Monthly Archives: October 2020

Trump vs. Biden on the Economy, Fed, and Markets

Trump vs. Biden on the Economy, Fed, and Markets

On November 3, 2020, the White House, one-third of the Senate, and the entire House of Representatives are on the ballot. In case it is not obvious, this election will be significant.

In the current politically charged environment, either Presidential candidate will be powerless to enact significant change if the opposing party holds a majority in the Senate and House. Conversely, a sweep whereby the President and both houses are from the same party can produce substantial change.

This article’s focus is on Donald Trump’s and Joe Biden’s policies; however, we stress the outcome of the legislative elections may nullify or exaggerate our forthcoming thoughts.

Does It Matter?

The age of passive investing is upon us. Passive investors do not assess earnings or economic factors. They buy and sell based on cash on hand or cash needs. They are price insensitive. It is a brain-dead strategy.

It is tempting to conclude that the election will not matter in this environment. That might be true, but this current bit of investor irrationality will end. When it does, we would be well-served to understand the economic underpinnings of corporations. Therefore, it is incumbent upon us to review the candidates and consider how they might affect the economy, Fed, and, ultimately, the financial markets.

The following sections provide our unbiased opinions on how Donald Trump and Joe Biden are likely to approach critical economic matters if elected.

International Trade

The most significant change in international trade over the last 40+ years is the “America First” stance Donald Trump hoisted onto global trade. His policy was most evident in China relations.

Trump is the first President to attack China’s trade policies since they became an exporting powerhouse. Not only did he put $350bn in tariffs on China, but pledges more negotiations if wins. The effectiveness of actions is questionable, but they are a step in the right direction to reduce our trade deficit and become less dependent on a totalitarian adversary.

Biden seems to agree with Trump’s stance on China and may leave the tariffs in place. We are less sure as to whether he will take the baton and stay aggressive.

The more significant difference between them lies in how they manage relationships with our second and third biggest trade partners, Canada and Mexico, as well as Europe and Japan. Trump has upped rhetoric towards these countries and introduced tariffs in some cases. We suspect similar actions will continue under a second term as he aims to level the trade playing field.

Biden will likely be friendlier to our allies and much less likely to buck current trade norms. Any trade agreement/pact in place is much more likely to remain intact under Biden than Trump.

The dollar may fare worse under Trump as his actions will incentivize foreign nations to use their currencies for trade.

Taxes

Trump reduced taxes in 2018 and is now allowing the deferral of payroll taxes for lower and middle-class wage earners. Both changes are temporary but Trump promises to make them permanent if he wins a second term. He is also likely to push for further tax cuts for individuals and corporations. The tweet below speaks volumes.

Biden’s team has made a variety of tax proposals, but we can outline the “Big 5” –

  1. Raising the top income tax rate on regular income to 39.6% from 37.0%
  2. Raising the corporate tax rate to 28% from 21%
  3. Ending the step-up basis at death
  4. Treating long-term capital gains and qualified dividends as regular income for those earning over $1 million
  5. Applying the social security payroll tax on incomes over $400,000

Needless to say, Biden appears likely to increase taxes on the wealthy. It is unclear how Biden will treat lower and middle-income taxpayers.

JP Morgan believes stockholders may see an increase in their tax burden under a Biden presidency. Per JP Morgan “Biden’s proposal is for the maximum tax rate for long-term capital gains to rise to 39.6% from 23.8% currently, a 66% proportional rise.

All of the “Big 5” are controversial and politically charged, so a Biden-Harris administration would probably need more than a 51 or 52 Senate advantage to enact some or all the changes.

Regulations

Trump is perceived to be business-friendly as he rolled back a large number of regulations. Some of the key regulations include those in agriculture, education, environmental, finance, health, housing, labor, and transportation.

In Trump’s words- “For every one new regulation added, nearly eight regulations have been terminated.”  We expect more deregulation under a second term. From a shareholder perspective, this will be favorable for corporate earnings.

Biden is likely to walk back some of Trump’s regulatory actions, especially those affecting labor, environment, and housing. The energy sector probably has the most at risk.

Trump has opened up drillable land and waters and promoted pipelines. He is even trying to keep the coal industry alive. His agenda is very much pro domestic carbon energy.

As was the case under Obama, the Biden-Harris administration will be greener. They will probably create headwinds for the carbon-based energy industry while favoring renewable energy. The “Green New Deal” liberal wing of the Democratic Party has a strong voice and power to persuade legislation.

Biden and Harris are accused of wanting to shut down fracking. Although they have been documented as having said it, they both deny it. Natural Gas, on the other hand, maybe more at risk. Per Bloomberg: “Biden’s plan could speed up natural gas becoming “economically and environmentally untenable within the power sector.”

Under Biden, renewable energy producers are likely to benefit. This helps explains why TAN (Invesco’s solar ETF) has been surging as Biden’s polling lead expands.

Biden will likely try to re-engage in the Paris Climate Agreement and possibly enter the U.S. into other global environmental pacts. Again, those companies in alternative energy space should benefit at the expense of carbon-based companies.

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

Deficit Spending

One thing we can count on from both candidates is massive fiscal deficits. In the first debate, both candidates made it clear that spending, albeit on different items, is a top priority. They both recognize that economic growth is heavily reliant on federal spending. As we know, electability heavily rests on economic activity.

One crucial difference between the two is that Biden will likely spend more than Trump but will raise taxes. Trump may spend less but cut taxes. At the end of the day, both are likely to administer trillion-dollar-plus annual deficits

Before COVID, Trump averaged deficits of almost $800 billion per year. In the current fiscal year ending this month, he will administer a record $3.1 Trillion deficit. That deficit is massive, even by 2009/10 recession standards.

While government spending accelerated under Trump due to COVID, we should expect similar trends if Biden is the President. He says he will introduce over five trillion dollars in additional spending to what is already in forecasts.

Trump is more likely to focus on defense spending, while Biden on infrastructure and social causes.

Both will perpetuate the deficit problems. Companies that are closer to the Treasury’s money spigot are likely to benefit the most. As discussed earlier, policy implementation is dependent on the composition of the House and Senate and the ability of Congress and the President to work together.

“Under our central estimate, neither major candidate for President of the United States in 2020 has put forward a plan that would address our unsustainable fiscal path. Instead, both President Donald Trump and former Vice President Joe Biden have promoted policy agendas that would likely significantly add to annual deficits and increase debt-to-GDP over the next decade.” – The Cost of the Trump and Biden Campaign Plans – Committee for a Responsible Federal Budget (CRFB)

Federal Reserve

Chairman Jerome Powell’s current term ends in February 2022. We suspect that both candidates are likely to keep him at the helm. While Trump had public qualms with Powell, Powell seemed to redeem himself with the COVID era policy. Powell’s Fed has, and continues to provide monetary stimulus to a level this country has never seen before. Markets are up in large part due to the Fed flooding the system with liquidity. Despite his criticism of Jerome Powell, President Trump has been a beneficiary of Federal Reserve policies.

While Powell is a Republican, we think Biden could likely keep him aboard as well for similar reasons.

COVID

When assessing COVID from an economic standpoint, it may not matter who the President is. As we have learned, much of the power to restrict economic activity lies at the state, county, and city levels. Further, most individuals, regardless of restrictions, take matters into their own hands.

Biden is much more likely to encourage restrictions than Trump. Indeed, both candidates will aggressively push for a vaccine and treatments.

Summary

In 2016, as it became evident that Trump would beat Hillary Clinton, the market plummeted. It followed the “Trump is bad for the market” narrative of the time. In 24 hours, the market ran an audible with a new “Trump is pro-market” narrative.

Coincidently, until a few weeks ago, Trump was considered good for the Market and Biden bad. Biden has extended his lead in polling, and not surprisingly, the narrative changed. Biden’s massive spending plans can only be good for stock prices, they say.

As we noted earlier, a President’s power is dependent on the composition of the House and Senate. If the future President is working with the opposite party in Congress, less is likely to occur. As such, many of the differences noted above may not matter. Conversely, if one party sweeps the legislative and executive branches, the differences will be significant.

One final consideration. We know what we are getting with Trump. Despite nearly 50 years in government, Biden is a wild card. He has shown a willingness to change prior long-held views to accommodate the quickly evolving liberal wing of his party. How will that play out if Biden wins the election? Will he take on the platform of his party’s very liberal side, or will he maintain the more moderate views he has held consistently over his lifetime?

Sector Buy/Sell Review: 10-20-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 10-20-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when. It also guides what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

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

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

SECTOR BUY/SELL REVIEW: 10-20-20

Basic Materials

  • XLB held support and bounced off the 50-dma surging back to its previous highs. There is now a double-top with a more extreme overbought condition. 
  • Take profits on trading positions and look for a correction back to support to increase sizing.
  • Momentum is good, but it is still underperforming the market as a whole.
  • Keep stops on trading positions at the 50-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: Hold Positions
    • Stop-Loss moved up to $62
  • Long-Term Positioning: Bullish

Communications

  • Communications is continuing to flirt with its 50-dma support level. 
  • The uptrend remains intact, but XLC is underperforming the broad market while working off its overbought condition. This will likely provide a good setup for a trade post-election, but keep stops in place for now. 
  • Stops remain at $58.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Bullish

Energy

  • Energy did bounce off of recent lows but failed to do much with it. Energy is massively underperforming the broad index and will retest recent lows. 
  • The lows must hold, or XLE is going to retest the March lows. 
  • The overall trend is fragile, remain clear for now.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Bearish

Financials

  • Financials continue to underperform, and the “earnings bounce” has now reversed.
  • XLF is testing it’s 50- and 200-dma with a “Golden Cross” now in place. If XLF can hold support and rally, there is a decent upside for the sector. A failure at support will be very disappointing. 
  • We saw the same bounce last quarter that eventually failed, but there wasn’t a positive bias to the moving averages. So, give financials a little breathing room. 
  • We are still avoiding the sector for now, but we will add holdings to our portfolios if support holds and performance improves.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Industrials

  • XLI has rallied sharply and is back to extreme overbought levels and extensions.
  • We are holding our exposure for now, but take profits and rebalance risks as needed. 
  • XLI is pushing back up into the 3-standard deviations of the 50-dma and is underperforming the S&P. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bullish

Technology

  • Technology stocks and the Nasdaq failed at a lower high than previous, which is concerning. 
  • The sector is back to very overbought and is now running into the previous resistance. 
  • Beware of short-term risks, but the 50-dma is holding for now. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Hold positions
  • Stop-loss moved up to $110
  • Long-Term Positioning: Bullish

Staples

  • XLP has exploded higher over the week and went back into extreme overbought territory. The correction on Monday was not surprising. 
  • The sector is back to very overbought and well above the 50-dma, so more correction is likely. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $62 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Real Estate

  • Last week, XLRE rallied back into previous resistance. On Monday, the sell-off took it back below the 50-dma. 
  • Last week, we noted that XLRE was very overbought and extended with multiple tops providing resistance at current levels. That resistance proved to be too formidable for now. 
  • Move stop-losses up to the 200-dma.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Utilities

  • XLU had been struggling with resistance at the 200-dma. However, XLU surged back to extremely overbought conditions after breaking above resistance. 
  • XLU is now 4-standard deviations above the moving average. 
  • Take profits and rebalance risk. 
  • Short-Term Positioning: Neutral
    • Last week: Reduced XLRE by 50%.
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • XLV is sitting on its 50-dma and needs to hold here. 
  • The previous overbought conditions have been resolved and are still intact. Use weakness to add to holdings.
  • The 200-dma is now essential price support for XLV.
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Discretionary

  • XLY rallied back to new highs last week after we added exposure and is extremely extended. 
  • Take profits and rebalance risk. The 50-dma is an important initial support. 
  • Stop-loss moved to $140
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Long-Term Positioning: Bullish

Transportation

  • Transportation has been rallying on hopes from infrastructure but failed at its previous highs. 
  • The sector is overbought and ran into previous resistance. 
  • The “buy signal” remains very extended. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and are waiting for a better entry point to add to our holdings.
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Neutral

Technically Speaking: Market Bulls Are “All-In” Again

In yesterday’s post on “Moral Hazard,” we discussed how Fed actions shifted the “risk appetite” of investors through “perceived” insurance against losses. As we head into a potentially contentious election, market “bulls” are “all in” again as hopes remain high that more “stimulus” will soon come.

Since the Fed intervened in March, investor sentiment has gotten run back up to extremes despite the economy remaining amid a deep recession.

As I noted in this past weekend’s RIAPro Subscriber Newsletter (30-day Risk-Free Trial), both the Technical and market positioning “Fear/Greed” gauges have moved back into more extreme territory following the brief September decline. Such is the case even though “stimulus” remains elusive, the Fed is on the sidelines, and economic growth has begun to disappoint as noted by the Economic Surprise Index.

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. Given this is weekly data, its readings move slowly and align with short-term peaks and troughs of markets

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade

This Week 10-02-20, #WhatYouMissed On RIA This Week: 10-02-20

More Sentiment Extremes

One of the sub-components of the “Fear/Greed” gauge is the NAAIM index of professional investors, which measures the percentage allocation to that group’s equities. Currently, equity allocations of professional investors are back to full weightings. While such doesn’t mean the markets are about to crash, more often than not, their “bullishness” has tended to be an excellent short-term “contrarian” indicator.

The same goes for large speculative traders in the options market. With call option buying back to more extreme levels, the risk remains skewed to the downside.

Short-term market timers are also back into the “excessively bullish” zone.

Okay, you get the idea; investors are “all-in” as we head into the election.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Short-Term Trends Remain Bullish

Despite market sentiment on the more extreme side, the market’s short-term dynamics remain bullish for now. As shown below, the market remains above both the 20- and 50-dma, with the 20-dma very close to a positive cross. Such gives the market a decent level of nearby support, which should buoy prices near term.

There is a risk of a deeper sell-off in the short-term. As noted this past weekend, a contested election leaves the market vulnerable to a decline. September lows, and below that, the 200-dma are viable targets for a short-term correction. Furthermore, given the markets have been running on hopes of “more stimulus,” there is a growing realization that another rescue package may not be coming until well after the election.

Either of those events would most certainly lead to lower asset prices in the short-term.

Intermediate Trends More Cautious

On a weekly basis, the market remains in a clear bullish trend from the 2009 lows. The correction in March did not clear the market excesses in terms of valuations and price action. Note in 2008, chart below, the depth of the decline in the indicators. The decline in March did not reach those more extreme levels. As noted in that article:

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

I discussed this concept in the video below.



While the “correction” in March was unusually swift, it did not break the long-term bullish trend. Such suggests the bull market that began in 2009 is still intact as long as the monthly trend line holds.

With the current deviation above the long-term bullish trend and a negatively diverging RSI, the risk of a bigger correction in 2021 has grown. The only two real questions that investors must consider:

  1. What will be the catalyst that starts the liquidation event; and, 
  2. Will the Federal Reserve be able to “bailout” the markets a third time?

The monthly trends confirm the same.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Monthly Trends Remain Bearish

On a longer-term basis, we remain concerned about the dichotomy of signals from the market. RSI’s negative divergences also appear on a monthly basis, along with the number of stocks above their respective 200-dma and extreme monthly overbought conditions.

Market Stumbles Stimulus Fade, Market Stumbles As Stimulus Hopes Fade 10-16-20

The previous extensions over the last decade have led to decent corrections and outright bear markets.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Hedging For Unknowns

Could this time be different? Sure, anything is possible. However, as investors, we want to remain focused on the “probabilities.”

What it won’t be is the “election.” Market participants have already “weighed and measured” the various outcomes of the election from a Biden “win” to a “blue wave.” Historically speaking, the markets quickly adapt to the next President and “price in” potential policy shifts.

The market likely has not fully priced in a “contested election” as we saw in 2000, which implies a 7-10% decline in the market. 

There is no clear pathway for the markets currently, which is why we are beginning to evaluate our current holdings and starting to hedge for potential risks heading into the election.

Slow At First, Then All Of A Sudden

What all of this suggests is that “risk” is building in the markets.

However, risk builds slowly. Such is why the investment community often uses the analogy of “boiling a frog.” Turning up the heat slowly, frogs don’t realize the peril until it’s too late. The same is true for investors who make a series of mistakes as “risk” builds up slowly.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

The end effect is not a pretty one.

When the buildup of “risk” is finally released, the explosion happens all at once, leaving investors paralyzed, trying to figure out what just happened. Unfortunately, by the time they realize they are the “frog,” it is too late to do anything about it.

Rules To Follow

Given that markets are still hovering within striking distance of all-time highs, there is no need to take action immediately. However, the continuing erosion of underlying fundamental and technical strength keeps the risk/reward ratio out of favor. As such, we suggest continuing to take actions to rebalance risk.

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Hedge portfolios against major market declines.
  3. Take profits in positions that have been big winners.
  4. Sell laggards and losers.
  5. Raise cash and rebalance portfolios to target weightings.

