options prices. It is a measure of what investors think volatility will be in the future.

While calculated differently, the gauges quantify the movement of prices, past and expected. Further, and a story for another article, the difference between them can sometimes be telling.

More importantly, volatility is not just a mathematical calculation. Volatility measures liquidity! And liquidity defines risk.

Volatility Measures Liquidity

Liquidity is variable. Changes in sentiment or policies, for example, can quickly alter liquidity. When liquidity is high, many buyers and sellers are poised to act on prices at or very close to current market prices.

As we discussed in our earlier example, selling or buying 20 shares of Apple, even if done repeatedly, will have little to no effect on price. In such an environment, the price will move up and down as factors change, but the movement will be gradual.

Now consider a market in which each 20-share purchase of Apple moves the stock by a nickel or more. In this circumstance liquidity is weak, and prices are susceptible to a motivated buyer or seller. In such instances, daily price moves in Apple are much more elevated than in the liquid market example. Accordingly, Warren Buffett could easily introduce significant downside pressure in such a market.

This example shows how liquidity is the critical determinant of volatility.

Evidence

To help better cement the concept, we provide actual data.

The graph below from the CME shows the S&P 500 E-mini futures contracts price (blue) and its book depth (red and green). Book depth measures how many bids and offers, on average, are available. As you see, when markets are rising, book depth is deeper. A deeper book implies investors are more comfortable, willing, and able to offer liquidity.

The second graph shows the bullish trend from April through December of 2021 had relatively low levels of realized and implied volatility. In January 2022, markets started falling, and liquidity gave way. During that period, book depth weakened, and the volatility readings rose.

market depth evidence
volatility realized implied

Fed’s Liquidity Role

Liquidity comes from those investors that are willing and able to buy and sell. Therefore, sentiment, monetary and fiscal policy and a host of other factors affect the willingness and ability of investors. Over the past 20 years, the Fed has increasingly played a more prominent role in regulating liquidity.

The Federal Reserve does and doesn’t directly provide liquidity. As part of QE, the Fed purchases and sells bonds. In doing so, they add or remove securities available to markets. Removing assets increases liquidity as the amount of investable dollars chases fewer assets.

However, and equally important, is the Fed’s indirect influence on liquidity. This occurs via the perception that the Fed is adding or reducing liquidity and supporting or not supporting markets. Investors feel more comfortable knowing the Fed is adding liquidity. As we have repeatedly seen, Fed liquidity is an excellent backstop in many investors’ opinion. Conversely, as we see now, angst tends to occur when they remove liquidity.

Raising and lowering interest rates is another way they affect liquidity. Trades using margin increase the purchasing power of buyers and sellers. Higher interest rates make it more costly to buy assets on margin and vice versa for lower rates. The graph below from Jesse Felder shows margin debt (leveraged speculation) tends to peak at market tops and troughs near market bottoms.

fed liquidity

Lastly, the Fed regulates the banks. Accordingly, its rules and restrictions affect capital and collateral requirements, which directly influence the volume of financial market assets banks may own and or make loans against.

Summary- Don’t Fight The Fed

We often say, “don’t fight the Fed”. What we mean is that when the Fed is providing liquidity, do not fight them. It is likely the Fed’s liquidity will pacify investors and result in a less risky environment. Fed liquidity emboldens investors and adds liquidity, even when valuations are extreme.

Conversely and incredibly important today, when the Fed is removing liquidity, do not get in their way. Anxieties are increased, which results in reduced market depth and increased volatility.

There is no sign the Fed’s current quest to remove liquidity is close to ending. We recommend you carefully consider that liquidity is fading due to the Fed, and therefore, volatility is on the rise. Illiquid and volatile markets are not conducive to long-term wealth generation.

Fear is Driving Yields Higher, Not Inflation

Fear, not inflation, is driving bond yields higher despite popular beliefs. The graph below shows that implied inflation expectations derived from TIPS and Nominal Treasury bond yields have actually declined since late March. Adding to the case that fear, not fundamentals, is at play, global economic growth expectations are declining rapidly. Based solely on those important fundamental factors, bond yields should be stable to falling. Clearly, there is intense, fear-based selling pressure that is ignoring fundamentals. Once the bond market can find a better balance, it’s likely that yields will be falling, not rising.

inflation yields

What To Watch Today

Economy

  • 6:00 a.m. ET: NFIB Small Business Optimism index, April (92.9 expected, 93.2 in prior print)

Earnings

Pre-market

  • Norwegian Cruise Lines (NCLH) to report an adjusted loss of $1.53 on revenue of $739.85 million
  • Hyatt Hotels (H) to report an adjusted loss of $0.38 on revenue of $1.11 billion
  • Warner Music Group (WMG) to report adjusted earnings of $0.21 on revenue of $1.37 billion
  • Peloton (PTON) to report an adjusted loss of $0.80 on revenue of $971.5 million
  • Planet Fitness (PLNT) to report adjusted earnings of $0.28 on revenue of $190.06 million

Post-market

  • Roblox (RBLX) to report an adjusted loss of $0.03 on revenue of $648.31 million
  • Occidental Petroleum (OXY) to report adjusted earnings of $2.05 on revenue of $8.22 billion
  • Coinbase (COIN) to report adjusted earnings of $0.20 on revenue of $1.48 billion
  • Sofi Technologies (SOFI) to report an adjusted loss of $0.14 on revenue of $284.91 million
  • Allbirds (BIRD) to report an adjusted loss of $0.12 on revenue of $62.19 million
  • Rocket Cos. (RKT) to report adjusted earnings of $0.19 on revenue of $2.14 billion
  • Wynn Resorts (WYNN) to report an adjusted loss of $1.21 on revenue of $979.92 million
  • Electronic Arts (EA) to report adjusted earnings of $1.43 on revenue of $1.77 billion

Market Trading Update – Market Breaks Support

Not much good has happened in the market over the last few trading days. On Friday, as noted below, the market held support at the 100% Fibonacci retracement level from the March rally peak. Today, that support was broken and stocks got met with heavy selling all day. The market is now extremely oversold at 3-standard deviations below the mean and is sitting at the bottom of the downtrend channel.

The market needs to rally back above the 410 level on the S&P 500 index soon, or the market will continue to leak lower. We have now broken important stops on several levels that will require a higher cash position in the portfolios. We will update you on trades accordingly at SimpleVisor.com or in our weekly newsletter.

Credit Cards Fill The Gap

Wages are growing at around 5%, while inflation is nearly 9%. As we have noted, many consumers are getting killed as real wage growth is declining rapidly. Some consumers are using their credit cards to fill the gap. March consumer credit just set a new record at $52.4 billion. The old record was $37.7 billion. The average pre-Covid level was around $15 billion per month. Such spending is not sustainable and comes at a dear cost to consumers as credit card borrowing rates are near 20%. While credit-based spending may boost retail sales in the short run, it will inhibit them in the long run.

credit cards revolving

Used Car Prices Are Finally Falling

The Manheim Used Car Index, shown below, recorded its largest 90-day decline in history -6.6%. The demand for used cars is finally slowing, and buyers may have some bargaining power. Per Manheim:

The average daily sales conversion rate increased to 58.4% but was below normal for the time of year. For example, the sales conversion rate averaged 60.6% in April 2019. The lower conversion rate indicates that the month saw buyers with more bargaining power for this time of year.

used car prices inflation

What Ever Happened to Dogecoin?

A year ago, Elon Musk was on Saturday Night Live and called out the latest cryptocurrency fad DogeCoin as a scam. Before his appearance, Elon Musk was a big supporter of Doge, in fact, he called himself the “Dogefather.” The graph below shows Dogecoin stumbled on his statements but rallied back to hit an all-time high days later. Since then, greed for quick profits has faded, and fear has taken over. Dogecoin, like many cryptocurrencies and other once-popular risky assets, is out of favor. Dogecoin is now trading 80+% below last May’s highs.

dogecoin crypto

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Investor Sentiment Is So Bearish – It’s Bullish

Investor sentiment has become so bearish that it’s bullish.

One of the hardest things to do is go “against” the prevailing bias regarding investing. Such is known as contrarian investing. One of the most famous contrarian investors is Howard Marks, who once stated:

Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, particularly when momentum invariably makes pro-cyclical actions look correct for a while.

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”

Currently, everyone is bearish. As noted in “Stock Market Rollercoaster,” everything, everywhere, is bearish. CNBC is running “Markets In Turmoil” specials, and individuals get convinced the world is ending. However, as Howard Marks once stated

In good times skepticism means recognizing the things that are too good to be true; that’s something everyone knows. But in bad times, it requires sensing when things are too bad to be true. People have a hard time doing that.

The things that terrify other people will probably terrify you too, but to be successful an investor has to be stalwart. After all, most of the time the world doesn’t end, and if you invest when everyone else thinks it will, you’re apt to get some bargains.

Such is the point where investors make the most mistakes. Emotions make them want to sell. However, from a contrarian view, such is precisely the time you want to be a buyer.

But that is always a difficult thing to do.

Everybody Is Bearish

Currently, everybody is bearish. Not just in terms of “investor sentiment” but also in “positioning.” As noted by MarketEar on Friday, the Goldman “Sentiment Indicator” measures stock positioning across retail, institutional, and foreign investors versus the past 12 months. Readings below -1.0 or above +1.0 indicate extreme positions that are significant in predicting future returns.

GS Sentiment indicator

More importantly, investor allocations, particularly among professional investors, remain extremely light, suggesting a much higher level of caution. The following is the 4-week moving average of the National Association of Investment Managers bullish index. At a reading of 129.25, such is often coincident with short-term market bottoms.

NAAIM bullish investors

The composite index below, which combines both retail and institutional investor sentiment, is extremely negative and typically marks short- to intermediate-term market bottoms.

Composite net bullish sentiment

Of course, with investor sentiment negative, net flows into global equity and fixed-income funds also turned negative. Since the second week of January, global bond funds have experienced $125bn of net selling, and flows have been negative for 16 of the last 17 weeks. 

Net flows into global stocks and bonds

As shown, when levels of negativity have reached or exceeded current levels, such has historically been associated with short- to intermediate-term market bottoms.

“A dovish Fed, excessively bearish sentiment for risk assets and a lot priced-in relative to current fundamentals. We think that risk assets can trade reasonably robust over the next 4-8 weeks” – Citi

However, there are two critical points to note:

  1. During bull markets, negative sentiment was a clear buying opportunity.
  2. During bear markets (2008), negative sentiment stays negative while markets decline.

Such raises the vital question: Are we still in a bull market, or are we in the early stages of a bear market?

Longer-Term The Outlook Remains Bearish

While the negative sentiment is “bearish” currently enough to be “bullish,” the longer-term fundamental and technical dynamics suggest a continued correction is possible. As noted above, the negative sentiment levels could support a rally over the next couple of months. Such would lure investors into the market just as the more bearish fundamental and technical backdrop unfolds.

However, the NYSE index is currently down to the 100-week moving average. Michael Hartnett recently noted:

“A recession/crises over the last 25-years has always seen our favorite Wall Street barometer break decisively below the 100-week moving average.”

NYSE vs 100-week moving average

More importantly, like in 2008, 2000, and 1929, valuations on stocks are incredibly high. While the bullish mantra over the last decade was “low rates justify high valuations,” rates are rising, which puts valuations at risk. The Fed historically hikes rates until “something breaks,” which drastically lowers valuations (i.e., prices fall sharply.)

Fed funds vs CAPE

Furthermore, the market remains exceptionally overbought in terms of both standard deviations from long-term means and relative strength (RSI) from a long-term technical perspective.

Quarterly technical conditions

Notably, consumer confidence is also at levels that historically align with more substantial mean-reverting events. (The chart below is the consumer confidence composite index of UofM and Conference Board measures.)

Consumer sentiment composite

These fundamental and technical measures can take long periods before they matter. Positioning for adverse outcomes today can both appear wrong in the short-term and cost capital appreciation opportunities.

However, these measures will likely prove beneficial in limiting capital losses in the longer term. The trick will be recognizing when they start to matter.

But when they do matter, they tend to matter a lot.

Don’t Let Emotions Control Your Investing

As Bob Farrell’s rule number-9 states:

When all the experts and forecasts agree – something else is going to happen.

As a contrarian investor, excesses get built by everyone being on the same side of the trade. Currently, everyone is so bearish that the reflexive trade will be rapid when the shift in sentiment occurs.

As Sam Stovall, the investment strategist for Standard & Poor’s, once stated:

“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

The takeaway from this commentary is not to let media headlines, financial narratives, or concerns over long-term issues like valuations, economics, or geopolitical events impact the decision-making process in your portfolio strategy.

Our job as investors is to capitalize on available opportunities but avoid the long-term risks.

There are plenty of reasons to be very concerned about the market over the next few months. However, markets can often defy logic in the short term despite the apparent weight of evidence to the contrary. As I noted previously:

“It is always important to never discount the unexpected turn of events that can undermine a strategy. While we continue to err on the side of caution momentarily, it does not mean we will remain wed to that view.”

The next few weeks, and even the next couple of months, will likely be frustrating. Markets are likely to remain rangebound with little progress made for either the bulls or the bears. We are maintaining our exposures to higher-than-normal levels of cash and underweight both equities and bonds.

portfolio allocations

There is little value in trying to predict market outcomes. The best we can do is recognize the environment for what it is, understand the associated risks, and navigate cautiously.