As stated, the market’s long-term dynamics remain unfavorable, and the liquidity-fueled rally from the March lows have only exacerbated previous overvaluations. Could the market rise from current levels through the end of the year? Absolutely, and is something that we currently expect to happen. 

However, we think 2021 may start the “payback” process as economics and fundamentals play catch up with reality.

But we will deal with that issue next year.

TPA Analytics: Top 10 Buys & Sells As Of 10-19-20

Top 10 Buys & Sells As Of 10-19-20

These are high conviction stocks that TPA has recommended recently. They are technically positive for “buys,” or negative for “sells.” They are also trading at, or near, the recommended action price levels.


Note from the RIAPro Team:

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

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

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

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

Viking Analytics: Weekly Gamma Band Update 10/19/2020

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 10/19/20

  • We continue to maintain full exposure to the S&P 500 (SPX) entering this week. Price retreated from the upper gamma band and found support near the Gamma Neutral level last week.  
  • The upper band is currently at 3,542, and while this level may occasionally be seen to act as resistance, the back-test does not suggest reducing exposure when SPX hits the upper band level.
  • Our binary Smart Money Indicator continues to have a full allocation, as discussed in greater detail below. The Smart Money indicator is turning lower but is a long way from changing to a flat allocation.
  • SPX skew, which measures the relative cost of puts to calls, continues to be neutral.
  • Our Thor Shield daily allocation model will significantly reduce exposure to SPY at the close today (10/19).  ThorShield is a fast, daily signal based upon daily put and call volume.  Samples of all of our SPX and ThorShield daily reports can be downloaded from our website.

Smart Money Residual Index

This indicator compares “smart money” options buying to “hot money” options buying.  Generally, the smart money will purchase options to ensure stable returns over the longer-term.  The smart money has in-depth knowledge and data in support of their options activity. In contrast, “Hot money” acts based on speculation, seeking a large payoff.

At the moment, hot money is more cautious than smart money, and the back-test supports a long position during this time.  When the Residual Sentiment Index in the second graph turns to red, then this model will cut all equity exposure to zero.  When the market is in the red regime below, the market has an overall negative return.

SPX Skew – the Price of Protection

In evaluating equity market risk, we also consider the cost of buying puts versus the cost of buying calls.  When puts command a larger-than-usual premium to calls, then the market will have higher volatility (in the red zone below), and this might be a signal to reduce equity exposure.  We consider skew to be neither bullish nor bearish at the moment.

Gamma Band Background

Market participants are increasingly aware of how the options markets can affect the equity markets in a way that can be viewed as the “tail wagging the dog.” 

We created a Gamma Band indicator to demonstrate the effectiveness of the Gamma Neutral level in reducing equity tail risk.  In our model, we compare the daily close of the SPX to the Gamma Neutral and Lower band levels to adjust our equity exposure allocation from 0% to 100%.  

We back-tested this strategy from 2007 to the present and discovered a 76.4% increase in risk-adjusted returns (shown below).  The Gamma Band model is a relatively slow but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish a faster, daily signal in a portfolio model which we call Thor’s Shield.  Thor Shield has a 20-year Sharpe of 1.5 and a rolling 1-year Sharpe of over 3.4.  Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

Authors

Viking Analytics is a quantitative research firm that creates tools to navigate complex markets.  If you would like to learn more, please visit our website, or download a complimentary report.

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 B.S. 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. Furthermore, he 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.


Major Market Buy-Sell Review: 10-19-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 10-19-20

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

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

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

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

Major Market Buy/Sell Review 10-19-20

S&P 500 Index

  • As noted last week: “The oversold condition that existed last week has now been reversed. While some extreme extensions have been reduced, the market is likely to run into some decent resistance at the previous highs.” 
  • This past week, the market did indeed struggle but is currently holding above the 50-dma.
  • Maintain exposures for now, but be ready to adjust if more weakness shows up heading into the election. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: Maintaining holdings.
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The tradeable rally in the Dow we suggested previously has worked well. It is now time to take profits and rebalance risk accordingly. 
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • The Nasdaq continues to work off its more extreme buy signal and has continued to hold above the 50-dma. 
  • If the market correction continues to hold support, such will likely provide a good opportunity to add exposure aggressively.
  • The tradeable opportunity in Technology stocks recommended previously has passed for now. Hold current positions and honor stop losses.
  • Short-Term Positioning: Bullish
    • Last Week: No changes this week.
    • This Week: No changes this week.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • The rally in small caps has gotten a bit overbought and has again become very deviated from its long-term mean.  
  • Risk is currently to the downside, but there is a chase to gain exposure to lagging sectors by investors right now. 
  • It is still suggested to use the current rally to rebalance positions until the downtrend is reversed. 
  • Short-Term Positioning: Bullish
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY performed better than SLY last week, but it is extremely extended from its long-term mean like SLY. 
  • The tradeable opportunity in Mid-caps we discussed previously is likely over for now. Keep stops tight at the 50-dma for now. Look for pullbacks to support to add exposure.
  • The $330 stop-loss remains intact, but just barely. 
  • Short-Term Positioning: Bullish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss is set at $330
  • Long-Term Positioning: Bullish

Emerging Markets

  • Emerging markets had performed better on a relative basis during the correction. Still, now they are pushing back into 3-standard deviation territory, which has previously been a good opportunity to take profits. 
  • EEM is no longer oversold, so use this rally to reduce risk temporarily. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved to $42 for trading positions.
  • Long-Term Positioning: Bullish

International Markets

  • International markets performed worse than emerging markets last week but are not as grossly extended either. 
  • As long as the 50-dma holds, positions can be maintained. However, please pay attention to the dollar as it has begun gaining some strength. 
  • Maintain stops.
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bullish

West Texas Intermediate Crude (Oil)

  • The rally in oil occurred and finally broke above the 200-dma. The worst may be over for now in oil if prices can hold above these levels. 
  • Energy stocks, unfortunately, are not performing with the rally in oil. However, there may be a point where the historical correlation comes back into play, and we see a strong rally in energy. 
  • Historically, the worst-performing sector in the market in any given year has tended to be one of the leaders in the following year. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • After previously adding to our positions in GDX and IAU, we continue to hold our positions. 
  • The sector is currently on a sell-signal and is not extremely oversold. However, further consolidation may provide a perfect entry point to add further exposure. 
  • Stops are reset at $165. 
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Added 1% to GDX and IAU
    • This week: No changes this week.
    • Stop-loss adjusted to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds continued to hold up last week and is continuing its consolidation process. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Sold AGG and added a 5% position in PFF.
    • Stop-loss moved up to $157.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar rally stumbled this past week and is testing the 50-dma and did hold that support. 
  • If the dollar just formed a higher low, we could see a stronger rally in the weeks ahead. This will be good for bonds and not-so-good for stocks and commodities.
  • Watch for the buy signal in the lower panel of the chart for a signal to go long the $USD.
  • Subsequently, a dollar rally will devalue international and emerging market holdings, so act accordingly. 
  • Use weakness to add to positions that hold the 50-dma. 
  • Stop-loss adjusted to $92.

Neel Kashkari Is The Definition Of “Moral Hazard”

Neel Kashkari, in a recent CNBC interview, said, “I don’t see any moral hazard here when asked if the Fed’s massive liquidity injections have blown a bubble.

What exactly is the definition of “moral hazard.” 

Noun – ECONOMICS
The lack of incentive to guard against risk where one is protected from its consequences, e.g., by insurance.

Take a look at the following chart.

The Zombie Apocolypse

Zombie companies depend on a speculative investment climate for bond issuance for their survival. As discussed in “Recessions Are A Good Thing:”

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem. Zombie firms are less productive, and their existence lowers investment in, and employment at, more productive firms. In short, a side effect of central banks keeping rates low for a long time is it keeps unproductive firms alive. Ultimately, that lowers the long-run growth rate of the economy.” – Axios

Recessions Are A Good Thing, #MacroView: Recessions Are A Good Thing, Let Them Happen

Such also explains why there are currently record levels of “junk bond” issuance in the market.

“Issuance in 2020 through August was $291.9 billion, up 71% year over year. Credit strategists at BofA Global Research now project a full-year primary volume of $375 billion. Such would shatter the current record total of $344.8 billion in 2012, according to LCD.”

Interestingly, the number of “Zombie” companies in the market has hit decade highs in 2020. The massive Federal Reserve interventions, bailouts, and zero rates provided the life support failing companies needed. From a market perspective, the liquidity flows from the Federal Reserve increased speculative appetites and investors piled into “zombies” with reckless abandon.

Why?  Because of a lack of incentive to guard against risk as investors believe the Fed is protecting them from the consequences of risk.

In other words, the Fed has “insured them” against potential losses.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No-Risk Anywhere

Of course, Neel doesn’t see any moral hazard in the charts above. Nor does he see any “moral hazard” from the distortion of the credit markets either. Currently, yield spreads are trading near historically low levels in the midst of an economic recession.

Nor does he seem to notice the “moral hazard” of both a surge in debt accumulation and inflated asset prices. Such can only exist as long as rates remain near zero and monetary policy remains accommodative.

While Kaskari “doesn’t see any correlation between the Fed’s monetary interventions and the stock market,” even CNBC made the connection.

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

, Technically Speaking: Extreme Deviations & Eventual Outcomes

However, there is no “free lunch.” 

Not The Worst Of It

For the Fed to continue providing monetary support to the markets, they must monetize nearly every dollar of U.S. debt issuance for the foreseeable future.

“Randy Quarles said the Fed might have to remain engaged in asset buying for some time as financial markets are dealing with too many Treasurys to handle on their own. Total public debt now stands at just under $27 trillion, up from $23 trillion in this year’s first quarter. Debt is also $9.4 trillion higher than in the first quarter of 2008 in the midst of the financial crisis and the Government engaged in a long-running surge in borrowing.” – WSJ

Given the amount of debt required to sustain current economic growth, the Fed has no choice but to continue monetization of the Federal debt indefinitely. 

Such leaves only TWO possible outcomes from here, both of them are not good.

    1. Powell & Co. continue to keep rates at zero. As aging demographics strain the pension and social welfare systems, the debt will continue to stifle inflation and economic growth. The cycle that started nearly 40-years ago will continue as the U.S. adopts the “Japan Syndrome.”
    2. The second outcome is far worse, which is an economic decoupling that leads to a massive deleveraging process. Such an event started in 2008 but was cut short by Central Bank interventions. In 2020, the Fed arrested the deleveraging process once again. Both events led to an even more debt-laden system, which increases the risk of a crisis the Fed’s interventions may not stop.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

As noted, there is a precedent for a Central Bank becoming nearly the entire holder of the bond market.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Failure To Launch

Since the financial crisis, Japan has been running a massive “quantitative easing” program, which, on a relative basis, is more than 3-times the size of that in the U.S. While stock markets have performed well, economic prosperity is less than before the century’s turn.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

Furthermore, despite the BOJ’s balance sheet consuming 80% of the ETF markets, not to mention a sizable chunk of the corporate and government debt market, Japan has been plagued by rolling recessions, low inflation, and low-interest rates. (Japan’s 10-year Treasury rate fell into negative territory for the second time in recent years.)

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

While financial engineering props up asset prices, I think Japan is a perfect example that financial engineering not only does nothing for an economy over the medium to longer-term, it actually has negative consequences.” – Doug Kass

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Forgetting The Lessons Of 2008

The debt problem exposes the Fed’s risk and why they are now forever trapped at the zero-bound.

Given economic growth remained elusive over the last decade, it is unlikely doubling the Fed’s balance sheet will improve future outcomes. While Mr. Kashkari fails to recognize the impact of their policies, we now have a decade of experience showing that surging debt and deficits inhibit organic growth.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

The US economy is literally on perpetual life support. Recent events show too clearly that unless fiscal and monetary stimulus continues, the economy, and by extension, the stock market, would fail.

Interestingly, while Mr. Kashkari says he “sees no moral hazard,” he recently stated we are forgetting the lessons of the 2008 financial crisis“:

“The shareholders got bailed out. The boards of directors got bailed out. Management got bailed out. So from their perspective, there was no crisis. We forget the lessons of the 2008 crisis. The bailouts worked too well. Financial crises keep happening ‘because we forget how bad they were.’” – Neel Kashkari

Yes, we bailed out everything, and the consequences of not allowing the system to “clear itself” has led to further distortions in the economy and markets.

The Fed Is The Cause

When the Fed tries to normalize monetary policy, they immediately cause a financial crisis in the market. The resulting destruction of household net worth requires an immediate response by the Fed of zero interest rates and liquidity. Subsequently, they create the next “bubble” to offset the deflation of the last.

A recent Fed study shows the result of their actions is the retardation of economic growth and a massive expansion of the “wealth gap,” where the top-10% controls most of the net worth.

Fed Top 10% Richer, Fed Study: How We Made The Top 10% Richer Than Ever.

Since a majority of the population does not, or only marginally, participates in the financial markets, the “boost” has remained concentrated to the upper 10%. The Federal Reserve’s study confirms this. So either the Fed willfully chose to ignore the consequences of their actions, or blatantly lied about it.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No Choice

Unfortunately, policy-makers, along with the Federal Reserve, are stuck.

“Since politicians want to get re-elected, sending money to households is a way to ‘buy the vote.’ The average American doesn’t understand their demands on the Government for more support creating their economic inequality.” 

Conversely, the Federal Reserve serves at the mercy of the central Wall Street banks. Such is why their policy focuses on inflating asset prices for the top 10%, hoping it will one day trickle down to the bottom 90%. After a decade, it hasn’t happened.

As noted, Japan is the path we are following.

“Monetary growth (and QE) can mechanically elevate and inflate equity markets. For example, in the U.S. market, a side effect is that via the ‘repo’ market, it turns into leveraged trades into the equity markets. Again, authorities are running out of bullets and have begun to question the efficacy of monetary largess.

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

One thing is for sure, “repeating the same failed actions and expecting a different outcome” has never been a solution for success.

We are reasonably confident it won’t work this time either.

Market Stumbles As Stimulus Hopes Fade


In this issue of “Market Stumbles As Stimulus Hopes Fade.”

  • Hopes For More Stimulus
  • Election Night Risk
  • Economic Disappointment
  • Portfolio Positioning Update
  • MacroView: Recessions Are A Good Thing, Let Them Happen
  • Sector & Market Analysis
  • 401k Plan Manager

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


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP, for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for.

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
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This Week 10-09-20, #WhatYouMissed On RIA This Week: 10-09-20

Catch Up On What You Missed Last Week


Market Stumbles As Stimulus Hopes Fade

Over the past couple of weeks, we have discussed the market rally from the recent oversold lows.

“The Federal Reserve needs ‘more stimulus’ to monetize the underlying debt issuance for investors. Such is how, ultimately, liquidity gets into the markets. With markets only about 3% away from all-time highs, there is really nothing to stop it from getting there unless stimulus talks break down once again.”

Unfortunately, the latter happened as the stalemate between House Democrats and Treasury Secretary Mnuchin continued. While both the Treasury Secretary and the President have signaled they are open to a much bigger stimulus package, the House’s Speaker isn’t budging off her demands for State bailouts. Neither is Senate Majority Leader Mitch McConnell, who has already stated he will not take up any House bill. He stated he would put a roughly $500 billion targeted relief bill to vote in the Senate as soon as next week. That bill is also doomed.

However, even without a stimulus package, the market rallied nicely from recent lows. The good news is the bit of trading sloppiness last week allowed the market to start working off the overbought condition. While we could see some additional weakness early next week, the downside risk is fairly limited going into the election.

Conditions Are Less Favorable

As shown below, both the 20- and 50-dma’s sit just below current levels. Those averages should act as initial support. Below that support are the recent lows, which will likely contain the market within the current range. Such would entail a roughly 8% decline from current levels and certainly well within the context of a normal market correction.

However, a break of that important support will quickly find the 200-dma, which is currently about 11% below current levels. As we will discuss momentarily, a “contested election” could certainly provide the catalyst for such a decline.

The fuel for a bigger decline remains this week. With speculation ramping up again, the risk/reward in the short-term has become less favorable. Call option buying remains extremely elevated relative to historical norms and exacerbates market declines when those positions are unwound.

On a longer-term basis, we remain concerned about the dichotomy of signals from the market. Negative divergences of RSI,  the number of stocks above their respective 200-dma, and the more extreme monthly overbought condition are concerning.

The previous extensions over the last decade have led to decent corrections. Could this time be different? Sure, anything is possible. However, as investors, we want to remain focused on the “probabilities.”

While the market seems assured that more stimulus is coming sooner rather than later, one risk facing the market may be a “contested election.”

An Election Night Risk

Over the last few weeks, we have discussed much of what happens to the stock market both pre- and post-Presidential elections.

However, there is the potential for a delayed election outcome this year, which could rattle the stock market. As noted by Morgan Stanley via Zerohedge:

“Contrary to some expectations that the election outcome could take as much as a month to be decided – a la Gore vs Bush – new data cited by Morgan Stanley suggests ‘the worst-case outcome is the least likely.’ And while vote-by-mail (VBM) requests are breaking records, a concern given the slower process for counting those ballots, voters appear to be returning those ballots at a rapid pace in key battleground states according to Morgan Stanley’s Michael Zezas.”

“Morgan Stanley says thatthere is an 80% chance the result is not determined on election night.'”

Is there a precedent for such an outcome?

Markets Don’t Like Uncertainty.

From a historical perspective, we have the precedent of the Gore/Bush election in 2000.

What does this mean for financial markets? The outcome of the election between George W. Bush and Al Gore was not decided on election day. Instead, Gore demanded a recount in Florida, where the vote was close, and “hanging chads” were at issue. It took over a month before we knew the election outcome when the U.S. Supreme Court decided Bush v. Gore on December 12, 2000.

What markets don’t like is uncertainty; over the course of the next several weeks, the S&P 500 decline by 7.5% at its nadir. However, the volatile swings of the market over that period were excruciating for investors. While not the “devastating event” the media has portrayed such an outcome to be, it is still worth noting. The inherent risk of a sharp rise in volatility and potential loss of gains if the unexpected does indeed occur. 

Here’s the point.

If you are about to get on a boat and go out deep sea fishing, it generally never hurts to take a Dramamine if the seas get rough. Otherwise, the entire experience becomes a single nauseating memory.

Economic Disappointment

Another risk is a further economic disappointment. Coming off of the March lows and the economic shutdown, expectations for recovery had gotten extremely dire. However, as the Federal Reserve and the Government injected money directly into the financial system, sent checks to households, and provided additional benefits, the data improved faster than expected.

However, what is important to remember is that we measure data on a “rate of change” basis.

For example, think about a restaurant that was shut down entirely. When they are allowed to reopen, they go from ZERO customers to just ONE. That is a 100% increase from the prior period. Next period they have TWO customers, which is a 50% increase from the period. The business remains on the brink of bankruptcy, but the growth rate of sales is stunning. 

This is what is happening with the economic data currently. The Citigroup Economic Surprise Index measures the difference between Wall Street’s expectations for economic data versus what is actually reported. If the data is better, the index rises, and vice versa. The chart below, courtesy of Sentimentrader, shows the index compared to the S&P 500 index.

“The Citigroup Economic Surprise Index is retreating after the biggest spike in this data series’ history.”

Why is this important?

Back To Uncertainty

With no stimulus currently on the horizon and a resurgence of economic weakness, there is more than a reasonable risk we may see more disappointment in economic data ahead. Such could have return implications for the stock market.

“When the Citigroup Economic Surprise Index dropped rapidly in the past, the S&P’s returns over the next month were slightly more bearish than random.” – Sentimentrader

With the potential for a delayed or contested election, weaker economic data, no stimulus, and already elevated asset prices and valuations, the risk of a correction has certainly risen.

All that is need is an “unexpected, exogenous event,” which sends traders scrambling for the exits.

Such leads us to this week’s portfolio positioning.

Portfolio Positioning Update

As we have noted previously, we currently have more equity exposure than we are comfortable with. However, technically, there is no reason to reduce exposure as trends remain positive sharply, the sentiment remains clearly bullish, and volatility remains suppressed.

With that said, we are still hedging portfolios by holding slightly higher levels of cash and adjusting the duration of the bond portfolio to mitigate drawdown risk. It’s challenging to hedge portfolios in an environment driven by daily news flows and sentiment and ignoring a wide range of “risks.”

The following quote from Sven Heinrick seems apropos at this juncture:

“Markets have been rallying not only on stimulus hope but also on the premise that the risk of a contested election is diminished or so the popular pablum goes. Well, for there to not be a contested election there needs to be a concession speech on the eve of the election. If that doesn’t happen, there is no election clarity until at least December 14 when the electoral college votes. That’s 6 weeks of uncertainty. And what if this gets contested, or what if there are legal challenges in between or beyond?

I’m raising these questions to highlight that there are all sorts of risks floating about that this market is not pricing in. At all. Rather the market is making all kinds of positive presumptions in terms of what it appears to perceive as the most positive outcomes. And they may well be correct, But whether these presumptions are correct, or not, I’m not one to say. However, it appears that if these presumptions are wrong, then the risk is very much under-appreciated. For now, this market hears of no risk, sees no risk, and speaks of no risk.”

Risk Happens Fast

His comments are certainly worth considering, even if you are “uber” bullish and completely disagree with my assessment. The reason is that when markets heavily discount downside risk or become exceedingly complacent, such creates an atmosphere where a rapid unwinding of markets can occur.

“When we superimpose the market structure (with so many in one side of the investment boat), the secondary market implication is a continuation of a new regime of heightened volatility and a wide trading range. Such favors trading sardines over eating sardines.” –Doug Kass

Investors tend to make critical mistakes in managing their portfolios.

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

While the market is bullish now, and there is clearly an upside bias, an unexpected, exogenous event will cause a sharp reversal. Such suggests hedging equity risk until there is more “clarity” concerning the risk and reward.

As we have stated previously, “risk happens fast.” 

Why We Hold Cash

The great thing about holding extra cash is that it is a simple process to make the proper adjustments to increase portfolio risk if we’re wrongs. However, if we are right, we protect investment capital from destruction and spend far less time “getting back to even.”

Importantly, I want to stress that I am not talking about being 100% in cash.

I am suggesting that holding higher levels of cash during periods of uncertainty provides both stability and opportunity. With heightened political, fundamental, and economic risks, understanding the value of cash as a “hedge” against loss becomes more important. 

Given the length of the current market advance, deteriorating internals, high valuations, and weak economic backdrop, reviewing cash as an asset class in your allocation may make some sense. Chasing yield at any cost has typically not ended well for most.

Of course, since Wall Street does not make fees on investors holding cash, maybe there is a reason they are so adamant that you remain invested all the time.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. 


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.


Sector Model Analysis & Risk Ranges

How To Read.

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


Weekly Stock Screens

Currently, there are 3-different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Aggressive Growth Strategy


Portfolio / Client Update

The market rally stumbled this week as hopes of more stimulus faded. While the market came close to testing previous highs, it fell a bit short.

The good news is there is a good bit of support just below Friday’s closing levels, with the 20-dma very close to crossing back above the 50-dma. Such should keep the markets fairly range-bound heading into next week.

The not-so-good news is that we are just two weeks away from the Presidential election, which potentially argues for more market volatility between now and then. With the risk of a contested election higher than normal, and as noted in this week’s missive’s main body, there is downside risk.

We are aware of that risk and continue to position ourselves accordingly. Over the last few weeks, we have increased our bond duration, reduced laggards, and repositioned holdings to align portfolios with our expected outcomes. We also continue to carry a slightly higher than normal cash level, which we can increase quickly if the need arises.

We are also continuing to monitor our positioning closely and let the market dictate our next moves.

Portfolio Changes

There were no changes to the portfolio this week.

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


401k Plan Manager Live Model

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

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

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

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

Technical Value Scorecard Report For The Week of 10-16-20

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis (versus the assets benchmark) and on an absolute stand-alone basis. You can find more detail on the model and the specific tickers below the charts.

Commentary 10-16-20

  • On a relative and absolute basis, the utility and consumer discretionary sectors are the most overbought.
  • On a relative basis versus the S&P, healthcare, communications, banks, and energy are cheap. Healthcare, energy, and communications both have a lot of skin in the game in regards to the Presidential election, so they will be tougher to handicap over the coming weeks. Energy and banking remain the two most oversold sectors.
  • Banks (XLF) are an interesting play here as the ETF sits on top of its 50 and 200-day moving averages. Further, the 50-day is about to cross above the 200-day forming a so-called Golden Cross. For those wishing to buy XLF, manage risk with a stop loss a few percent below both moving averages.
  • On an absolute and relative basis, Small and Mid-cap stocks remain overbought. Foreign stocks (EFA and EEM) are back to oversold on a relative basis, yet emerging markets are still rich on an absolute basis.
  • On an absolute basis, TIPs are now oversold. They were flat on the week despite a decent performance from the other bond sectors. Inflation expectations fell slightly calling into question the reflationary recovery. This was likely the result of CPI and PPI which did not show signs of an inflationary burst.
  • Like last week, the S&P is overbought, but over the last few days, the signal has moderated.
  • When a sector is trading 3 standard deviations above its 200 or 50-day moving average or 2 standard deviations above both, a sell-off or consolidation is likely. There are no sectors that meet either criterion.
  • XLY looks to be the strongest sector on the spaghetti graphs as it runs toward the upper right-hand corner. That said, it is overbought with limited room to run. The sector is likely nearing a period of weaker relative performance.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum/minimum score, as well as on a normalized basis (sigma) for the last 200 trading days. Assets with scores over or under +/-60% and sigmas over or under +/-2 are likely to either consolidate or change trend. When both the score and sigma are above or below those key levels simultaneously, the signal is stronger.

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. Lastly, we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner the most bearish.

The technical value scorecard report is just one of many tools that we use to assess our holdings and decide on potential trades. This report may send a strong buy or sell signal, but we may not take any action if other research and models do not affirm it.

The ETFs used in the model are as follows:

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

#MacroView: Recessions Are A Good Thing, Let Them Happen

It is a given that you should never mention the “R” word. People immediately assume you mean the end of the world: death, disaster, and destruction. Unfortunately, the Federal Reserve and the Government also believe recessions “are bad.” As such, they have gone to great lengths to avoid them. However, what if “recessions are a good thing,” and we just let them happen?

“What about all the poor people that would lose their jobs? The companies that would go out of business? It is terrible to think such a thing could be good.”

Sometimes destruction is a “healthy” thing, and there are many examples we can look to, such as “forest fires.”

Wildfires, like recessions, are a natural part of the environment. They are nature’s way of clearing out the dead litter on forest floors, allowing essential nutrients to return to the soil. As the soil enrichens, it enables a new healthy beginning for plants and animals. Fires also play an essential role in the reproduction of some plants.

Why does California have so many wildfire problems? Decades of rushing to try and stop fires from their natural cleansing process as noted by MIT:

“Decades of rushing to stamp out flames that naturally clear out small trees and undergrowth have had disastrous unintended consequences. This approach means that when fires do occur, there’s often far more fuel to burn, and it acts as a ladder, allowing the flames to climb into the crowns and takedown otherwise resistant mature trees.

While recessions, like forest fires, have terrible short-term impacts, they also allow the system to reset for healthier growth in the future.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

No Tolerance For Recessions

Following the century’s turn, the Fed’s constant growth mentality exacerbated rising inequality and financial instability. Rather than allowing the economy to perform its Darwinian function of “weeding out the weak,” the Fed chose to “mismanage the forest.” The consequence is that “forest fires” are more frequent.

Deutsche Bank strategists Jim Reid and Craig Nicol previously wrote a report that echos what other Austrian School economists and I have been saying.

“Actions are taken by governments and central banks to extend business cycles and prevent recessions lead to more severe recessions in the end.” 

, Trying To Prevent Recessions Leads To Even Worse Recessions

Prolonged expansions had become the norm since the early 1970s, when President Nixon broke the tight link between the dollar and gold. The last four expansions are among the six longest in U.S. history .

Why so? Freed from the constraints of a gold-backed currency, governments and central banks have grown far more aggressive in combating downturns. They’ve boosted spending, slashed interest rates or taken other unorthodox steps to stimulate the economy.” MarketWatch

But therein also lies the problem.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

More Debt Leads To Less Of Everything Else

The massive indulgence in debt, what the Austrians refer to as a “credit induced boom,” has now reached its inevitable conclusion. The credit-sourced boom led to artificially stimulated borrowing, which sought out diminishing investment opportunities.

Ultimately, diminished investment opportunities led to widespread malinvestments. Not surprisingly, we saw it play out “real-time” in everything from subprime mortgages to derivative instruments previously.

Tytler cycle, Tytler Cycle & Why More Government Help Leads To Less

When credit creation can is no longer sustainable, the markets must clear the excesses before the cycle can restart. Only then, and must be allowed to happen, can resources be allocated towards more efficient uses.

Such is why all the efforts of Keynesian policies to stimulate growth in the economy have ultimately failed. The ongoing fiscal and monetary policies, from TARP and QE to tax cuts, only delayed the clearing process allowing it to grow larger. That delay worsens the current impact and the eventual reversion.

The economy currently requires roughly $5 of total credit market debt to create $1 of economic growth. A reversion to a structurally manageable debt level would require a reduction of nearly $40 trillion. The last time such a clearing process occurred, it was called the “Great Depression.”

Tytler cycle, Tytler Cycle & Why More Government Help Leads To Less

The chart shows why “demands for socialism” is now “a thing.”

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

Austrian Theory Of Business Cycles

“As the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles, and lowered savings.”

In other words, the proponents of Austrian economics believe that a sustained period of low rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. In other words, low rates tend to stimulate borrowing from the banking system that, in turn, leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money.

Therefore, as one would ultimately expect, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities, ultimately resulting in widespread malinvestments.

When the exponential credit creation is longer sustainable, a “credit contraction” occurs. Such ultimately shrinks the money supply and the markets finally “clear.” The clearing process allows resources to be allocated back towards more efficient and productive uses.

As shown in the chart above, the Federal Reserve’s actions halted the much needed deleveraging of the household balance sheet. With incomes stagnant and debt levels still high, it is worth little wonder why 80% of Americans currently have little or no “savings” to meet an everyday emergency.

Furthermore, the velocity of money has plunged as overall aggregate demand has waned.

Monetary Velocity

What the Federal Reserve has failed to grasp is that monetary policy is “deflationary” when “debt” is required to fund it.

How do we know this? Monetary velocity tells the story.

What is “monetary velocity?” 

“The velocity of money is important for measuring the rate at which money in circulation converts into purchasing of goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

With each monetary policy intervention, money velocity has slowed along with the breadth and economic activity strength.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

However, it isn’t just the Fed’s balance sheet expansion, which undermines the economy’s strength. It is also the ongoing suppression of interest rates to try and stimulate economic activity.

In 2000, the Fed “crossed the Rubicon,” whereby lowering interest rates did not stimulate economic activity. Instead, the “debt burden” detracted from it.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

To illustrate the last point, we can compare monetary velocity to the deficit.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

To no surprise, monetary velocity increases when the deficit reverses to a surplus. Such allows revenues to move into productive investments rather than debt service.

The problem for the Fed is the misunderstanding of the derivation of organic economic inflation.

A Sellable Rally, Technically Speaking: Why This Is Still A Sellable Rally, For Now.

The Fed’s Mistake

The Fed continues to follow the Keynesian logic, mistaking recessions as periods of falling aggregate demand. They believe lower rates and asset price inflation will stimulate demand and increase the rate of consumption.

However, these policies have all but failed to this point. From “cash for clunkers” to “Quantitative Easing,” economic prosperity worsened. Pulling forward future consumption, or inflating asset markets, exacerbated an artificial wealth effect. Such led to decreased savings rather than productive investments.

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, is wrong. It has not happened in 30 years. Despite the short-term benefit of policies like tax cuts, or monetary injections, they do not create economic growth. Debt-driven policies merely reschedule future growth into the present. The average American may fall for a near-term increase in their take-home pay. However, any increased consumption in the present will be matched by a decrease later when the tax cut is revoked.

Of course, such assumes the balance sheet at home is not a complete disaster. As we saw during the “Great Depression,” most economists thought that the simple solution was just more stimulus. Work programs, lower interest rates, and government spending didn’t work to stem the depression era’s tide.

There Has Been A Cost

The Fed’s foray into “policy flexibility” did extend the business cycle longer than normal. Those extensions led to higher structural budget deficits, increased private and public debt, lower interest rates, negative real yields, and inflated financial asset valuations.

The Fed’s interventions have also led to a massive leveraging of U.S. corporations, which has led to lower defaults via cheap corporate debt.

Unfortunately, it has also created an economy with a record level of “zombie companies.” 

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms. In short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.” – Axios

Just as poor forest management leads to more wildfires, not allowing “creative destruction” to occur in the economy leads to a financial system that is more prone to crises.

Given the structural fragility of the global economic and financial system, policymakers remain trapped in the process of trying to prevent recessions from occurring due to the extreme debt levels. Unfortunately, such one-sided thinking ultimately leads to skewed preferences and policymaking.

As such, the “boom and bust” cycles will continue to occur more frequently at the cost of increasing debt, more money printing, and increasing financial market instability.

Welcome Recessions

The problem currently is that the Fed’s actions halted the “balance sheet” deleveraging process keeping consumers indebted and forcing more income to pay off the debt, which detracts from their ability to consume.

Such is the one facet that Keynesian economics does not take into account. Most importantly, it also impacts the equation’s production side since no act of saving ever detracts from demand.

Consumption delayed is merely a shift of consumptive ability to other individuals. Even better, money saved is often capital supplied to entrepreneurs and businesses that will use it to expand and hire new workers.