Leave being “bullish or bearish” to the media.

Portfolio Trade Alert – May 9, 2022

Trade Alert For Equity Model Only

Last week, Albemarle (ALB) surged back into extreme overbought territory. We are reducing ALB back to target portfolio weights for now.

We have 3-other positions that are on stop levels but are extremely oversold. So we will look to reduce positions further on a reflexive rally.

  • Reduce ALB to 3.5% of the portfolio

Viking Analytics: Weekly Gamma Band Update 5/9/2022

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) rallied mid week before falling sharply on Thursday and reaching new weekly lows on Friday. The pre-market today has seen S&P futures achieve new 2022 lows. Our gamma band model enters the week with a 0% allocation to the SPX and will remain flat as long as the SPX remains below the lower gamma level, which is currently near 4,220.

The Gamma Band model[1] can be viewed as a trend following model that is shows the effectiveness of tracking various “gamma” levels. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level,” the model will reduce the SPX allocation to zero.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

Risk management tools like this have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report). 

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. Rob has deep experience with market data, software and model building in financial markets.  Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.

 


This Week’s Top 10 and Bottom 10

KNX – negative

SELL

  • KNX dove below its 17-month uptrend line in early April. KNX has now recovered, rallying almost 10% since the first week in April, but it is now facing resistance from the earlier breakpoint (zoom chart). The weekly chart reveals that the recent break makes KNX vulnerable to the 2018, 2019, and 2020 lows.

TPA-RRG analysis shows that:

  1. The Transportation sector has moved quickly into the Lagging quadrant and that…
  2. …KNX has established a position in the Lagging quadrant.

Relative Rotation Graphs (RRG) – explanation video

RRG – written explanation

Fat Tails Scare Investors

The S&P 500 was down seven points this past week. Last week’s extreme volatility made it feel much worse. The “fat tails” graph below from the Daily Shot helps better appreciate the magnitude of volatility last week. The distribution of S&P 500 daily returns looks relatively normal. The two large fat tail moves, Wednesday and Thursday, appear to be anomalies, but are they? In a statistically perfect normal distribution of returns, there should have been 17 moves of 3 standard deviations or greater since 1970. We had two fat tails (>3 standard deviation) moves last week and 182 since 1970.

The bottom line is that fat tails are not as irregular as statistics and many risk analysts understand. More importantly, fat tails are more prevalent during bear markets. The markets are violent, but this is when it is most important to stick with our risk management and trading signals and not let emotions get the best of us.

fat tails returns sp 500

What To Watch Today

Economy

  • 10:00 a.m. ET: Wholesale inventories, month-over-month, March final (2.3% expected, 2.3% in prior print)
  • 10:00 a.m. ET: Wholesale trade sales, month-over-month, March (1.8% expected, 1.7% in prior print)

Earnings

Pre-market

  • Palantir Technologies (PLTR) to report adjusted earnings of 3 cents on revenue of $442.83 million
  • Coty Inc. (COTYto report adjusted earnings of 1 cent on revenue of $1.16 billion
  • Duke Energy Corp. (DUK) to report adjusted earnings of $1.33 on revenue of $6.30 billion
  • Tyson Foods (TSN) to report adjusted earnings of $1.90 on revenue of $12.85 billion
  • Blue Apron (APRN) to report adjusted losses of 69 cents on revenue of $125.00 million

Post-market

  • Plug Power (PLUGto report adjusted losses of 16 cents per share on revenue of $142.53 million
  • Novavax (NVAXto report adjusted earnings of $2.65. per share on revenue of $806.80 million
  • Simon Property Group (SPG) to report adjusted earnings of $2.76 per share on revenue of $1.22 billion
  • Zynga (ZNGA) to report adjusted earnings of 9 cents on revenue of $741.20 million
  • Vroom (VRM) to report adjusted losses of $1.02 on revenue of $872.73 million
  • Lemonade Inc. (LMND) to report adjusted losses of $1.42 on revenue of $43.3 million
  • AMC Entertainment (AMC) to report adjusted losses of 62 cents on revenue of $769.88 million

Market Trading Update

It was quite a stock market rollercoaster last week with a massive surge on Wednesday, followed by an equally significant plunge on Thursday. Volatility is both gut-wrenching and exceptionally hard to manage during fat tails.

stock market rollercoaster, Stock Market Rollercoaster Nauseates Investors

The market continued to hold support at the March lows and remains oversold on many levels. Sentiment also remains exceptionally negative, which will provide fuel for a reflexive rally when one occurs.

Notably, this is where investors tend to make the most mistakes. Everything, everywhere, is bearish. CNBC is running “Markets In Turmoil” specials (see below), and individuals get convinced the world is ending. However, as Howard Marks once stated:

In good times skepticism means recognizing the things that are too good to be true; that’s something everyone knows. But in bad times, it requires sensing when things are too bad to be true. People have a hard time doing that.

The things that terrify other people will probably terrify you too, but to be successful an investor has to be stalwart. After all, most of the time the world doesn’t end, and if you invest when everyone else thinks it will, you’re apt to get some bargains.

But that is very hard to do.

The Week Ahead

Investors get a bit of a break this week as the Fed meeting is now behind us. That said, there will be many Fed speakers discussing monetary policy, inflation, and the state of the economy.

On Wednesday, the BLS will release CPI. The current estimate is for the year-over-year inflation rate to tick up to 8.8%, from 8.5%. On the positive side, the monthly inflation rate is expected to slow significantly from 1.2% to 0.3%. Any downward surprise could be music to the stock and bond markets’ ears. The year-over-year PPI rate, due on Thursday, is also expected to rise. More inflation data comes Friday with import/export prices and the University of Michigan Inflation Expectations survey.

There will be a 10-year Treasury auction on Wednesday and a 30-year auction on Thursday. The auctions tend to weigh on prices, but we might see the opposite going into these auctions, given how beaten up bond prices are.

BLS Jobs Report

The BLS employment report was strong, with the economy adding 428k jobs last month. Beneath the surface, there are some signs of weakness. The broad measure of unemployment- U6 inched higher to 7%, and the participation rate fell by .2%. More concerning, average hourly earnings only rose .3% and 5.5% annually. Both are well below the inflation rate and will crimp personal consumption going forward. Personal consumption accounts for about two-thirds of GDP.