The continued misuse of capital and erroneous monetary policies are responsible for 30-years of an insidious slow-moving infection that destroyed the American legacy.

We should embraceRecessions.” Allow recessions to clear the “excesses” accrued during the first half of the economic growth cycle.

Trying to delay the inevitable only makes the inevitable that much worse in the end.

#WhatYouMissed On RIA This Week: 10-16-20

What You Missed On RIA This Week Ending 10-16-20

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

Here is this week’s rundown of what you missed.


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for. 

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)

What You Missed This Week In Blogs

Each week, RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus is the risks that may negatively impact our client’s capital. These are the risks we are focusing on now.



What You Missed In Our Newsletter

Every week, our newsletter delves into the topics, events, and strategies we are using. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how we plan to trade it.



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 10-16-20


What You Missed: Video Of The Week

Michael Lebowitz, CFA and I discuss the important impact that passive investors have on the markets and the potential risk to future outcomes.



Our Best Tweets For The Week: 10-16-20

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Nick Lane: The Value Seeker Report- New Feature

This article is an RIA PRO exclusive for subscribers. If you are reading this article, this is a good example of the insights our subscribers read every day. Try it RISK-FREE for 30-days.

In this edition of the Value Seeker Report, we introduce our summary table and explain the table’s “Conviction Rating” feature.

Value Seeker Summary Table

  • The table, shown below, provides key details from all past Value Seeker reports in a central location. The full report for each stock can be accessed by following the link embedded in its ticker.
  • Future Value Seeker reports will include an updated version of this table.
Latest Report DateTickerLast Close Price (10/13)Intrinsic ValueForecast Upside RemainingOriginal Conviction RatingCurrent Conviction RatingCurrently Held in RIA Pro Portfolio?
8/6/2020T$ 27.75$ 38.0937.3%3-Star3-StarYes
8/13/2020XOM$ 34.22$ 55.4262.0%3-Star2-StarNo
8/28/2020VIAC$ 27.45$ 36.7033.7%4-Star2-StarNo
9/3/2020DOX$ 58.31$ 76.7631.6%3-Star3-StarYes
9/11/2020CVS$ 59.12$ 85.3544.4%3-Star3-StarYes
9/18/2020PETS$ 32.06$ 41.1428.3%3-Star3-StarNo
9/24/2020SPB$ 61.98$ 61.18-1.3%4-Star3-StarNo
10/2/2020DKS$ 62.04$ 68.7610.8%4-Star4-StarNo
10/9/2020WCC$ 45.63$ 61.4234.6%4-Star4-StarNo

Conviction Rating

  • Based on the degree of conviction we have in our forecasts, we assign a rating to each of our companies ranging from one to five stars. We will update conviction ratings as needed.
  • The conviction rating is based on both fundamental and technical analysis as well as any specific factors affecting the industry and the broad macroeconomic environment.
  • There are also other factors that affect our conviction rating. For instance, DCF valuations, and the embedded assumptions within the DCF model, can be more straightforward and easier to forecast for some companies than others. Unfortunately, the pandemic is exacerbating this factor in a variety of ways.
  • It is important to note that the conviction rating does not reflect the likelihood of a stock reaching our forecast intrinsic value. It only aims to provide our subscribers with more context for making investment decisions based on our reports.

For the Value Seeker Report, we utilize RIA Advisors’ Discounted Cash Flow (DCF) valuation model to evaluate the investment merits of selected stocks. Our model is based on our forecasts of free cash flow over the next ten years.

Medicare Q&A with Aetna’s Christopher Ciano.

To better understand Medicare, especially Medicare Advantage, I queried Christopher Ciano, president of Medicare at Aetna®, a CVS Health® company. He is also a caregiver to his 93-year-old parents. Therefore, I thought it would be beneficial for readers to gain his perspective.

(Note: Open Enrollment is from October 15 through December 7.)

QUESTION: Please give us your vision of the future for Medicare programs. What would be the most significant changes you anticipate over the next decade overall?

COVID-19 has already impacted Medicare programs and will likely continue to have an impact for the foreseeable future.

Telehealth – A strong area of growth.

One of the areas where we’ve begun to see tremendous growth is in digital health, particularly telehealth. Medicare plans will continue to offer benefits that allow for care at home. The next few generations of seniors will likely have a higher level of comfort with technology than previous generations.

We already see this trend start to rise. According to the CVS Health Path to Better Health Study, 45% of respondents 65+ said they would be more likely to communicate with health care professionals if they could do so through digital messaging. Older adults opening up to new, digital means for communication is something I believe we’ll see much more of in years to come.

At Aetna, we’re taking steps to make sure our Medicare plans can help support members stay healthy in their homes during this time. Such is essential since older adults are among the most vulnerable to serious effects from COVID-19.

To ensure our members can safely receive the care they need, we extended waivers for Medicare Advantage member cost shares. Such allows for in-network primary care office visits and all telehealth visits for any reason through December 31, 2020.

Self-Care At Home Gains Popularity.

We also recently shipped Caring for You kits of over-the-counter items, such as thermometers, hand sanitizer, and face masks. Such helped support all Medicare Advantage members with simple self-care at home.

Also, all Aetna 2021 Medicare Advantage plans will offer virtual primary and urgent care visits to help members access to care, including after-hours or weekend care, sick visits, and prescription refills. Select plans will also cover virtual mental and behavioral health visits.

QUESTION: Medicare Advantage is a cost-effective program. However, we have great concerns over Part C, especially when it comes to innovative treatments for life-altering diseases. What improvements do you foresee down the road for Medicare Advantage?

In recent years, the Centers for Medicare & Medicaid Services (CMS) expanded the supplemental benefits Medicare Advantage plans can offer to members with chronic conditions. This increased flexibility allows MA plans to offer more innovative programs and benefits.

For example, in 2021, Aetna implements a Congestive Heart Failure (CHF) Remote Monitoring Program with six individual plans in Pennsylvania, Ohio, and Kentucky.

Eligible high-risk members with CHF who agree to participate in the program and follow the care management requirements will receive a 5G-enabled scale, blood pressure cuff, and electronic tablet to monitor their weight and blood pressure at home.

We’re also expanding the number of plans offering supplemental benefits for members with high cholesterol or high blood pressure to make it easier to access care. Aetna will provide a blood pressure monitor for our members with high blood pressure, which allows members to monitor their blood pressure from home at their convenience.

Individual members with high blood pressure and high cholesterol may also be eligible for transportation assistance to keep their appointments with health care providers.

Additional Benefits To Aetna’s Plans.

Other benefits we’re introducing with select plans in select locations include a Healthy Foods debit card, companionship benefit, a fall prevention benefit, and a program to lower insulin costs. These benefits are designed to bring care closer to home and make it more affordable for our members.

I foresee the continued expansion of benefits like these to help members with chronic conditions and more programs to address social determinants of health.

QUESTION: Please provide your thoughts for caregivers of elderly loved ones. How can they remain healthy and viable?

Speaking as a caregiver to my own 93-year-old parents, one of the most important, and often overlooked, is remembering to take time for yourself.

While caregiving is rewarding, it can also take a toll on your physical and emotional well-being. This is especially true during COVID-19, as we all continue to deal with additional stressors the pandemic has placed on our everyday lives. Ensure you’re taking care of yourself and finding time to relax, eat healthily, and exercise regularly.

Also, remember that you don’t have to do everything by yourself — ask for help. Aetna Medicare members and their caregivers have access to Resources for Living, which caregivers can use to connect with local support groups and other services that make their responsibilities feel more manageable.

Additionally, Aetna recently published a guide full of great information and resources for older adults and their caregivers called Putting the ‘Me” in Medicare, found at AetnaMedicare.com/eBook. The eBook offers tips and resources on eating healthy, staying active, using technology tools, and maintaining mental health during and after the pandemic.

QUESTION: What are your best ideas, pitfalls for the Medicare Open Enrollment season?

Choosing a Medicare plan and sifting through all the information Medicare beneficiaries receive can be overwhelming at this time of year.

Medicare Advantage Is All-inclusive.

It’s important to understand the various parts of Medicare and what each part covers. Original Medicare includes Part A (hospital insurance) and Part B (medical care), and consumers often elect to purchase a Part D plan for prescription drug coverage. On the other hand, Part C is a Medicare Advantage plan.

Such plans bring together the benefits of cost, coverage, and convenience into a single plan and often include:

  • Annual out-of-pocket maximum
  • Prescription coverage
  • Dental, vision, hearing, and fitness-related benefits
  • Coverage through a private insurance company
  • A network of doctors and hospitals

 A common misconception about Original Medicare is that it pays for everything. Everyone who is enrolled in Original Medicare pays a premium for medical (or Part B) coverage.

Original Medicare Doesn’t Cover Everything.

Original Medicare also doesn’t cover prescription drugs or cap your annual out-of-pocket spending for medical care, which means that there’s no limit to the expenses you may have to pay each year for your medical services.

Second, check if the plan fits your budget. When it comes to plan pricing, no matter whether consumers select an Original Medicare or Medicare Advantage plan, many mistakenly only look at the monthly premium cost. While important, it is not the only price point to consider. Make sure you review all of the plan’s out-of-pocket costs, such as deductibles, copays, and co-insurance.

Prescription drugs are another important item to consider. Check if the plan’s formulary or drug list covers your prescriptions. Know what tier your prescription drugs are on and whether there are any coverage rules like step therapy or prior authorization. And don’t forget every year, plans can change which drugs are covered and at what tier and cost.

Also, check your plan’s network to see if your preferred doctors, hospitals, and pharmacies participate.

Finally, if extra benefits like routine vision, dental, hearing, and fitness are important to you, make sure the plan you choose covers them.

Visiting the Medicare.gov website and entering your zip code will allow you to see all of the various Medicare plans available in your area. You can also speak with a local trusted broker or community advisor. To learn more about Aetna’s 2021 Medicare plans, visit AetnaMedicare.com or see our latest announcement.

Important Points from RIA.

As a matter of disclosure, this post isn’t an endorsement of Aetna’s plans. However, it provides perspective from a senior professional in the trenches.

At RIA, we prefer Medigap solutions over Medicare Advantage plans. Many older Americans with strained cash flows find Medicare Advantage cost advantageous. Everybody’s situation is different; therefore, Medicare and healthcare planning are crucial.

HealthView Services is a company that provides healthcare projection analysis and tools to the financial services industry. The organization draws upon a database of 530 million medical cases, longevity, and government statistics to create their projections.

They estimate that the total lifetime healthcare costs (which include premiums for Medicare, supplemental insurance, prescription drug coverage) for a healthy 65-year-old couple retiring this year are projected to be $387,644 today’s dollars assuming the Mr. lives 22 years and Mrs. – 24.

Health-care inflation is averaging roughly 4.4% a year; we use a 4.5% inflation rate in our planning at RIA. Medigap or supplemental insurance coverage, which is offered by private insurance companies, has increased consistently by more than 6% a year, according to The Senior Citizens League.

Medicare Advantage vs. Medigap.

Medicare Advantage Plans are inclusive, which means they cover all services of Original Medicare, including prescription drugs. Most offer extra coverage like vision, hearing, dental, and/or wellness plans. Two-thirds of the plans offered are through closed-physician network HMOs.

Advantage Plans usually have lower premiums than Medigap (also known as Medicare Supplemental Insurance) and are offered without insurability evidence.

Per KFF.org: While average Medicare Advantage premiums paid by MA-PD enrollees have been relatively stable for the past several years ($36 per month in 2017), enrollees may be liable for more of Medicare’s costs, with average out-of-pocket limits increasing 21 percent and average Part D drug deductibles increasing more than 9-fold since 2011; however, there was little change in out-of-pocket limits and Part D drug deductibles from 2016 to 2017.

At RIA, we suggest older Americans select a Medigap policy over Medicare Advantage but our views may change in the future. Monthly premiums for Medigap policies will absolutely be higher. However, the Medigap insured can benefit from more choice among providers and ultimately lower total out-of-pocket costs.

Keep in mind, based on our study and Mr. Ciano’s expert commentary, if there’s room for great improvement and affordability, it would be within Medicare Advantage. Obviously, companies like Aetna are adept at changing with the tumultuous times!

Finally, Medicare-eligible individuals must be aware of Medigap enrollment periods; otherwise, they may not obtain coverage in the future.

, Medicare Advantage? A Couple of Things To Consider

Be mindful of Medigap’s open enrollment.

Medigap policies are available to eligible recipients during open enrollment periods regardless of pre-existing health conditions. Medicare Advantage plans are not subject to similar exclusions. Medigap’s supplemental coverage open enrollment is a six-month open enrollment period that starts the month you are 65 or older and enrolled in Part B.

Thank you, Mr. Ciano, for your insights from the C-Suite!

David Robertson: Should I Stay, Or Should I Go?

Should I Stay, Or Should I Go?

While large doses of monetary and fiscal policy got the rebound in stocks started, it was declining infection rates and economic recovery throughout the summer that kept the party going.

However, with progress stalling on both fronts in the fall, it’s a good time to reassess investment conditions. Liquidity is still ample, but momentum is slowing. Perhaps most importantly, several sources of potential volatility are imminent. That leaves investors with the challenge: Should I stay, or should I go?

Risky Business

That decision, of course, involves tradeoffs, and those tradeoffs involve some assessment of risk. Although it has been quite a while now since the financial crisis in 2008, that event focused minds on topics like risk management and financial system fragility that had earlier received little but passing attention, much like today.

Many of the insights came from physics, engineering, and other disciplines with long histories of contending with systemic failure.  Concepts such as “fat tails” and “nonlinearity” entered the investment vernacular.

However, after years of rising markets and a rapid recovery from the selloff in March, discussion of these topics has faded from the public sphere as concerns about risk have abated. This is a shame because the structural risk elements are more relevant now than ever.

London Bridge

On this note, it is useful to take a short walk down memory lane to review some of those risk elements, specifically the conditions leading to nonlinear events. Michael Mauboussin set the stage with a research report on nonlinearity in 2007 that predated the financial crisis. He described what has become a classic example of nonlinearity at work:

“On June 10. 2000, the Millennium Bridge opened to the public with great fanfare. London’s first bridge across the Thames in over a century had a sleek design. The architect wanted it to look like a ‘blade of light.’ However, when thousands of people stepped on the bridge that day, it started to sway from side to side so much that people had to stop or hold on to the rails. Fearing for the public’s safety, officials closed the bridge two days later and, following a retrofitting, it reopened in February 2002.”

An important element of a nonlinear system is the critical point or threshold. Mauboussin describes the critical point as a situation in which “small incremental condition changes lead to large-scale effects.” In the case of the Millennium Bridge, that critical point was about 165 pedestrians. Under that threshold of people walking the bridge, there was no noticeable effect. When thousands of people walked across on the day it opened, it began to sway to such a degree pedestrians had to grab for support.

One Small Step

What happened? Ren Cheng answered the question in a separate report that included the same example of the Millennium Bridge:

“‘The lateral vibration, or ‘wobble,’ as many Londoners called it, was attributed to a ‘positive feedback phenomenon,’ whereby pedestrians crossing a bridge that has a lateral sway have an unconscious tendency to match their footsteps to the sway, thereby exacerbating it.'”

Cheng used the example to investigate a more specific phenomenon, however. He had observed increases in both correlations and volatility in the stock market and wondered if the increasing popularity of passive strategies could explain the phenomena. He compared passive investing to the bridge:

“The Millennium Bridge example is analogous to the increased flows to passive strategies and the unwanted side effects of higher correlations and volatility. Passive strategies reflect the independent investment decisions of many people, but in reality, all passive investors are making the same investments (or steps). Like the pedestrians walking independently on the bridge, eventually, the bridge (equity market) starts to sway in the same direction (higher correlations.) It then sways more violently in the same direction (heightened volatility) as more people walk (or invest) the same way.”

Commonalities

Cheng makes a good case in highlighting the commonalities of the two systems. In both systems, individuals pursue their own optimal activity. In the case of the bridge, that is stepping in sync with the sway of the bridge. When it comes to investing, that is investing passively. In both systems, individually optimized activity leads to collectively risky conditions. 

Cheng concludes,

“As the Millennium Bridge analogy helps illustrate when a greater number of investors are choosing the same investments via passive strategies, there is less independent decision-making. Subsequently, there is less information discovery driving market prices.”

In other words, beyond a certain threshold, passive investing creates greater inefficiencies in the market.

Interestingly, Cheng raised his concerns about the impact of passive investing in 2012. Since then, the share of passive investments relative to active ones has continued to grow. Although Cheng’s concerns have remained underappreciated, they have resurfaced from a couple of prominent voices.

Going, Going … 

In 2018 Chris Cole at Artemis Capital Management published a report that highlighted the importance of liquidity. His broader point was that focusing too intently on liquidity prevents us from seeing a deeper reality underneath. His specific point was the increasing share of passive investing is increasing systemic risk at the expense of active investing. He forecasts, “A crisis-level drought in liquidity is coming between 2019 to 2022”. 

Mike Green from Logica Funds has also (frequently) discussed the structural impact of passive investing on the market. In an interview on MacroVoices, he described,

“When you move to a passive framework, it becomes rules literally as simple as: Did you give me cash? If so, then buy …”

In a RealVision interview, he described the influence of passives as providing “a giant, systematic player that reinforces momentum.”

Lessons Learned

All of this serves to provide a useful perspective from which to assess investment opportunities. The “reinforced momentum” generated by passive investing creates a short-term tailwind for traders and speculators that proves tempting.

For longer-term investors, passive management’s continued growth at the expense of active looks more like a nonlinear system that has exceeded its critical threshold. No longer does the balance of active and passive result in stock prices that reflect a semblance of fair value. Rather, passive investing’s ongoing march has served to stretch prices further away from a fair value like a rubber band.

This highlights another interesting take. Eight years after Cheng expressed his concerns about the role of passive investing in boosting systemic risk, passive has continued to grow, and we are much farther removed from balance than we were then. Instead of becoming more concerned about downside risk and volatility, many investors are becoming less so.

Mental Models

One reason for this may be that the nature of nonlinear systems does not fit neatly into the mental models of risk that many people have. For instance, one common set of beliefs is those bad things happen due to bad behavior. While bad behavior is often involved, many times, the more important cause is fragile systems. Certainly, this was the case in the financial crisis when several bad actors exacerbated problems but did not create the financial system they operated.

Another common belief is that passive investing is low risk. In narrow terms, this is true. Passive funds have lower fees than active funds and have a low risk of significantly underperforming their benchmark. However, passive funds do the same thing regardless of whether expected returns are plus ten percent or minus ten percent. Cheng highlights, “As importantly, investors should not view the decision to invest solely in passive strategies as a way to minimize their risk exposure in a certain asset class.”

Conclusion

In sum, one of the great challenges for long-term investors is to calibrate risk exposure to opportunity. It is important to remember that relationship changes over time. The particular example of the Millennium Bridge and the general case of nonlinear systems provide a useful tool for envisioning that risk. This is especially helpful in an environment in which passive investing continues to shape the investment landscape and the risks it entails.

The Market’s Invisible Guardrails Are Missing

The Market’s Invisible Guardrails Are Missing

If you have ever driven on California’s Pacific Coast Highway (PCH), you understand risk. For those that haven’t made the drive, you are missing out on a spectacular winding road perched between a steep cliff and the ocean well below. Staying safe on this harrowing road requires strong driving skills and a good set of brakes.

Above and beyond what is in the driver’s control, the essential defense protecting drivers are the guard rails. If the PCH were fortified with 20-foot concrete walls, the risks of driving the road would be minimal but the incredible views lost. Conversely, if there were no guardrails, the risks increase substantially. A healthy compromise lies between these two extremes.

Investors also have the ability to employ guardrails in the market. Sometimes they are large and protective. Other times they are negligible. Unfortunately, most investors have little appreciation for these invisible guardrails and which type of investors manage them. In reality, the efficacy of market guard rails’ should largely determine our risk-taking stance.

Credit

Before progressing, we would be remiss if we did not thank Steven Bregman from Horizon Kinetics. Steve brought the pitfalls of passive investing to our attention over six years ago. Here is a LINK to a great speech he gave at the Grants Fall 2016 conference.

Also, Chris Cole and Mike Green have done substantial work in quantifying the risks associated with the increasing popularity of passive strategies. The following LINK offers an outstanding interview of Mike Green by Grant Williams.

Passive versus Active

The market guardrails we allude to are based on the capabilities of active investors. Before explaining, it is worth a short review on passive and active investment strategies.

In 2016, we wrote Passive Negligence, the first of many articles on this topic. Per the article:

“Passive index strategies are all the rage. Investors, desperate for “acceptable” returns are investing in funds whose value is directly linked to stock market indices. Unlike active funds, indexed funds do not perform investment analysis and are not looking for sectors or companies that offer greater return potential than the market. They do one thing, and that is replicate a particular equity index.”

In 2016 passive index strategies were “all the rage.” Today they are the market. Active investors have become endangered species. Due to poor relative returns and short-term thinking clients, many active professionals have been forced to become less value and more growth oriented. Failing to adapt ultimately means business failure as clients flee to the growth/passive style. Similarly, most individual active investors have similarly swapped active for passive strategies.

The graph below shows how value investors (active) have recently fared versus growth investors (mostly passive). The duration and magnitude of value’s underperformance is unprecedented.

Passive in Action

In the article five years ago we also wrote: In other words, the prices of underlying stocks will increasingly rise and fall together in correlation with the market and not based on their individual merits.”

Little did we know how profound those words would be. In “How to Find Value in an Upside Down World” we show the following graph.

As of September 2020, year to date returns were highest for the largest companies and lowest for the smallest within the S&P 500. The return differentials are stunning. As the saying goes, size matters. It appears that size is all that matters.

As we wrote, “The S&P 500 and NASDAQ are market-cap-weighted indexes, meaning the largest companies contribute more to the index than the smallest.” Ergo, when passive investors buy the index, they are mainly buying the largest companies.

Value

Active investors seek out value. While value investing is defined in many ways, it generally means buying assets they deem cheap. Conversely, they tend to sell assets that fulfill their valuation forecast and become overpriced. Some active investors also short overpriced assets.

With that in mind, we present some graphs from the same article.

As shown, the companies with the best fundamental ratios had the worst performance.

From January to September, value was left for dead. The only thing that seems to matter to investors is market cap.

These results demonstrate that value investors are not a viable force in the market. The activities of those who are left are being overwhelmed by the growing preference for passive investing.

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

Active Guardrails

The graph below highlights the exodus from active to passive strategies over the last 12 years.

The obvious takeaway from the graph is the larger role of passive investors (net inflows) and the smaller share of active investors (net outflows). What is not obvious but of utmost importance to the health of the market are the repercussions of the dramatic shift taking place.

To help you understand the role active investors play, let’s consider a simple and somewhat hypothetical case. From 2010 to late 2019, Apple’s (AAPL) price to earnings ratio was between 10 and 20. In this case, it should be self-evident that active investors might generally view Apple as cheap at 10 and expensive at 20. By contrast, passive investors, are indifferent at any P/E.

As shown below, P/E gyrates in the range. As it approaches the bounds, active managers get involved. Their interest provides buying and selling pressure to regulate the range. Active investors have enough market share in our example to uphold the range.

The graph shows that active investors may have lost enough market share in 2019 and could not provide their protective services. It is important to note that there is little about Apple’s prospects to be giddy about. Their earnings have been flat for the last five years.

In reality, active investors have many different views and opinions. They also have different strategies and vastly different evaluations on rich versus cheap. That said, the more active investors there are, the more prices are grounded to historical valuation norms. In other words, active investors reduce volatility, and therefore risk. Active investors are the guardrail.

Quantifying our Guardrails

Market and individual stock guardrails can be thick or flimsy. Also, there is not one proverbial guardrail but many based on the differing opinions of active investors. Regardless, the ability of active investors to provide a valuation check is purely a function of how powerful active investors are.

The question, therefore, is at what point passive investors negate the ability of active investors to regulate markets.

Chris Cole of Artemis, in his brilliant article “What is Water?,” helps put a number on our question.

When passive participants control 60%+ of the market the simulation becomes increasingly unstable, subject to wild trends, extreme volatility, and negative alpha. In the real world, because the ratio between active to passive is not constant, the instability threshold will occur at a much lower threshold as investors shift their preference to passive in real-time.

The irony of the Bogle-head crowd is that they tout efficient market hypothesis to support passive investing while simultaneously failing to comprehend how the dominance of the strategy causes markets to become highly unstable and inefficient. The most immediate realities are the ones that are the hardest to see… If you want to know when volatility will truly arrive, watch the shift in the medium. 

The “medium”, in Cole’s terminology, is the balance between the roles of active and passive investors. He computes that when passive investors are more than 42% of the market, volatility increases and active investors gain an edge. As he writes, above 60%, the market lacks guardrails. Without guardrails, active investors have a considerable advantage as price becomes grossly detached from fundamentals.

Summary

The massive surge in passive strategies’ popularity has pushed the market to the brink of instability. Instability can result in price surges to unprecedented valuations. It can also produce immense volatility and tremendous price declines, as we saw in March. Volatility is here to stay as long as investor preferences remain the same.

There are no longer guardrails on our winding road of wealth accumulation. Those guardrails have been temporarily put out to pasture in favor of the laziness of passive strategies. Most troubling is that so few investors, many of which are heavily dependent on their investment portfolios, understand there are no guardrails for their wealth.

As you would drive on the PCH without guardrails, we recommend managing your wealth with the same attention. This article is not a recommendation to divest and sit in cash. However, it should serve as a warning that the hair raising declines in March, and vertical surge afterward may not have been an anomaly but a preview of things to come.

TPA Analytics: Top 10 Buys & Sells As Of 10-13-20

Top 10 Buys & Sells As Of 10-13-20

These are high conviction stocks that TPA has recommended recently. They are technically positive for “buys,” or negative for “sells.” They are also trading at, or near, the recommended action price levels.


Note from the RIAPro Team:

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

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

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

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

Sector Buy/Sell Review: 10-13-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 10-13-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when. It also guides what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. Currently, markets and sectors are back to “stupid” overbought on many levels. We advise caution.

SECTOR BUY/SELL REVIEW: 10-13-20

Basic Materials

  • Looking at XLB, you will see the same in Industrials and Transportation, which bounced on Monday, but there hasn’t been enough correction in the sector for a good entry point. 
  • While XLB held support and bounced off the 50-dma, it has been underperforming over the last few trading sessions and is back to 3-standard deviations. 
  • Be patient for a pullback to add to holdings. 
  • Keep stops on trading positions at the 50-dma. 
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: Added to our XLB position.
    • Stop-Loss moved up to $60
  • Long-Term Positioning: Bullish

Communications

  • Communications also jumped on Monday, as the sector bounced from the previous sell-off.
  • XLC did regain the 50-dma, so trading positions are still intact. 
  • Traders can use pullbacks to the 50-dma to add positions with a very tight stop at $56.
  • Short-Term Positioning: Bullish
    • Last Week: Added to holdings.
    • This Week: Hold positions
  • Long-Term Positioning: Bullish

Energy

  • As we noted last week: “Energy is deeply oversold and due for a bounce. However, there is not much support for the sector currently.” 
  • The sector did bounce on Monday…but barely. Furthermore, bounces are not holding. 
  • The overall trend is fragile, remain clear for now.
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Bearish

Financials

  • Financials continue to underperform but did bounce on Monday in anticipation of earnings.
  • We saw the same bounce last quarter that eventually failed. 
  • We are still avoiding the sector for now. 
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Industrials

  • As noted, like materials, XLI rallied sharply on Monday under the premise of more fiscal support. 
  • We added to our exposure previously and are holding for now. 
  • XLI is pushing back up into the 3-standard deviations of the 50-dma and is underperforming the S&P. 
  • We will likely take profits and rebalance risk. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bullish

Technology

  • Technology stocks and the Nasdaq found some buying yesterday as an apparent short-squeeze fueled the FANG stocks’ rally. 
  • The sector is back to very overbought and is now running into the previous resistance. 
  • Sector investors will likely chase for now as the momentum trade continues. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Hold positions
  • Stop-loss set at $105
  • Long-Term Positioning: Bullish

Staples

  • XLP has exploded higher over the last couple of trading sessions.
  • While the rally did underperform the broad market, the sector is back to very overbought and is pushing into 3-standard deviation territory. 
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $62 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Real Estate

  • On Monday, XLRE rallied back into previous resistance. Such is likely a good time to take profits and rebalance this sector. 
  • XLRE is very overbought and extended with multiple tops providing resistance at current levels.
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Utilities

  • XLU had been struggling with resistance at the 200-dma. However, over the last couple of sessions, and opposed to the 10-year yield rising, XLU has surged back to very overbought conditions.
  • XLU is now 4-standard deviations above the moving average. 
  • Take profits and rebalance risk. 
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Reduce XLU by 50%.
  • Long-Term Positioning: Bullish

Health Care

  • XLV broke below its 50-dma but held support and has now blasted higher into an extreme overbought and deviated condition. 
  • We stated previously; there was an opportunity to add exposure, which we did. 
  • The 200-dma is now essential price support for XLV.
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Discretionary

  • XLY corrected back to the 50-dma, where we added exposure to our portfolio. 
  • On Monday, the sector rallied but underperformed the market as a whole. 
  • The sector is back to extreme overbought and is now pushing into 3-standard deviation territory. Look to take profits and rebalance. 
  • Stop-loss moved to $140
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Long-Term Positioning: Bullish

Transportation

  • Transportation, like Materials, has been rallying on hopes from infrastructure. That is a long-shot.
  • The sector is not overbought but is running into previous resistance.
  • The “buy signal” remains very extended. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and are waiting for a better entry point to add to our holdings.
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Neutral

Technically Speaking: COT – Everyone’s Back In The Pool: Q3-2020

As discussed in Hopes Of More Stimulus, the market has rebounded following the September decline. Unfortunately, the market has again gotten quite ahead of the fundamentals as money continues to chase performance. In the Q3-2020 review of the Commitment Of Traders report (COT,) we can see how positioning has moved back towards extremes. Once again, “everyone’s back in the pool.” 

The market remains in a bullish trend from the March lows but has returned to more extreme overbought conditions on an intermediate-term basis. Despite valuations on a 2-year forward basis at more extreme levels, economic growth recessionary, and a significant risk of a failure to pass more stimulus, investors continue to chase markets.

Furthermore, as noted in this past weekend’s newsletter:

“Retail investors have also ramped up speculative bets again, pushing the Put/Call ratio back towards previous highs. There is still room before getting back to previous levels, which suggests a run to all-time highs is possible.”

Market Regains Footing Stimulus, Market Regains Footing On Hopes Of More Stimulus 10-09-20

While this does not mean the market is about to crash, it does suggest “everyone” is once again on the long side of the “risk trade.”  The piling back into stocks following the brief September decline has sent our technical composite gauge back towards extreme overbought levels as well. (Get this chart every week at RIAPRO.NET)

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

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

So, how are traders positioning themselves currently?

Positioning Review

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

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

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

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

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

Volatility 

Since 2012, the favorite trade of bullish speculators has been to “short the VIX.” Shorting the volatility index has been an extremely bullish and profitable trade due to the inherent leverage in options. Of course, as with all things option related, it works great when it works. Just not so much when it doesn’t.

With the market rally from the March lows, investors have become encouraged to take on risk. Currently, net shorts on the VIX are rising sharply and are back to more extreme levels. While not as severe as seen in 2017 or 2020, the positioning is large enough to fuel a more significant correction.

The only question is the catalyst.

Crude Oil Extreme

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

While prices collapsed along with the economy in March, there has been a sharp reversal of global economic recovery expectations. Interestingly, with the economic recovery showing signs of slowing, crude oil has stalled at its 200-dma.

Furthermore, while Oil prices have had a sharp recovery from the March lows, the energy sector has not, and many stocks continue to trade near their previous lows. It is quite a dichotomy between the commodity and the companies that operate in that space. In fact, as noted at the top of the chart, the outperformance of crude oil versus $XLE is at the highest level on record.

The speculative long-positioning is driving the dichotomy in crude oil by NCTs. While levels have been reduced from previous 2018 highs by a series of oil price crashes, they remain more extreme at 471,536 net-long contracts. While not the highest level on record, it is definitely on the “extremely bullish” side.

Libya bringing production back online would further exacerbate the oil supply problem. Or, a lack of fiscal stimulus would derail the economic “reflation” story. Either event could trigger an unwinding of oil contracts pushing prices lower once again.

U.S. Dollar Extreme

Another catalyst for a decline in commodity prices, equities, and ultimately bond yields would be a rise in the U.S. dollar.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE. Such has also been the tailwind for the rally in International and Emerging Markets. However, over the last couple of months, the long-dollar bias has reverted to a net “short” positioning. Historically, these reversals are markers of more important peaks in the market and subsequent corrections as the dollar begins to rally.

Given the more extreme long-positioning in risk assets and commodities, a decent hedge to reduce portfolio risk appears to be in the contrarian positioning of being long the US Dollar. Such is generally when the media is rampant with stories about the “demise of the dollar.”

Interest Rate Extreme

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

Since then, rates fell to the lowest levels in history as economic growth collapsed. Importantly, while the Federal Reserve turned back on the “liquidity pumps” in March, juicing markets back to all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Such has continued to confound the “bond bears” who were sure rates would go screaming higher. Of course, as discussed in the article, they can’t go higher when the economy is saddled with debt.

Currently, mainstream expectations are for an economic recovery, more stimulus, and a rise in inflationary pressures. However, the number of contracts “net-long” the 10-year Treasury, suggests the recent uptick in rates, while barely noticeable, maybe near its peak. Such suggests the mainstream narrative may not come to pass. 