So, from a market perspective, what do we think? It is certainly good that the job market is expanding and the economy is hiring significant numbers of people. Growth is good for stocks. However, the strong jobs data gives the Fed reasons to continue to hike interest rates aggressively and start QT. Markets are already skittish over the Fed’s aggressive forecast, and this report will not ease those fears. However, weakness in real earnings may, in time, slow inflation and, at some point, allow the Fed to back off.

employment jobs labor

Tech & Media Stocks Are Having A Tough Time

On Thursday, the NASDAQ index fell 5%, its biggest one-day decline since 2020, as the list of stocks with eye-watering losses got a little bit longer.

Most notable yesterday was e-commerce darling Shopify, which fell 15% after posting its slowest revenue growth in 7 years, leaving its shares down 70% this year, worse even than Netflix’s high profile meltdown, which has seen its shares fall 69%.

Indeed, of the 192 large stocks in the Technology and Communication Services sectors, 167 are down this year. The only notable exception? Twitter — thanks to Elon Musk’s bid for the company that was way ahead of where the shares were trading. – Chartr

Bitcoin On The Edge

Bitcoin and stocks, especially the riskier Nasdaq stocks, have been very well correlated as of late. As such, the graph below of Bitcoin may help with the assessment of the Nasdaq. The weekly graph shows that Bitcoin sits on a critical upward support line. Four other times in the last year, the line has proven to be an excellent entry spot. Will it hold this time?

bitcoin

Markets In Turmoil Might Be What The Doctor Ordered

By airing their “markets in turmoil” special edition Thursday night, CNBC might have provided the panacea for what is ailing the markets. The table below from Charlie Bilello shows that the one-year S&P 500 returns following these specials have always been positive and very good in many cases. Before you get all bulled up, it’s worth sharing that a large number of the instances were all during the 2020 Pandemic crisis.

cnbc markets in turmoil
cnbc markets turmoil

Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Market Sector Buy/Sell Review – 05-09-2022

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

HOW TO READ THE CHARTS

There are five primary components to each chart if you want to recreate them yourself in the CHARTING application under the RESEARCH tab.

  • The top chart is the Williams %R set at 14-days
  • The candlestick price chart is bounded by two Bollinger Band studies set at a 50-dma with 2- and 3-standard deviations.
  • Below the price chart is a Stochastic indicator set at 14 %K periods, 3 %K smoothing, and 3 %D periods.
  • The MACD chart at the bottom is the primary buy/sell signal set at 12/26/9 days.
  • Some charts will also compare to the S&P 500 index itself as a measure of over/underperformance.

When the indicators are at the TOP of their respective charts, there is typically more risk and less reward available. In other words, the best time to BUY is when the majority of the indicators are at the BOTTOM of their respective channels.

Major Market Technical 05-01-2022, Major Market Technical Review – 05-01-2022

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

Basic Materials

  • While inflation is high, it erodes the profit margins of companies that can’t pass those costs along in full. As such we are seeing materials getting impacted.
  • Materials have broken both the 50- and 200-dma and remain on a short-term sell signal that is only about 50% through its reversion process.
  • There is a reasonable expectation that Materials will retrace to the bottom of their 2-standard deviation range over the next couple of weeks.
  • Short-Term Positioning: Bearish
    • Buy target is $80
    • Stop-loss is currently $84
  • Long-Term Positioning: Neutral

Communications

  • Long-term trend line is currently broken
  • Communications are extremely oversold and trying to base on recent lows.
  • Currently on a very deep sell signal (bottom panel) which is close to triggering a “buy signal.”
  • The downtrend in Communications from last September will present headwinds to reflexive rallies.
  • Short-Term Positioning: Bearish
    • Buy with a target of $65-66
    • Stop-loss is currently $58
  • Long-Term Positioning: Neutral

Energy

  • In November of 2020, no one wanted to own Energy stocks. Now, everyone is aggressively long the sector. Such is a warning sign in and of itself from a contrarian perspective.
  • Energy is extremely overbought on multiple levels and is pushing more extreme deviations from its 50-dma.
  • Currently, Energy is on a buy signal, but rallies from current levels should be sold into to take profits and reduce overweight positions.
  • Short-Term Positioning: Bullish
    • Hold current positions, look to add new positions on a pullback to $70
    • Stop-loss is currently $60 which doesn’t make a good risk/reward ratio at the current time.
  • Long-Term Positioning: Bullish

Financials

  • Financials have broken below both the 50- and 200-dma with the 50-dma now crossing below the 200-dma. Such does add additional downside pressure on Financials currently.
  • Support is currently holding along the $34.70 level and is currently pushing 3-standard deviations below the 50-dma. Such previously denoted short-term bottoms and tradeable rallies.
  • Currently on very deep sell-signal (bottom panel)
  • Short-Term Positioning: Bearish
    • Buy with a target of $37
    • Stop-loss is currently $34
  • Long-Term Positioning: Neutral

Industrials

  • As with Materials, Industrials are also being impacted by inflation eating into their profit margins.
  • Unlike Materials, Industrials are deeply oversold currently and sitting on decent support at the March lows.
  • Currently on very deep sell-signal (bottom panel)
  • Industrials are trading at more extreme 2-standard deviation levels below the 50-dma.
  • The 200-dma previously provided important overhead resistance and a failed test. The 50-dma is trading below the 200-dma providing downward pressure on the sector.
  • Short-Term Positioning: Neutral
    • Buy with a target of $100
    • Stop-loss is currently $94
  • Long-Term Positioning: Neutral

Technology

  • Technology has been under a lot of pressure this year with the sector now trading well into 2-standard deviation territory below the 50-dma.
  • Previous minor support from March is holding for now, but with the 50-dma trading below the 200-dma, rallies are likely limited for now.
  • Currently, Technology is on a very deep sell-signal (bottom panel)
  • While a rotational rally from overbought sectors like Energy to Technology is likely, the rally will likely be short-lived so use rallies to reduce risk and rebalance.
  • Short-Term Positioning: Bearish
    • Buy with a target of $150
    • Stop-loss is currently $139
  • Long-Term Positioning: Neutral

Staples

  • Staples remains one of the better-performing sectors this year but after getting extremely overbought has been correcting back to support at the 50-dma.
  • The 200-dma has been solid support and good buying opportunities for Staples.
  • Currently on an early sell-signal (bottom panel)
  • Short-term the sector is oversold and the 50-dma should hold.
  • Short-Term Positioning: Bullish
    • Hold current positions.
    • Look to add to positions at the 200-dma.
    • Stop-loss is currently $73
  • Long-Term Positioning: Bullish

Real Estate

  • Real estate took a fairly sharp hit over the last couple of weeks as rates continued to increase and weakness appeared in the housing market.
  • Support is holding at multi-month lows going back to June and July of last year.
  • Currently on an early sell-signal (bottom panel)
  • Currently oversold (top panel)
  • Short-Term Positioning: Bullish
    • Buy with a target of $50
    • Stop-loss is currently $43
  • Long-Term Positioning: Bullish

Utilities

  • Like the Energy sector, Utilities continue to perform well with the sector holding the 200-dma.
  • Support at the 200-dma has consistently been a good entry point to add holdings and selling when the sector pushes 2-standard deviations above the 50-dma.
  • Currently, Utilities are on a late sell signal. (bottom panel)
  • Oversold on a short-term basis.
  • Short-Term Positioning: Bullish
    • Buy at the 200-dma
    • Stop-loss is currently $65
  • Long-Term Positioning: Bullish

Health Care

  • Health care has performed better this year than other sectors but has certainly seen its share of volatility.
  • Currently on a very deep sell-signal (bottom panel)
  • Healthcare is also oversold short-term (top panel)
  • Support continues to hold at multiperiod lows back to October.
  • Short-Term Positioning: Bullish
    • Buy 1/2 of a position at current levels and 1/2 more at $128
    • Stop-loss is currently $123
  • Long-Term Positioning: Bullish

Discretionary

  • Like Technology, because of its exposure to Amazon (AMZN), the sector continues to perform poorly.
  • Support failed at the 200-dma which has now become notable resistance on failed rallies.
  • The sector is deeply oversold pushing into 3-standard deviation territory below the 50-dma. However, the negative cross of the 50-dma below the 200-dma provides formidable resistance.
  • Currently on a deep sell signal. (bottom panel)
  • Oversold on a short-term basis (top panel)
  • Short-Term Positioning: Bearish
    • Buy at current levels with a target of $175
    • Stop-loss is currently $157
  • Long-Term Positioning: Bearish

Transportation

  • So goes the economy, and so goes transportation. As the economy is showing signs of slowing Transportation has come under pressure.
  • Previous support is holding for now.
  • Currently, the sell-signal is in neutral territory which offers less reliable guidance. (bottom panel)
  • Transportation is approaching oversold on a short-term basis. (top panel)
  • Short-Term Positioning: Bearish
    • Buy at current levels with a target of $84
    • Stop-loss is currently $79
  • Long-Term Positioning: Bearish

ETSY Falls Victim to Strapped Consumers

Shares of ETSY plunged yesterday on a poor quarterly earnings report. We are not very concerned about ETSY, per se, but its woes tell a lot about the state of the consumer. ETSY is a moderate to higher-priced arts & crafts etailer. ETSY flourished during the Pandemic when consumers were flush with cash and had nothing to do but shop online. Now, consumers are increasingly strapped for cash as wages fail to keep up with inflation.

As we saw with Netflix, consumers now have to make hard decisions about what they purchase. Discretionary, non-necessity items, like those sold by ETSY, are the first type of items that consumers often step away from. Investors are picking up on the situation. The graph below shows consumer staple stocks are holding up much better than consumer discretionary stocks.

discretionary etsy staples

What To Watch Today

Economy

  • 8:30 a.m. ET: Change in non-farm payrolls, April (380,000 expected, 431,000 in March)
  • 8:30 a.m. ET: Unemployment rate, April (3.5% expected, 3.6% in March)
  • 8:30 a.m. ET: Average hourly earnings, month-over-month, April (0.4% expected, 0.4% in March)
  • 8:30 a.m. ET: Average hourly earnings, year-over-year, April (5.5% expected, 5.6% in March)
  • 8:30 a.m. ET: Labor Force Participation Rate, April (62.5% expected, 62.4% in March)

Earnings

Pre-market

  • Under Armour (UAA) to report adjusted earnings of 7 cents on revenue of $1.33 billion
  • Cigna (CI) to report adjusted earnings of $5.18 on revenue of $43.5 billion
  • DraftKings (DKNGto report quarterly results before market open

Post-market

  • No notable reports scheduled for release

Market Trading Update – A Failed Rally

The market continues to flirt with deep oversold and deviated levels from the 50-dma. As shown, since this consolidation started last September, deeply oversold levels repeatedly led to reflexive rallies of some magnitude. So far, the market remains unable to do that, however, such is usually the case just before it rallies. The markets tend to do things that frustrate the most investors every time.

We suspect the market is likely doing just that and yesterday’s selloff had many of the hallmarks of capitulatory selling. However, without a rally that has some follow-through, the markets will continue to struggle for the time being.

Market trading update

A Very Normal Year

Last year, I wrote that it had been so long since we had a 10% correction, that when it eventually came it would FEEL much worse than it actually was. Such has certainly been the case this year with investors panicking and dumping stocks like ETSY en masse. However, as Sam Ro noted for Yahoo Finance this morning, this is indeed a fairly normal year. To wit:

“It’s been an incredibly unpleasant year for stock market investors.

After setting a record closing high of 4,796 on January 3, the S&P 500 tumbled 13% to 4,170 on March 8. It then rallied to 4,631 on March 29, but then fell again hitting a closing low of 4,146 on Thursday, reflecting a max drawdown (i.e. the biggest intra-year sell-off) of 14%.

However, this year’s moves are nothing out of the ordinary. Since 1950, the S&P has seen an average annual max drawdown of 14%.”

He went on to quote RBC Capital Markets on how markets reacted during four recent growth scares. RBC noted that following market troughs, the six-month returns ranged from 18.2% and 28.6%. The 12-month returns ranged from 26.6% to 32.0%.

While it is easy to find a lot of reasons to be bearish, these data points are useful in retaining perspective and combatting confirmation bias.

Okay, now back to being bearish.

The Fed Taper

The Fed’s taper path is shown in the chart below. I plotted the taper through the end of 2023. Just to show you how gargantuan the Fed’s balance sheet is, at a $95 billion dollar monthly pace, they will only reduce their balance sheet to ~$7.25 Trillion.

Fed Taper

Jobs- a Mixed Picture

Today’s BLS jobs report follows Wednesday’s ADP report and will update us on the state of the labor markets. As we noted yesterday, the ADP report was good, but it showed a decline in the number of workers employed by small businesses. While there is little evidence the jobs market is peaking, the ISM manufacturing and services Employment surveys hint this may be changing. The manufacturing survey fell to 50.9, while services fell to 49.5. A reading below 50 points to economic contraction.

Assessing today’s labor market will be more complicated than in the past. For the last year or two, it was exceedingly hard to hire employees. As such, we think employers will hold onto employees longer than usual despite a slowing in business. This may make it initially difficult to see a declination in the jobs market in the traditional data sources such as initial jobless claims. To this point, the graph below from the latest JOLTS report shows that the layoff & discharge rate is the lowest in at least 20 years. At the same time, employees are still emboldened and willing to quit to find a better job.