Importantly, even while the previous “net-short” positioning in bonds has reversed, rates failed to rise correspondingly. The reason for this is due to rising levels of Eurodollar positioning as foreign banks push reserves into U.S. Treasuries for “safety” and “yield.”

There is a probability interest rates will fall in the months ahead, coinciding with an acceleration of economic weakness. 

Conclusion

Despite the “selloff” in March, retail positioning is once again very long-biased. The implementation of QE-4 once again removed all “fears” of a correction, recession, or bear market.

Historically, such sentiment excesses from around short-term market peaks, not investable bottoms.

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

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

Investors miss that while a warning doesn’t immediately translate into a negative consequence, such doesn’t mean you should ignore it.

“There remains an ongoing bullish bias that continues to support the market near-term. Bull markets built on ‘momentum’ are very hard to kill. Warning signs can last longer than logic would predict. The risk comes when investors begin to ‘discount’ the warnings and assume they are wrong. 

It is usually just about then the inevitable correction occurs. Such is the inherent risk of ignoring risk.'”

The cost of not paying attention to risk can be extraordinarily high.

Viking Analytics: Weekly Gamma Band Update 10/12/2020

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 10/12/20

  • Gamma Neutral in the S&P 500 (SPX) acted as apparent support and resistance in recent weeks, and the SPX launched higher to end the week last week.  Our Gamma Band model has had SPX exposure at 100% for four of the past five days.   
  • The upper band is currently at 3,511, and while this level may occasionally be seen to act as resistance, the back-test does not suggest reducing exposure when SPX hits the upper band level.
  • Our binary Smart Money Indicator continues to have a full allocation, and this is discussed in greater detail below.
  • SPX skew, which measures the relative cost of puts to calls, presents a neutral environment at the moment.  
  • Our Thor Shield daily allocation model continues to have SPY at 100% as of Friday. ThorShield is a fast, daily signal based upon daily put and call volume. Samples of all of our SPX and ThorShield daily reports can be downloaded from our website.

Smart Money Residual Index

This indicator compares “smart money” options buying to “hot money” options buying.  Generally, smart money will purchase options to insure stable returns over a longer-term.  Smart money has in-depth knowledge and data in support of their options activity. In contrast, “Hot money” acts based on speculation, seeking a large payoff.

At the moment, hot money is more cautious than smart money, and the back-test supports a long position during this time.  When the Residual Sentiment Index in the second graph turns to red, then this model will cut all equity exposure to zero.  When the market is in the red regime below, the market has an overall negative return.

SPX Skew – the Price of Protection

In evaluating equity market risk, we also consider the cost of buying puts versus the cost of buying calls.  When puts command a larger-than-usual premium to calls, then the market will have higher volatility (in the red zone below), and this might be a signal to reduce equity exposure.  We consider skew to be neither bullish nor bearish at the moment.

Gamma Band Background

Market participants are increasingly aware of how the options markets can affect the equity markets in a way that can be viewed as the “tail wagging the dog.” 

We created a Gamma Band indicator to demonstrate the effectiveness of the Gamma Neutral level in reducing equity tail risk.  In our model, we compare the daily close of the SPX to the Gamma Neutral and Lower band levels to adjust our equity exposure allocation from 0% to 100%.  

We back-tested this strategy from 2007 to the present and discovered a 77% increase in risk-adjusted returns (shown below).  The Gamma Band model is a relatively slow but reliable signal if one’s goal is to increase risk-adjusted returns.  We also publish a faster, daily signal in a portfolio model which we call Thor’s Shield.  Thor Shield has a 20-year Sharpe of 1.5 and a rolling 1-year Sharpe of over 3.4.  Free samples of our daily SPX report and Thor’s Shield model can be downloaded from our website.

Authors

Viking Analytics is a quantitative research firm that creates tools to navigate complex markets.  If you would like to learn more, please visit our website, or download a complimentary report.

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 B.S. 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. Furthermore, he 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 Analytics: Look Out BigTech, There’s A New Sheriff In Town

LOOK OUT BIGTECH, THERES A NEW SHERIFF IN TOWN.

Yesterday, we saw Will Hobbs, Barclays Wealth Chief Investment Officer, tell CNBC* that there was a potential for a big sell-off in big technology companies such as Amazon AMZN, AAPL, GOOG, NFLX, TSLA, and MSFT.

The message to investors really is to make sure that you don’t let your portfolio, or your batch of investments, get sucked into that ever smaller, more concentrated batch of recent winners. The industry has long been obsessed, and investors are understandably obsessed with the idea that you can protect the downside and capture equity upside. That is like the Holy Grail of investing.

Not to pick on Mr. Hobbs, but isn’t the cow already out of the barn? Megacap TECH has been underperforming for over a month. Since the market peaked on 9/2/20, TPAs BIGTECH is down almost 12%, while the benchmark S&P500 is down a little more than 4%. On the other hand, TPA has been warning clients about a BIGTECH selloff since 8/25. In the 8/25 World Snapshot, TPA told clients that

Large Cap Growth Warning

Large Cap Value is now more oversold versus Large Cap Growth than it has been in the past 40 years. Although the long-term trend for Large Cap Growth outperformance will continue, the current extreme will most likely reverse for a time-period ample enough for TPA clients to benefit [from the change]

The underperformance in BIGTECH is directly tied to the S&P500s reversal. The chart below shows that the S&P500 topped out on 9/2. This also marks the beginning of the underperformance of BIGTECH. Mr. Hobbs, it seems, is over a month late with his warning.

Note that the underperformance since 9/2 has reduced the weight of BIGTECH in the S&P500 from 31% to 29%, but 29% is still plenty of weight to be able to drag down the overall index.

S&P500 2020 YTD

Fortunately, TPA repeatedly told clients to be in BIGTECH since 4/8/20. They have benefited greatly from this guidance. Since 4/8, the S&P500 +25%, but the NDX 100 and TPA BIGTECH were up 42% and 54% in the same timeframe (relative performance chart below).

In the 4/8 World Snapshot, TPA told clients, It can be argued that the nature of the Pandemic put the businesses of the DJIA at more risk than those of the NDX, which is probably why they underperformed from 2/19 to 3/23.TPA sees NDX continuing the longer-term pattern of outperforming its older brother, the DJIA.

RELATIVE PERFORMACE S&P500, TPA BIGTECH, NDX 100, RUSSELL 1000 GROWTH SINCE 4/8/20

On 4/15 TPA again told clients to stick with Large Cap Growth and BIGTECH:

The stock market in 2020 is now an ongoing story of a great divergence between winners and losers.  TPA breaks this widening divide down into 3 [winning] categories: 1. BIGTECH versus the broader market, 2. Large Cap versus Small Cap, 3. Growth versus Value

TPA reiterated its stance again on 4/17:

this pattern should continue unabated. The only chance for the pattern to be interrupted was anti-trust or some other regulation from the government. Given the recent state of the world, governments focus will be elsewhere for months and perhaps years to come.

MORE TPA REPORTS:

  • 6/10/20 TPA clients should still be in the 2020 winners
  • 7/31/20 How to avoid sad performance for the rest of 2020
  • 8/10/20 Outperformance demands adherence to long term patterns
  • 8/19/20 Stick with the new safety stocks

TPA continued to recommend BIGTECH until 8/25.

The chart below shows the relative performance of the BIGTECH, NDX 100, Large Cap Growth, and the S&P500 year to date for 2020. TPA has highlighted the periods from its 4/8 report to its 8/25 report and the period since 8/25.

The second chart shows (again) the huge outperformance of BIGTECH and growth from 4/8 to 8/25. The third chart highlights how the performance pattern has changed since 8/25. Since 8/25, BIGTECH is down 5.2%, while the S&P500 is almost unchanged. Given that BIGTECH makes up approximately 30% of the S&P500, a lot of other stocks have to do some very heavy lifting to keep the S&P500 stable.

Warning Remains

On 9/4/20, TPA again warned clients that the performance patterns have changed and they should avoid BIGTECH and Large Cap Growth:

Yesterdays trading pattern fell in line with what TPA discussed last week. On 8/25, the World SnapshotTPA will continue to watch for a pattern to develop. Clients should also monitor the Canaries in the Coalmine for a confirmed pattern change in momentum stocks (TSLA, CRM, ADBE, AAPL, and NVDA) mentioned in yesterdays World Snapshot. These stocks finished the day as big underperformers; TSLA -9.02%, CRM -4.22%, ADBE -4.87%, AAPL -8.01%, and NVDA -9.28%.

On 10/1. TPA put out a sell recommendation on AMZN and MSFT. It is still early on, but since 10/1 AMZN is down 0.38% and MSFT is down 1.71% and the S&P500 is basically unchanged. So far, the move away from BIGTECH is continuing as forecasted.

  1. RELATIVE PERFORMACE S&P500, TPA BIGTECH, NDX 100, RUSSELL 1000 GROWTH 2020 YTD

2) RELATIVE PERFORMANCE S&P500, TPA BIGTECH, NDX 100, RUSSELL 1000 GROWTH 4/8/20 TO 8/25/20

3) RELATIVE PERFORMACE S&P500, TPA BIGTECH, NDX 100, RUSSELL 1000 GROWTH SINCE 8/25/20

4) RELATIVE PERFORMACE S&P500, TPA BIGTECH, NDX 100, RUSSELL 1000 GROWTH SINCE 9/2/20

Broad Market Performance

Finally, a look at the performance of broad U.S. market categories confirms TPAs analysis that there is a larger investment shift at play since the start of September. The chart below shows the relative performance of the benchmark S&P500, BIGTECH, Russell Large Cap Growth, Russell Large Cap Value, Russell Small Cap Growth and Russell Small Cap Value.

After trailing for the past 8 months, Small Cap has pulled ahead and Small-Cap Growth is the leader.  The worst performer (by far) is BIGTECH and the second worse performing category is Large Cap Growth.

Two themes deserve repeating:

  1. The performance discrepancy between Large Cap Growth and other stocks had just become too extreme from a historical perspective.
  2. BIGTECH makes up so much of the market that many stocks have to rally to counteract their weakness; this means big moves in much smaller stocks

RELATIVE PERFORMACE S&P500, TPA BIGTECH, R1000 GROWTH, R1000 VALUE, R2000 GROWTH, R2000 VALUE SINCE 9/2/20


TECHNICAL INDICATOR EXPLANATIONS:

ASCENDING – DESCENDING TRIANGLE

BASING-TOPPING-CONSOLIDATION

BREAKOUT (Breakdown)

CHANNEL & RANGE

DIRECTIONAL MOVEMENT INDEX (DMI)

DOUBLE BOTTOM or DOUBLE TOP

MACD-MOVING AVERAGE CONVERGENCE-DIVERGENCE

MOVING AVERAGES

RELATIVE STRENGTH & PEER STOCK PERFORMANCE

REPEATING PATTERNS

RSI-RELATIVE_STRENGTH

SUPPORT, RESISTANCE, BREAKOUT, BREAKDOWN

TREND


Note from the RIAPro Team:

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

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

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

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

Major Market Buy-Sell Review: 10-12-20

HOW TO READ THE MAJOR MARKET BUY-SELL REVIEW 10-12-20

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

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

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

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

Major Market Buy/Sell Review 10-12-20

S&P 500 Index

  • The oversold condition that existed last week has now been reversed. While some extreme extensions have been reduced, the market is likely to run into some decent resistance at the previous highs. 
  • As noted previously, the break back above the 50-dma provided the bulls some support to take on additional equity risk. There is currently about 3% to all-time highs, so remain long for now. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: Removed short-hedge last Monday at the open. 
    • Stop-loss set at $310 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The tradeable rally in the Dow we suggested previously has worked well. 
  • Maintain long positions for now, but take some profits near all-time highs. 
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • The Nasdaq has been lagging performance this past week as other market sectors have been playing a bit of catch up.
  • This is actually good news as the extreme overbought condition has been reversed. If the next market correction holds support, such will likely provide a good opportunity to add exposure aggressively.
  • There is still a tradeable opportunity in Technology stocks, just honor stop losses.
  • Short-Term Positioning: Bullish
    • Last Week: No changes this week.
    • This Week: Taking profits.
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • As noted last week, “With the 50-dma crossed above the 200-dma, there is support for a further rally in small-caps.” That rally came to pass, and now small-caps have again become very deviated from their long-term mean.  
  • Risk is to the downside currently, but there is a chase to gain exposure to lagging sectors by investors right now. 
  • It is still suggested to use the current rally to rebalance positions until the downtrend is reversed. 
  • Short-Term Positioning: Bullish
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss violated.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • MDY performed better than SLY last week, but it is extremely extended from its long-term mean like SLY. 
  • The tradeable opportunity in Mid-caps we discussed previously is likely over for now. Keep stops tight at the 50-dma for now. Look for pullbacks to support to add exposure.
  • The $330 stop-loss remains intact, but just barely. 
  • Short-Term Positioning: Bullish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss is set at $330
  • Long-Term Positioning: Bullish

Emerging Markets

  • Emerging markets had performed better on a relative basis during the correction. Still, now they are pushing back into 3-standard deviation territory, which has previously been a good opportunity to take profits. 
  • EEM is no longer oversold, so use this rally to reduce risk temporarily. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved to $42 for trading positions.
  • Long-Term Positioning: Bullish

International Markets

  • International markets performed worse than emerging markets last week, but are not as grossly extended either. 
  • Maintain stops and use the rally to reduce risk. 
  • Short-Term Positioning: Bullish
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bullish

West Texas Intermediate Crude (Oil)

  • The rally in oil occurred and finally broke above the 200-dma. The worst may be over for now in oil if prices can hold above these levels. 
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • After previously adding to our positions in GDX and IAU, we continue to hold our positions. 
  • The sector is currently on a sell-signal and is not extremely oversold. However, further consolidation may provide a perfect entry point to add further exposure. 
  • Stops are reset at $165. 
  • We believe downside risk is relatively limited, but as always, maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Added 1% to GDX and IAU
    • This week: No changes this week.
    • Stop-loss adjusted to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds continued to hold up last week and is continuing its consolidation process. 
  • There is still upside potential in bonds from the current oversold condition. 
  • Furthermore, the “sell signal” is now at levels that have typically preceded more massive rallies in bonds. 
  • Investors can still add to Treasuries at current levels.
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions.
    • This Week: Sold AGG and added a 5% position in PFF.
    • Stop-loss moved up to $157.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar rally stumbled this past week and is testing the 50-dma. 
  • We still suspect that we could see a further rally in the next couple of weeks with the large short-position. Watch for the buy signal in the lower panel of the chart for a signal to go long the $USD.
  • Subsequently, a dollar rally will devalue international and emerging market holdings, so act accordingly. 
  • Use weakness to add to positions that hold the 50-dma. 
  • Stop-loss adjusted to $92.

The K-Shaped Recovery. A “V” For Some, Not For Most.

Economists have come up with every variation of applying a letter of the alphabet to the economic recovery. Whether it’s an “L,” a “W” or a “V,” there is a letter that suits your view. But what is a “K”-shaped recovery?

Take a closer look at the letter “K.” It’s a “V” on the top, and an inverted “V” on the bottom.

According to Investopedia:

“A K-shaped recovery occurs when, following a recession, different parts of the economy recover at different rates, times, or magnitudes. This is in contrast to an even, uniform recovery across sectors, industries, or groups of people. A K-shaped recovery leads to changes in the structure of the economy or the broader society as economic outcomes and relations are fundamentally changed before and after the recession.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Creative Destruction

Following the economic shutdown, much of the data shows strong signs of improvement. However, several different economic phenomena are driving a K-shaped recovery.

One of the more interesting aspects of the recovery has been that of “creative destruction:”

“Creative destruction is a concept in economics which since the 1950s has become most readily identified with economist Joseph Schumpeter. Schumpeter derived it from the work of Karl Marx and popularized it as a theory of economic innovation and the business cycle.

According to Schumpeter, the ‘gale of creative destruction’ describes the ‘process of industrial mutation. The process continuously revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one'” – Wikipedia

Industries like technology, retail, and software services are leading the way in “creative destruction.” Technology companies like Apple Inc., Alphabet Inc., and Microsoft Corp. saw earnings expand during the economic recession. General merchandise retailers such as Target, Walmart, and Costco, along with online video entertainment giants Netflix Inc., Walt Disney Co., and YouTube, made sizeable gains as the economy closed. Biotech, Pharmaceuticals, and, of course, “Work From Home” firms like Slack and Zoom blossomed with online retailers like Amazon and Shopify.

However, while the “fire of necessity” gave birth to a host of new companies, simultaneously others got lost. Travel, airlines, cruises, movie theaters, traditional retailers, and real estate remain under significant financial pressures.

The Other Side

In the bottom half of the “K” shaped recovery lies the majority of the economy. Its recovery is questionable the longer the pandemic goes on. The shift to “Work From Home” or “WFH,” along with the rise of the associated technologies, has companies questioning the need for expansive commercial offices.