The BLS jobs report is expected to show the economy added 400k jobs in April. Of growing importance, expectations are for a .4% increase in monthly earnings. While strong, such a result remains well below the inflation rate and further crimps the ability of consumers to spend.

jobs labor bls

Value Is Leading the Way

As we think about our investment portfolios, we strongly consider the economic and monetary factors that will likely guide the broader market trends. We then hone in on the stocks, sectors, and factors poised to out and underperform, given our economic and monetary outlooks. Thus far, in 2022, weak/slowing economic growth and tightening monetary policy are our guideposts. We do not see that changing in the near term. In this environment, low volatile, higher dividend stocks have outperformed while higher growth stocks have underperformed.

The graph below shows that the “growth” factor has separated winners from losers. If the same economic and monetary trends continue, as we think they might, the graph below may provide an excellent road map for portfolio allocations.

value growth

Expect the Expected- FOMC Recap

On Tuesday we wrote to “expect the expected” from the Fed meeting. We thought there was little chance the Fed or Powell would surprise in a dovish or hawkish manner. Post-meeting, the media considered it dovish that Jerome Powell dismissed raising rates by 75bps at the June meeting. Yes, 75bps was priced into the markets, but Fed members had not previously mentioned such a large increase. In our opinion, the market’s favorable reaction Wednesday was not justified by anything the Fed or Powell said. As such, the reversal on Thursday should not be shocking either.

As far as looking ahead, we must remember that the stock and bond markets remain a hostage to tightening Fed policy and tightening financial conditions. That will not change until inflationary data shows signs of slowing and the Fed starts to back down from its monetary forecasts. That said, there will be opportunities when markets deviate too far from trends.


Please subscribe to the daily commentary to receive these updates every morning before the opening bell.

If you found this blog useful, please send it to someone else, share it on social media, or contact us to set up a meeting.

Three Stocks to Short

This week’s scan differs from previous scans in two ways. First, we seek companies to sell or short, not potential long investments. Second, we only produced three selections this week. While we could have eased up on our criteria and included more companies, it would have cheapened the results too much for our liking. As such, here goes three for Friday!

With interest rates rising rapidly, we started our screening process by focusing on companies with higher debt levels. We then considered earnings, which is often how companies often make good on their debt. The screen resulted in three small-cap companies with less than $1 billion market caps. Often smaller cap companies do not have good access to bank financing, debt markets, or lines of credit due to their size. This puts them more at risk than larger corporations during periods of economic weakness and or crucial financial situations.

We caution short sales involve significant risks. While the companies met our short sell screening requirements, they may have factors we are unaware of that will significantly improve their financial condition.

Screening Criteria

We used the following screening criteria:

  • Debt to Equity >1
  • Long Term Debt to Equity >1
  • Quick Ratio (liquid assets/current liabilities) <1
  • EPS Growth This year and next year <0%
  • EPS Growth Past 5 years <0%
  • Sales Growth Past 5 years <2%

Company Summaries (all summaries courtesy of Zacks)

Clearwater Paper Corporation (CLW)

Clearwater Paper, a standalone company, produces pulp and paperboard at six facilities across the country namely Lewiston, Idaho; Las Vegas, Nev.; Elwood, Ill.; and near McGehee, Ark. The company manufactures quality paperboard, consumer tissue, and wood products. It has direct access to the public capital markets. The company is a premier supplier of private label tissue to major retail grocery chains, and also produces bleached paperboard used by quality-conscious printers and packaging converters.

CLW has a growth problem. Sales have increased a paltry 0.4% annually over the last 5-years, while EPS has decreased nearly 21% annually over the same period. Furthermore, EPS is expected to fall another 13% next year. Growth and profitability troubles combined with high debt and a times interest earned (TIE) ratio of 0.2 spell trouble in a rising rate environment.  

GasLog Partners LP (GLOP)

GasLog Partners LP owns, operates and acquires LNG carriers with multi-year charters. The Company charges customers for the transportation of their LNG using its LNG carriers. GasLog Partners LP is based in Monaco.

GLOP faces similar growth struggles to CLW. Its sales have grown 0.5% annually over the past five years while EPS has fallen 17.3% annually over the same period. To take it one step further, expectations are for EPS to decline 11% over the next five years. Despite all this, the stock is up more than 80% during the past year and over 30% YTD. The stock price appears to have gone too far, too fast on geopolitical developments. Insiders own 29% of the company, which is encouraging. That said, if they become sellers, the short thesis gets much more potent.

Rite Aid Corporation (RAD)

Rite Aid Corporation is on the front lines of delivering health care services and retail products to over one million Americans daily. It provides an array of whole being health products and services for the entire family through retail pharmacies across states.

RAD has an astronomical debt/equity ratio of 27.8. At the same time, it’s the only company in our screen results with a negative TTM operating margin and faces similar growth troubles. The market is not optimistic about RAD. The stock has fallen over 51% YTD versus a decrease of 17.2% in the Russell 2000 index. RAD is obviously struggling, and we’re not the only ones noticing. It has a high short interest percentage of 35%. While they may be correct, it does pose a risk to short-sellers if other short-sellers are forced to cover shorts resulting in a “short squeeze.”

Disclosure

This report is not a recommendation to buy or sell the named securities. We intend to elicit ideas about stocks meeting specific criteria and investment themes. Please read our disclosures carefully and do your own research before investing.

Buy And Hold Investing. Is It A One Size Fits All Solution?

“Buy and hold” investing. Is it truly a “one size fits all solution” to the investing conundrum? Or are there other considerations that would make such a solution less optimal?

I ask the question due to an email I received recently from one of the large Wall Street firms.

“Despite the tumble to begin this year, investors should not panic. Over the long-term course of the markets, investors who have remained patient have been rewarded. Since 1900, the average return to investors has been almost 10% annually…our advice is to remain invested, avoid making drastic movements in your portfolio, and ignore the volatility.”

As shown in the chart below, the advice given is not entirely wrong. Since 1900, the markets have averaged roughly 10% annually (including dividends). However, that figure falls to 8.08% when adjusting for inflation.

market total return nominal and real

By looking at the chart above, it’s pretty evident that you should invest heavily in the market and “fughetta’ bout’ it.”

If it was only that simple.

Advertisement to schedule a consultation today.

Two Important Problems

While the average rate of return may have been 10% over the long term, the markets do not deliver 10% every year. Let’s assume an investor wants to compound their returns by 10% a year over 5-years. We can do some basic math.

Compound return table

After three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required. 

There is a significant difference between AVERAGE and ACTUAL returns. The impact of losses destroys the annualized “compounding” effect of money.

To prove that, the purple shaded area shows the “average” return of 7% annually. However, the differential between the promised and “actual return” is the return gap. See the problem?

Stock market average vs actual returns.