WFH also requires less employment. In traditional office environments, assistants, associates, and others were previously relied on for more mundane tasks. However, in the WFH environment, those roles become less important as independent working rises.

The need for “less” during the employment recovery is very much part of the “K” shape. Yes, certainly those with skill sets are finding jobs versus those without. Importantly, employers are also finding out they can hire higher qualified talent for less money. For example, I spoke to a restaurant owner who has been hiring as the economy reopened in Texas. His experience has been an overwhelming number of applications for waitstaff, bartenders, and hosts by individuals with bachelor degrees or better.

It isn’t there aren’t jobs for those with a high-school diploma or less, individuals are just taking those jobs with greater education levels.

The process of “creative destruction” is in action, and there are plenty of statistics currently suggesting such is the case.

Not A Broad Recovery

Just recently, Michael Snyder released a list of startling economic facts.

  1. All 546 Regal Cinema theaters in the United States are shutting down, and there is no timetable for reopening them.
  2. AMC Entertainment (the largest movie theater chain in the U.S.) reported they would “run out of liquidity” in 6 months.
  3. The average rent on a one-bedroom apartment in San Francisco is 20.3 percent lower than it was one year ago.
  4. During the 3rd quarter, the number of vehicles delivered by General Motors was down about 10 percent from a year ago.
  5. Anheuser-Busch will be laying off 400 employees in Loveland, Denver, Littleton, and Colorado Springs.
  6. Allstate has just announced that they will be laying off 3,800 workers.
  7. JCPenney says that it will be cutting approximately 15,000 jobs as we approach the holiday shopping season.
  8. On Thursday, we learned that another 787,000 Americans filed new claims for unemployment benefits during the previous week.
  9. Overall, more than 60 million Americans have filed new claims for unemployment benefits so far in 2020.  That number is far higher than anything we have ever seen before in all of U.S. history.
  10. Retail store closings in the United States continue to surge along at an unprecedented pace.
  11. Bankruptcy filings in New York City have risen 40 percent so far in 2020.
  12. This number is hard to believe, but almost 90 percent of New York City bar and restaurant owners couldn’t pay their full rent for August.

However, if you look at the stock market as an indicator of economic recovery, it certainly seems these are isolated cases.

Unfortunately, such isn’t the case.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

A “V” For The Top 10%

As noted by the WSJ previously:

“As of December 2019—before the shutdownshouseholds in the bottom 20% of incomes had seen their financial assets, such as money in the bank, stock and bond investments or retirement funds, fall by 34% since the end of the 2007-09 recession, according to Fed data adjusted for inflation. Those in the middle of the income distribution have seen just 4% growth.” – WSJ

Fed Top 10% Richer, Fed Study: How We Made The Top 10% Richer Than Ever.

Indeed, one of the simplest ways to envision the current “K” shaped recovery is by looking at the surge of the stock market since late March. However, as we have noted previously, the “stock market” is no longer representative of the underlying economy. Such is due to massive interventions by the Federal Reserve, which pushed speculation in “risk” assets to historic levels

Even though the revenues generated by corporations come from economic activity, the Fed has fostered a “debt-driven” explosion of speculative investment activity. Despite the economy plunging in Q2 by most since the “Great Depression,” unemployment surging, and nearly 50% of small businesses nationwide failing, the stock market soared to new highs. Such is a clear example of how Central Bankers distorted the economic relationship.

It also exacerbated financial inequality when the top 1% of earners owns 52% of the stocks and mutual funds.

As I showed last week, the differential in ownership in financial assets between the top 10% of the economy, which owns fully 88% of the stock market, and everyone else isn’t even close.

Fed Top 10% Richer, Fed Study: How We Made The Top 10% Richer Than Ever.

While the “rich get richer,” the poor continue to suffer. Unfortunately, the fiscal stimulus will only worsen the divide.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Expecting A Different Outcome

In the current recovery, it is clear that those at the top of the “K” are indeed experiencing a “V”-shaped recovery. For the rest, not so much.

Unfortunately, policy-makers, along with the Federal Reserve, are stuck. Since politicians want to get re-elected, sending money to households is a way to “buy the vote.” The average American doesn’t understand their demands on the Government for more support is leading to their economic inequality. 

Conversely, the Federal Reserve serves at the mercy of the major Wall Street banks, so their policy focuses on inflating assets prices for the 10%, hoping it might one-day trickle down to the bottom 90%. After a decade, it hasn’t happened.

What we are confident of is that these “new policies” are very much the same as the “old policies.” As such, they will continue to foster economic inequality, inflated assets, and a further widening of the “wealth gap.” 

These policies will ultimately result in further social instability and populism. History is replete with examples of the “endgame” of socialistic experiments of running unbridled debts and deficits.

Maybe we should try something different, and allow recessions to reset economic imbalances. Yes, it will be painful in the short-term, but the long-term benefits of expanded economic prosperity might be worth it.

One thing is for sure, “repeating the same failed actions and expecting a different outcome” has never been a solution for success.

We are reasonably confident it won’t work this time either.

Market Regains Footing On Hopes Of More Stimulus


In this issue of “Market Regains Footing On Hopes Of More Stimulus.”

  • Hopes For More Stimulus
  • Market Regains Its Footing
  • Policies Over Politics
  • Portfolio Positioning Update
  • MacroView: The Second Derivative Of More Stimulus
  • Sector & Market Analysis
  • 401k Plan Manager

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


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP, for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for.

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)
This Week 10-09-20, #WhatYouMissed On RIA This Week: 10-09-20

Catch Up On What You Missed Last Week 


Market Regains Its Footing

“Live by the sword, die by the sword.” – Matthew 26, 26:52

Such was the lesson quickly retaught to President Trump when we decided to halt stimulus talks on Tuesday, sending the market careening into the red. By Wednesday, Trump quickly reversed and has been talking up more stimulus all week.

The inherent problem of tying your Presidency to the stock market is that it’s all fine until it isn’t. The market crash in December of 2018, and again in March 2020, should have been a wakeup call. Unfortunately, it wasn’t, and now valuations, deviations for long-term means, and speculation have increased risk significantly.

Also, while more stimulus may be a great short-term “fix” for the economy, and ultimately the market when the Federal Reserve monetized the debt issuance, as  discussed in this week’s #MacroView:

“More debt doesn’t lead to stronger rates of economic growth or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.”

stimulus 2nd derivative effect, #MacroView: More Stimulus And The 2nd Derivative Effect

Nonetheless, the market rallied on what is for now “hope” of more stimulus. There is still no deal on Capitol Hill, and the parties are still far apart primarily on funding for states and municipalities.

Market Regains Its Footing

As I penned last week, we were expecting a rally this week.

“Notably, while the rally that we have witnessed from the recent lows has eaten up a fair bit of the previous oversold condition, the MACD “buy signal” was triggered on Friday. Such suggests that we could see some additional buying next week.”

The market did indeed rally out of the gate on Monday but was cut short on Tuesday by Trump’s tweet shutting down stimulus talks. However, his quick retraction put the market back on more solid footing short-term.

Again, the Federal Reserve needs “more stimulus” to monetize the underlying debt issuance for investors. Such is how, ultimately, liquidity gets into the markets. With markets only about 3% away from all-time highs, there is really nothing to stop it from getting there unless stimulus talks break down once again.

Speculation Ramps Up

Retail investors have also ramped up speculative bets again, pushing the Put/Call ratio back towards previous highs. There is still room before getting back to previous levels, which suggests a run to all-time highs is possible.

However, while a retest of highs is certainly possible, the truncated rally so far has consumed much of the previous oversold condition. Such may limited upside returns in the short-term to some degree.

Furthermore, the cumulative Advance/Decline line is also at levels which has typically denoted short-term market peaks.

However, for now, the markets surge into the election has a history of picking the next President.

“The performance of the S&P 500 in the three months before an election has predicted 87% of elections since 1928 and 100% since 1984. When returns were positive, the incumbent party wins. If the index suffered losses in the three-month window, the incumbent loses.”

For now, the market is favoring the re-election of President Trump.

However, from an investment standpoint, we must focus on “policies” and not “politics.”

Presidential Return Recap

Over the last two weeks, we have discussed much of what happens to the stock market before post-Presidential elections. As a quick recap:

“Will policies matter? The short answer is, “Yes.” However, not in the short-term. Presidential platforms are primarily ‘advertising’ to get your vote. As such, a politician will promise many things that, in hindsight, rarely get accomplished.

Therefore, while there currently much debate about whose policies will be better for the stock market, historically and statistically speaking, it doesn’t matter much. A look back at all election years since 1960 shows an average increase in the market of nearly 7.7% annually (exluding the 2008 ‘financial crisis.'” – Selloff Overdone

Pre-Election Correction, The Pre-Election Correction Continues, Is It Over? 09-18-20

“However, it is worth noting that while returns are positive regardless of who is elected, it should be of no surprise the markets performed better during a year when voters re-elect the incumbent. The market hates uncertainty. In this case, Biden presents many unknowns: the potential for increased regulations, higher taxes, and other shifts the market perceives as anti-business.” – Is The Market Bounce Over?

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Furthermore, this analysis only gets us through the end of the year.

What will matter as we head into 2021 will be the policies, not the politics.

Whoever Wins Loses

I don’t envy the person who takes the Oval Office in the months ahead. Whoever is inaugurated on January 20, 2021, will enormous fiscal challenges as trillion-dollar annual budget deficits will become the new normal. As we discussed recently, the national debt is projected to exceed the post-World War II record high over the next four-year term and reach twice the economy’s size within 30 years.

“Projected debt in 2050 is nearly five times higher than the 50-year average of 42 percent of GDP. It will be on track to double the previous record of 106 set just after World War II. In dollar terms, debt will rise from nearly $21 trillion today to $121 trillion by 2050.” – CFRB

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Four major trust funds are also headed for insolvency, including the Highway and Medicare Hospital Insurance trust funds, within the next presidential term.

Furthermore, economic growth rates will decline as the “wealth gap” continues to widen.

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

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Therefore, given there is no “will” to fix the problems before they break, whoever wins the Presidency will likely wind up losing.

Policies Over Politics

From an investment standpoint, the candidates’ policies will have an important bearing on economic growth and, ultimately, stock market returns. Our friends at the Committee For A Responsible Federal Budget (CFRB) did an excellent breakdown of candidates’ policies.

“President Donald Trump has issued a 54 bullet point agenda that calls for lowering taxes, strengthening the military, increasing infrastructure spending, expanding spending on veterans and space travel, lowering drug prices, expanding school and health care choice, ending wars abroad, and reducing spending on immigrants. 

Vice President Joe Biden has proposed a detailed agenda to increase spending on child care and education, health care, retirement, disability benefits, infrastructure, research, and climate change, while lowering the costs of prescription drugs, ending wars abroad, and increasing taxes on high-income households and corporations.

Importantly, neither of these plans will significantly improve economic prosperity, growth, or reduce the wealth gap. What both plans will do is significantly increase the debt and deficits.

The table below breaks down the spending by candidates in different areas of the economy.

Bridges To Nowhere

While markets tend to get excited over infrastructure projects, they are not the projects that create long-term revenue streams and are a productive use of debt. Over the last 30-years, most of the projects have been “roads and bridges to nowhere,” which has left America financially worse off as the debt service mounts.

Importantly, there is a simple equation for future stock market returns:

  • Corporate Profits = Revenue (derived from economic growth) – Taxes

Due to the misguided use of debt and higher tax rates on corporations, slower economic growth rates will negatively impact earnings growth. Given multiples are already extremely expensive, policies that reduce future earnings growth will make valuations increasingly difficult to justify. (Chart shows the 5-year average P/E as a percentage deviation from the long-term average.)

  • The stock market, and investors, will favor Trump’s policies over Biden’s.
  • The masses begging for more handouts, and Government largesse will prefer Bidens.

Both leave us worse off.

“Under our central estimate, neither major candidate for President of the United States in 2020 has put forward a plan that would address our unsustainable fiscal path. Instead, both President Donald Trump and former Vice President Joe Biden have promoted policy agendas that would likely significantly add to annual deficits and increase debt-to-GDP over the next decade.” – CFRB

Both candidates have the wrong policy prescription for fixing what ails the economy. However, this is “the trap.” After 40-years of deficit spending, politicians continue to hope that more deficits will somehow create a surplus.

The math doesn’t work that way.

At some point, you have to stop digging.

Portfolio Positioning Update

We have been increasing our equity exposure during the previous two weeks to take advantage of the market’s short-term bottom and reflexive rally. Following the same trading guidelines we have set out in this missive previously, we reduced laggards, added to our core long-term holdings, and rebalanced our risk hedges by reducing credit risk and shortening duration in our bonds.

Here are the rules:

Technically Speaking: Tudor’s 10-Rules To Navigate Q4-2020

Therefore, we are currently carrying only a slight overweight in cash, which has been a rarity this year. We are confident we will be rebuilding our cash position as the current rally reaches its conclusion near previous highs.

Above all, the longer-term market dynamics remain extremely skewed, and the recent correction failed to reduce those conditions. In other words, the market remains at risk of a deeper correction in the months ahead. As shown, the rising upper trendline continues to provide significant resistance, and combined with negative divergences in both breadth and relative-strength, there is a risk of failure.

In conclusion, such is why we continue to reiterate our positioning from last week:

“We continue to play the rally for what it is – a sellable one.

Over the next few weeks, a retracement back towards previous highs is possible. However, without fiscal support well on its way, another correction is likely. On a longer-term basis, as shown in the chart below, the market remains well deviated from longer-term means. That deviation will get resolved either through price or time. We don’t know which one it will be.”

Remember, when increasing equity exposure to chase market returns, “risk” is a function of how much you will “lose” if you are wrong.

If you manage the “risk” of losing more than you expected, generally, everything else tends to work out.


The MacroView

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

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet


Performance Analysis


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. 


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.


Sector Model Analysis & Risk Ranges

How To Read.

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


Weekly Stock Screens

Currently, there are 3-different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Aggressive Growth Strategy


Portfolio / Client Update

As noted in this week’s newsletter’s main body, the market rally we have been building into stumbled on Tuesday as President Trump stalled stimulus talks. On Tuesday, the selloff was a sharp reminder of who actually runs the White House, and the president reversed course to tell Congress on “go big” on stimulus. Such got the market back on track, and we finished near the highs of the week.

As such, the market is on track to make it back to all-time highs. Therefore, we have been adding exposure, reducing hedges, and rebalancing risk accordingly to participate. There is currently little resistance for the market, except for stimulus talks failing to complete.

Conversely, another stimulus package will require the Federal Reserve to monetize the debt, which will find its way into higher asset prices. While the deficits are “economically corrosive” long-term, there seems to be no one on Capitol Hill that even feigns to care about such things any longer.

The “Japanifcation” of America has begun, and it’s now a “one-way” trip of debts and deficits.

Portfolio Changes

This past week we rebalanced portfolio risks by adding stronger names and removing some of the “weaker” players for now. Such is also part of our ongoing process to consolidate the portfolio into fewer overall holdings.

Equity Portfolio:

  • Sold 100% of DUK to remove “buyout risk” from the portfolio
  • Sold 100% of AGG to remove credit risk from the portfolio
  • +.50% to VZ and T, bringing weight to 3% each.
  • +5.0% position in PFF in the Fixed Income holdings to increase yield
  • +.50% to V, KHC, MCHP, ABT

ETF Portfolio:

  • Sold 50% of XLU to take profits as XLU was extremely overbought.
  • Sold 100% of AGG to remove credit risk from the portfolio
  • +5.0% position in PFF in the Fixed Income holdings to increase yield
  • +3.0% to XLB
  • +1.0% to XLY

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


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


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


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

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

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

Technical Value Scorecard Report For The Week 10-09-20

The Technical Value Scorecard Report uses 6-technical readings to score and gauge which sectors, factors, indexes, and bond classes are overbought or oversold. We present the data on a relative basis (versus the assets benchmark) and on an absolute stand-alone basis. You can find more detail on the model and the specific tickers below the charts.

Commentary 10-09-20

  • XLE, small-cap, mid-cap, and XLU were the top four performers on the week.
  • With the strong rally, XLC and XLE are the only two sectors trading below their 50-day moving averages. XLE is the only one below its 200-day moving average. XLU is the most stretched above its 50-day moving average at +6.16%.
  • XLU is now the most overbought sector. We sold DUK and cut our XLU exposure in half on Thursday in part due to this and other analyses.
  • Energy, XLE, remains oversold but is showing signs of life. Its relative normalized score is now close to fair value, but its raw score is still oversold. If this bounce is the beginning of a rebound there should be plenty of time to confirm the trend and participate. We are optimistic but very cautious.
  • TIPs are now grossly overbought reflecting the broader market’s reflation expectations.
  • Technology (QQQ) has traded poorly on a relative basis as investors are chasing a broader basket of stocks that in most cases are not as overvalued. To that end, RSP has a high normalized score. The analysis suggests tech may outperform the broader market in the coming weeks.
  • On an absolute basis, Utilities, Realestate, Industrials, Materials, Discretionary are all getting overbought. Technology, Staples, and Communications may be sectors to rotate into if you are you looking to reduce exposure from the reflation trade.
  • The S&P 500 is heading back toward overbought territory, but still has a good amount of room to rise before reaching the grossly overbought levels of a month ago.
  • The “Spaghetti” charts confirm that Utilities have been the right sector to be in. XLV, XLB, and XTN look poised to outperform. XLF is also showing some optimistic signs.