The differential between what investors were promised (and a critical flaw in financial planning) and actual returns are substantial over the long term.

Secondly, and most importantly, you DIED long before you realized the long-term average rate of return.

The chart box below shows a $1000 investment for various starting periods. The total return holding period is from 35-years until death using actuarial tables. There are no withdrawals. The “promise” of 6% annualized compound returns is the orange sloping line. The black line represents what occurred. The bottom bar chart shows the surplus, or shortfall, of the 6% annualized return goal.

Real total return for selected periods with life expectancy.

At the point of death, the invested capital is short of the promised goal in every case except the current cycle starting in 2009. However, that cycle is yet to be complete, and the next significant downturn will likely reverse most, in not all, of those gains.

The Problem With Long-Term

Such is why using “compounded” or “average” rates of return in financial planning often leads to disappointment.

Let’s consider the following facts in regards to the average American. The national average wage index for 2020 is $55,628.60, lower than the $62,000 needed to maintain a family of four today.

Assuming that the average retired couple will need $40,000 a year to live through their “golden years,” they will need roughly $1 million, generating 4% a year in income. Since approximately 90% of Americans have saved less than one to two years of annual income, funding retirement could be problematic.

While many suggest the “buy and hold” investing will work over the long term, for most, that period is roughly 15-20 years until retirement.

Here is the problem.

There are periods in history where returns over 10-year periods were negative.

real total returns rolling 10-year returns

The return has everything with valuations and whether multiples are expanding or contracting. As shown in the chart above, real rates of return rise when valuations expand from low to high levels. But, real rates of return fall sharply when valuations have historically exceeded 23x trailing earnings and revert to their long-term mean.

Yes, “buy and hold” investing will work, but it depends on WHEN you start your investing journey. At 35x CAPE, such suggests that returns over the next 10-20 years could be disappointing.

Rolling 10-year forward returns and valuations scatterplot

Timing Is Everything

The MAJORITY of the returns from investing came in just 5 of the 9-major market cycles since 1871. Every other period yielded a return that lost out to inflation during that time frame.

market cycles

With this in mind, this is where the email went awry with selective data mining:

“Among the key findings: On average, participants who kept contributing to their retirement plans throughout the 18-month period (October 2008–March 2010) had higher account balances than those who stopped contributing; Participants who maintained a portion of their retirement plan asset in equities throughout the entire period ended up with higher account balances than those who reduced their equity exposure amid the peak period of market distress.

Stock market 2008

Thus, retirement investors who kept contributing to their plan and who maintained some exposure to equities throughout the period were better off throughout the market’s 18-month bust-boom period than those who moved in and out of the market in an attempt to avoid losses.”

The main problem is selecting the start and ending period of October 2008 through March 2010. As you can see, the PEAK of the financial market occurred a full year earlier, in October 2007. Picking a data point nearly 3/4ths of the way through the financial crisis is egregious.

It took investors almost SEVEN years to get “back to even ” on an “inflation-adjusted basis.”

Every successful investor in history, from Benjamin Graham to Warren Buffett, has particular investing rules that they follow. Yet Wall Street tells investors they can NOT successfully manage their own money, and “buy and hold” investing is the only solution.

Why is that?

More importantly, if it worked as stated, why are 80% of Americans broke instead of rich?

Advertisement to sign up for SimpleVisor, the self-guided investor research site from RIA Advisors.

Buy And Hold Works, Until It Doesn’t.

“buy and hold” investing works well during strongly trending market advances. Given enough time, the strategy will endure the eventual market downturn. However, three key considerations must get considered when endeavoring into such a strategy.

  1. Time horizon (retirement age less starting age.)
  2. Valuations at the beginning of the investment period.
  3. Rate of return required to achieve investment goals.

Suppose valuations are high at the beginning of the investment journey. If the time horizon is too short or the required rate of return is too high, the outcome of a “buy and hold” strategy will most likely disappoint expectations.

Mean reverting events expose the fallacies of “buy-and-hold” investment strategies. The “stock market” is NOT the same as a “high yield savings account,” and losses devastate retirement plans. (Ask any “boomer” who went through the dot.com crash or the financial crisis.”)

Therefore, during periods of excessively high valuations, investors should consider opting for more “active” strategies with the goal of capital preservation.

Important Points To Consider

Before engaging in a “buy and hold” investment strategy, the analysis reveals essential points to consider:

  • Investors should downwardly adjust expectations for future returns and withdrawal rates due to current valuation levels.
  • The potential for front-loaded returns in the future is unlikely.
  • Your life expectancy plays a huge role in future outcomes. 
  • Investors must consider the impact of taxationinflation, and current savings rates.
  • In a world where markets are highly correlated, MPT is likely not effective in portfolio allocation strategies.
  • Drawdowns from portfolios during declining market environments accelerate principal destruction. During up years, plans should be made to “safe harbor” capital for reduced portfolio withdrawals during adverse market conditions.
  • Over the last 12-years, the yield chase and the low rate environment have created a hazardous environment for investors. Investment strategies should accommodate for rising volatility and lower returns.
  • Investors MUST dismiss expectations for compounded annual return rates in place of variable rates of return based on current valuation levels.

There is no “one best way to invest.”

Every investor must account for the myriad of variables that will impact their investment returns and financial goals over time. Most importantly, investors must realize that surviving the eventual bear market is more important than chasing the bull market.

The “best way to invest” is navigating the entire market cycle between when you start investing and when you need your capital.

“Buy and hold” strategies are the “best way” to invest until they aren’t.

Just make sure you know where you are within a given market cycle to increase your odds of success.

Portfolio Trade Alert – May 5, 2022

Trade Alert For Equity & ETF Models Only

This morning markets took a sharp hit reversing all of yesterday’s Fed relief rally. The selling was broad across the markets with little room to hide. However, we have been watching companies on the value side of the ledger that pay strong dividends and should help protect the portfolio in the event of further market deterioration.

Therefore, we nibbled at a little exposure to both models via lower beta, more conservative stocks/sectors. In the sector model, we added VYM which is a high dividend value ETF. The graph below shows this factor has been the place to be thus far in 2022. If we assume the trends of the first four months continue, we suspect these stocks should continue to outperform.

Equity Model

  • Initiating a 1.5% position in Verizon (VZ) after selling it last year at higher levels.
  • Increasing exposure to Public Storage (PSA) to 2.5% of the portfolio following the recent selloff.

Sector ETF Model

  • Initiating a 2% position to VYM to increase value weighting in the portfolio.

Secure Act 2.0. How Will it Affect Your Retirement?

The Secure Act and all its iterations over the last few years remind me of the Terminator movies. After a while, you don’t care because it’s always the same plot with minor tweaks.  Secure Act 2.0 will affect your retirement, but how? Is it just another mindless sequel? Let’s explore.

H.R. 2954 has passed the Senate and is off to the House so, it’s time for  – Secure Act 2.0 – Judgment Day but without cool robots. Are there some good ideas on the table to bolster retirement savings? Yes. Can much more be done? Yes. Stay tuned for Secure Act 3.0 by 2023.

Overall, I cover the most significant changes. Again, we don’t know which version passes the Senate but my thought is Secure Act 2.0 is ready for launch just the way it is.

The expansion of automatic enrollment in retirement plans.

There are multiple studies that show humans do better when ‘nudged’. When given a choice most people have a difficult time opting into something. Yet, we rarely opt out of choices, especially if the decision proves beneficial.

In the case of auto-enrollment, success is evident. It’s proven to be the financial Roach Motel.  H.R. 2954, requires employers that establish new defined contribution plans to auto-enroll employees at 3% of pretax pay. Every year, this auto-enroll contribution increases by 1% up to no more than 10%. Subsequently, a participant can elect to stop or alter the contribution percentage.

There are specific types of retirement plans excluded, such as SIMPLE IRAs. Why? I have no clue.

Bolster of the Saver’s Tax Credit.

Keep in mind, that a tax credit is a dollar-for-dollar reduction in tax liability. The bill increases the credit to a flat 50%. for lower-income households

As part of Secure Act 2.0, more households receive the credit. This provision won’t be effective until after December 31, 2026.  Wisely, increased communication about the credit is also part of the bill.

Currently, a taxpayer can claim the credit for 50%, 20% or 10% of the first $2,000 contributed during the year to a retirement account. The tax credit is non-refundable and reduces a tax liability dollar for dollar.

Joint filer households with $39,500 or less AGIs would receive the maximum 50% credit. Sadly, the Saver’s Credit often gets overlooked. Overall, raising the bar to 50% and lower AGI requirements are positive developments.

Increase in ages for mandatory retirement distributions.

The Secure Act 2 raises the RMD age to 75.

In 2023, the RMD age would be 73 (for people who reach age 72 after December 31, 2022), 74 in 2030, and 75 in 2033. Hopefully, the final bill removes the unnecessary speed bumps. I have no clue why these mandatory distribution edicts must be so complicated.

Annual Roth conversions may take on new attention due to RMDs later. For example, instead of an RMD, an IRA holder may decide to convert those dollars to Roth instead. Required minimum distributions are not eligible for Roth conversion. Redirecting RMD dollars to a surgical, annual Roth strategy allows for the buildup of a tax-free bucket of money for tax control in retirement.

The indexing of IRA catch-up limits in the Secure Act 2.0.

Catch-up contribution limits to individual retirement accounts for those 50 and older have been $1,000 for an eternity. In the Secure Act 2.0, catch-up additions are indexed for inflation in 2023.

Also, the catch-up limits for SIMPLE plans would be raised to $5,000 from $3,000 and indexed for inflation. Accelerated catch-up contributions for retirement plans would increase to $10,000 but only for those who have attained ages 62, 63, 64 but not 65.

What makes 62, 63, and 64 so unique for robust catch-up contributions is beyond my scope to understand. I don’t think it’s a negative aspect, just a confusing one, especially since the average retirement age is 61. The Secure Act 2.0 looks to be a financial ‘smack in the head’ for people who are way behind saving for retirement.

Overall, a positive is how catch-up contributions beginning in January 2023 would be required to be in Roth options such as Roth 401k or 403b. The Secure Act is receptive to Roth because the government hungers for money now. Perhaps I should have compared the Secure Act 2.0 to The Hunger Games?

The government is following RIA’s ‘J.G. Wentworth – I need cash now!’ mentality and becoming more receptive to Roth options. As readers probably know, we are proponents of tax diversification and control in retirement. A retiree should maintain investments in various buckets, pre-tax, after-tax, tax-free, so they can craft tax-efficient account distributions.

A challenge may be that not every organization offers a Roth option and will need to do so.

Title II – Preservation of Income.

An encouraging aspect of this bill is the attention to guaranteed income options in retirement plans.

Let’s face it: Many retirees will need guaranteed options to generate lifetime cash flow. In the face of longer life expectancies, annuities will be an essential part of a retiree’s income plan.  As markets enter a tumultuous, lower return cycle, retirees will require a personal pension to do some of the heavy lifting stocks may not.

The Secure Act 2.0 provides instruction to add fiduciary disclosures and Safe Harbors for lifetime income providers. In addition, a provision for the portability of these products. So, if switching employers or rolling the assets into an IRA, an employee won’t need to start again with a new recordkeeper and lose the build-up of lifetime income benefits.

Overall, this is a positive development. Incorporating insurance into a retirement plan platform has been messy due to the services recordkeepers provide vs. ERISA fiduciaries. According to NAPA or the National Association of Plan Advisors, Safe Harbor rules are crucial to the viability of this part of the act.

What is a plan fiduciary?

Consider a proper plan fiduciary as one who protects participants from an improper vendor and is responsible for the selection of guaranteed income vehicles (annuities), that pass a fiduciary standard.

Per NAPA: the plan fiduciary needs to follow specific steps to obtain the safe harbor protection for the selection of a “guaranteed lifetime income contract.”

The need for education by plan sponsors will be paramount. As I believe their priorities are variable investment vehicles such as mutual funds and exchange-traded funds, the education necessary to help consumers make objective decisions on insurance products could be a challenge. However, with the proper fiduciaries involved along with guidance from a knowledgeable financial advisor, I am hopeful this initiative will be successful.

Expedite Part-Time Worker Plan Participation.

Part-time employees receive advantages too. Overall, Secure Act 2.0 would benefit long-term part-timers by shortening the period of eligibility for retirement plan enrollment from three to two years.

Matching Contributions for Qualified Student Loan Payments.

Think of it this way – You’re a young worker saddled with the decision to contribute to your employer’s retirement plan or pay down a student loan. With this proposal, an employee can receive matching contributions (most likely 3%), to a retirement plan even though not contributing due to a student loan debt burden.

Many other proposed actions include more aggressive tax credits for small businesses,  a national database for lost retirement accounts (more common than you think), and a broader reach for Roth with SIMPLE and SEP Roth options (about time).

Overall, I rate the Secure Act 2.0 a C+ which for me, is a vast improvement due to Rothification and Annuitization elements. However, there’s a long way to go, especially when it comes to broad initiatives and incentives to teach financial literacy.

We’ll see how the final version of the bill turns out.

As Arnold laments in the Terminator films – I’ll be back.

The Secure Act sequels have just begun. They will also – be back.

Click here for money geeks like me who’d like to read the entire bill.