Graphs (Click on the graphs to expand)


The score is a percentage of the maximum/minimum score, as well as on a normalized basis (sigma) for the last 200 trading days. Assets with scores over or under +/-60% and sigmas over or under +/-2 are likely to either consolidate or change trend. When both the score and sigma are above or below those key levels simultaneously, the signal is stronger.

The first set of four graphs below are relative value-based, meaning the technical analysis score and sigma is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. Lastly, we present “Sector spaghetti graphs” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner the most bearish.

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

The ETFs used in the model are as follows:

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

#MacroView: More Stimulus And The 2nd Derivative Effect

There is currently much hope for another fiscal stimulus package to be delivered to the economy from Congress. While President Trump recently doused hopes of a quick passage, there a demand for more stimulus by both parties. While most hope more stimulus will cure the economy’s ills, it will likely disappoint due to the “2nd derivative effect.”

Let me explain.

In March, as the economy shut down due to the pandemic, the Federal Reserve leaped into action to flood the system with liquidity. At the same time, Congress passed a massive fiscal stimulus bill that expanded Unemployment Benefits and sent checks directly to households. As shown in the chart below of the upcoming expected GDP report, it worked. (We estimated GDP to increase by 30% from the previous quarter.)

That expected 30% surge in the third quarter, and surging stock market to boot, directly responded to both the fiscal and monetary stimulus supplied. The chart below adds the percentage change in Federal expenditures to the chart for comparison.

The spike in Q2 in Federal Expenditure was from the initial CARES Act. In Q1-2020, the Government spent $4.9 Trillion in total, which was up $85.3 Billion from Q4-2019. In Q2-2020, it increased sharply, including the passage of the CARES Act. Spending for Q2 jumped to $9.1 Trillion, which as a $4.2 Trillion increase over Q1-2020.

Those are the facts as published by the Federal Reserve. From this point forward, we have to start making some estimates and assumptions.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Assuming CARES-2

During Q3-2020, not much happened as the Government was fighting over the next round of stimulus. As such, spending fell back to a more normal level of increase. However, if we assume that a second CARES Act is passed some time in Q4, and we apply a price tag of $2 Trillion to the package, it would represent a roughly 25% increase in Government spending over Q3-2020.

Such is the “second derivative” effect we mentioned previously.

“In calculus, the second derivative, or the second-order derivative, of a function f is the derivative of the derivative of f.” – Wikipedia

In English, the “second derivative” measures how the rate of change of a quantity is itself changing.

I know, still confusing.

Let’s run an example:

As Government spending grows sequentially larger, each additional round of spending will have less and less impact on the total. Going back to 2016, not including the CARES Act, the Government increased spending by roughly $50 billion each quarter on average. If we run a hypothetical model of Government expenditures at $50 billion per quarter, you can see the issue of the “second derivative.”

In this case, even though Federal expenditures are increasing at $50 Billion per quarter, the rate of change declines as the total spending increase.

More Leads To Less

The next chart shows how the “second derivative” is already undermining both fiscal and monetary stimulus. Using actual data going back to the Q1-2019, Federal Expenditures remained relatively stable through Q1-2020, along with real economic growth. However, in Q2-2020, with our estimates for Q3 and Q4, Federal Expenditures will almost double. However, the economy will not return to positive growth.

The chart below shows the inherent problem. While the additional fiscal stimulus may help stave off a more in-depth economic contraction, its impact becomes less over time.

However, this is ultimately the problem with all debt-supported fiscal and monetary programs.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Still In A Recession

As I stated above, even assuming a $2 Trillion fiscal relief package by the end of October, which I suspect may not come, the relative impact on GDP growth will fall short of expectations.

Take a look at the next chart. These are our current estimates for GDP growth over the next 3-quarters. These estimates dovetail reasonably nicely with mainstream consensus.

At first glance, it appears that after one negative quarter of GDP, the economy is well back on track to normalcy. However, such an assumption would be incorrect. Given that we measure economic growth on an annualized basis, the three-quarters of positive change following such a steep decline still leaves the economy in a recession.

Yes, add a couple of more quarters of economic growth, and you will eventually be back into positive territory. However, therein lies an even bigger problem.

Dollars Of Growth Deteriorate

As noted above, it requires increasing levels of debt to generate lower rates of economic growth. The chart below shows the previous and estimated CARES Acts and their impact on GDP growth.

To understand this better, we can view it from the perspective of how many dollars does it require to generate $1 of economic growth. Following the economic shutdown, when economic activity went to zero, each dollar of input had a more considerable impact as the economy restarted. However, in Q4, economic activity has already recovered and begun to stabilize at a slightly lower level than seen previously.

High-frequency data like credit card spending and main-street activity indicators tell us this is the case.

Given that stabilization of activity, it will require more dollars to generate economic growth in the future. As shown, it will require $8.80 of debt-supported expenditures to create $1 of economic growth.

Here is the exciting part. That is NOT a new thing. As I discussed just recently “The One-Way Trip Of American Debt:”

The “COVID-19″ crisis led to a debt surge to new highs. Such will result in a retardation of economic growth to 1.5% or less, as discussed recently.Simultaneously, the stock market may rise due to massive Fed liquidity, but only the 10% of the population owning 88% of the market benefits. In the future, the economic bifurcation will deepen to the point where 5% of the population owns virtually all of it.

As I noted previously, it now requires $7.42 of debt to create $1 of economic growth, which will only worsen as the debt continues to expand at the expense of more robust rates of growth.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

You Can’t Use Debt To Create Growth

As noted above, more debt doesn’t lead to stronger rates of economic growth or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.

, Powell’s Fantasy: The Economy Should Grow Faster Than Debt

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

, Powell’s Fantasy: The Economy Should Grow Faster Than Debt

The economic deficit has never been greater. For the 30 years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Such is why the Federal Reserve has found itself in a “liquidity trap.”

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

The deterioration of economic growth is seen more clearly in the chart below.

From 1947 to 2008, the U.S. economy had real, inflation-adjusted economic growth than had a linear growth trend of 3.2%.

However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve provided policies that fostered even greater levels of unproductive debt and leverage.

American Debt, #MacroView: CBO – The “One-Way Trip” Of American Debt

Coming out of the 2020 recession, the economic trend of growth will be somewhere between 1.5% and 1.75%. Given the amount of debt added to the overall system, the ongoing debt service will continue to retard economic growth.

A Permanent Loss 

As noted by Zerohedge, the permanent loss in output in the U.S. was shown by BofA previously. The bank laid out the pre-COVID trend growth and compared it to is base case recovery.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Such aligns closely with our analysis shown above. Given the permanent loss in output and rising unproductive debt levels, the recovery will be slower and more protracted than those hoping for a “V-shaped” recovery. The “Nike Swoosh,” while more realistic, might be overly optimistic as well.

However, this is the most critical point.

The U.S. economy will never return to either its long-term linear or exponential growth trends.

Read that again. 

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Spit-Balled Solutions

If you read between the lines, policymakers are “spit-balling” solutions and making potentially erroneous monetary policy decisions on unreliable data. However, given Central Banks’ only policy tool is more liquidity, it is a “shoot first, ask questions later” response. 

The problem is those policy measures continue to erode economic prosperity. Such is evident when the CBO’s own long-term economic growth potential projections fall below 2%.

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Due to the debt, demographics, and monetary and fiscal policy failures, the long-term economic growth rate will run well below long-term trends. Such will ensure the widening of the wealth gap, increases in welfare dependency, and capitalism giving way to socialism.

So for the Federal Reserve to intervene and support those asset prices, is creating a little bit of moral hazard in a sense you’re encouraging people to take on more debt.” – Bill Dudley

What policymakers haven’t come to grip with is the “second derivative” effects of more debt.

At some point, you have to realize that you can’t get out of a “debt hole” by piling on more debt.

Eventually, you have to stop digging.

Nick Lane: The Value Seeker Report- WESCO International (NYSE: WCC)

This article is an RIA PRO exclusive for subscribers. If you are reading this article, this is a good example of the insights our subscribers read every day. Try it RISK-FREE for 30-days.

In this edition of the Value Seeker Report, we analyze an investment opportunity in WESCO International (NYSE: WCC) using fundamental and technical analysis.

Overview

  • WESCO International (WCC) is a distributor of electrical and communications construction products in the US and abroad. WCC also offers value-added services ranging from supply chain management, to inventory management, to system installation and partial assembly of products.
  • The firm’s customers include independent contractors, industrial manufacturers, utility firms, public institutions, and various government agencies. WCC belongs to the Industrials sector and currently has a market cap of $2.4B.
  • WCC completed a large merger with Anixter in June 2020, making the combined firm a leader in the markets it serves. Still, the industrial distribution market remains fragmented, leaving plenty of room for organic growth.
  • WCC’s stock is currently trading at $48.95 per share. Using our forecasts, we arrive at an intrinsic value of $61.42 per share. This implies an upside of roughly 25% on the investment.

Pros

  • WCC is doing an exceptional job of integrating the two firms, especially considering the challenges presented by closing a merger mid-pandemic. Leadership has given some of the credit to the strong cultural alignment between the firms heading into the merger. Other contributing factors include the detailed pre-merger planning and sound execution of those plans at all levels of the business.
  • Overall, leadership has been proactive in providing investors with a clear view of its vision and the steps WCC will take to get there. This is particularly apparent in WCC’s second quarter earnings call and presentation. The presentation slides can be found here.
  • WCC expects to exploit substantial cost synergies through its merger with Anixter. Further, the once-separate entities offer complementary products and services. This opens the opportunity for cross-selling to existing customers.
  • Management is very intent on reducing leverage its target range by 2024. Although WCC substantially increased its debt to finance the deal, the firm has a proven ability to de-lever following acquisitions. As shown below, our forecasts confirm that WCC is capable of generating the free cash flow required to meet this goal.  

Cons

  • In the industrial and construction end-markets that WCC serves, demand has been materially impacted by the pandemic. For example, most of WCC’s contractor customers work in non-residential construction. An area which has suffered more than its residential counterpart and could remain weak for some time.

Key Assumptions

  • Revenue growth forecasts for 2020 and 2021 are primarily because of the Anixter deal’s expected impact on revenue. However, we do not expect the combined firm’s revenue to fully recover until 2023.  The chart below illustrates our forecasts in relation to historical revenue.  
  • As part of the integration, WCC will begin Anixter’s “gross margin improvement program”. Under this program, Anixter managed to deliver seven consecutive quarters of gross margin improvement. Taking this and other cost synergies into count, we forecast WCC operating margins to improve slightly each year until 2024 and settle thereafter. The chart below shows how our forecasts of operating profit evolve over time.
  • Based on guidance, we forecast the release of roughly $75M in working capital over the next three years as WCC realizes synergies from the merger.

Sensitivity Analysis

  • A brief note on why we present sensitivity analysis can be found here.
  • Incremental movements in margins are crucial to WCC’s intrinsic value because of the low margin nature of its business. The realization of cost synergies and margin improvements by the firm are an important part of our investment thesis, and thus will require special attention when the firm reports earnings.

Technical Snapshot

  • WCC is currently testing resistance near $48.35 per share. The stock recently closed above said level, but whether it can hold above remains to be seen. On the downside, the stock should receive support near its 50-day moving average.
  • The stock is sitting in overbought territory. Accordingly, it may be wise for investors to wait for a slight pull-back before initiating a position.

Value Seeker Report Conclusion On WCC

  • Following the deal with Anixter, WCC is better equipped to leverage the size and scale of its operations to create value for shareholders. Clearly, Management has a plan in place to achieve its targets and intends to execute it well.
  • We suspect that the stock remains undervalued because of the timing of the deal. It was announced just before the pandemic ensued and closed in June. For a small/mid-cap firm in the industrials sector, it is not implausible that this deal was simply overshadowed by the pandemic and is not yet fully priced in.
  • WCC reports third quarter earnings on November 5th, 2020. It will be WCC’s first report with a full quarter’s contribution from Anixter, and an early improvement in margins could spark the stock’s move to intrinsic value.
  • Based on our forecasts, WCC has 25.5% of upside remaining before reaching its intrinsic value.

For the Value Seeker Report, we utilize RIA Advisors’ Discounted Cash Flow (DCF) valuation model to evaluate the investment merits of selected stocks. Our model is based on our forecasts of free cash flow over the next ten years.

#WhatYouMissed On RIA This Week: 10-09-20

What You Missed On RIA This Week Ending 10-09-20

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

Here is this week’s rundown of what you missed.


The Pre-Election Event

“Policies, Not Politics.” 

Join Richard Rosso, CFP, and Danny Ratliff, CFP for an in-depth look at both party’s platforms and how upcoming changes could affect your retirement, social security, medicare, and how you invest. From taxes to the markets, they will provide the answers you are looking for. 

  • When: Saturday, October 24th, 2020
  • Time: 8-9am
  • Where: An exclusive GoTo Webinar Event (Register Now)

What You Missed This Week In Blogs

Each week, RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus is the risks that may negatively impact our client’s capital. These are the risks we are focusing on now.



What You Missed In Our Newsletter

Every week, our newsletter delves into the topics, events, and strategies we are using. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how we plan to trade it.



What You Missed: RIA Pro On Investing

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



The Best Of “The Real Investment Show”

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

Best Clips Of The Week Ending 10-09-20


What You Missed: Video Of The Week

Richard Rosso, CFP and Danny Ratliff, CFP discuss K-shaped economic recoveries and “mansplain” the Federal Reserve.



Our Best Tweets For The Week: 10-09-20

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Retirement Income Planning Truth with Jim Otar. Part 1.

Income is the lifeblood of retirement. 

In Part 1, wisdom from the early chapters of Jim Otar’s new book about retiree income challenges is explored.

A one-person revolutionary.

In 2004, I discovered the work of Canadian-based planner and Chartered Market Technician Jim Otar. As a result of his work, I changed my approach to planning. Compared to conventional financial gurus, Jim’s research showcased how stock market cycles changed over time and negatively affected a client’s retirement income planning success, sometimes permanently.

My thought is he’s not popular with mainstream financial professionals who constantly tout a neverending bull market. Bulls never seem to run out of steam to these folks. Jim showcases how markets truly behave:

Furthermore, the above illustration showcases market reality, whereby each box represents a secular or long-term cycle. Secular trends generally last 20 years. Markets may move higher, lower, or remain flat for extended periods. Just imagine how a retiree’s cash flow or lifestyle is affected during cycles when markets are down or flatlined.

How would your retirement income be affected through periods of market return headwinds?

Jim was dismayed by the available financial services planning tools. Most programs generated optimistic outcomes too often or minimized the impact of outliers. Mr. Otar discussed ‘Black Swans’ before they became mainstream cool to discuss.

His proprietary analysis incorporates actual market history. Jim calls an “aftcast” how his program tests distributions through past market behavior – from 1900 through the previous year using broad market long-term performance.

A study of market trends.

After the tech bubble burst in 2000, I burned countless hours studying market trends and became immersed in market history. In response, I moderated client portfolios by reducing equity exposure and increasing allocations to bonds.  I also rethought the importance of Social Security as part of a holistic income plan.

Throughout the years, my focus on long-term market cycles rarely wavered. I sought out academics and found Yale professor Robert Shiller and author of multiple editions of the book “Irrational Exuberance.” 

Then in 2007, I discovered value manager Vitaliy N. Katsenelson’s seminal book “Active Value Investing: Making Money in Range-Bound Markets,” and realized I was onto something.

In September 2007 (the 27th day to be exact), I employed Jim’s model to back-test client retirement plans. As a result, it appeared my former employer’s planning software results deviated dramatically from the output generated by Jim’s Retirement Optimizer.

Data four inches thick was generated to validate my case. I forwarded the research to senior management in charge of financial planning at my former firm. I was hesitant to advise clients to retire based on our current model results and greatly feared they’d run out of money.

The response to my analysis was polite acknowledgment. To clarify, no changes to procedures were implemented.

At the beginning of the financial crisis, I reached out to Lance Roberts to pick his brain. He validated my concerns for client financial planning outcomes.

A pragmatic approach to retirement income planning.

Now retired, Jim Otar lives firsthand his latest tome “Advanced Retirement Income Planning.” In his final book, he outlines how the luck factor and where one retires in a market cycle is forever aligned.

Unfortunately, I think Jim has retired in a bad luck cycle. However, who is better equipped than he to adjust to a market headwind and keep the rest of us abreast of his experience?

If the imminent headwind isn’t bad enough, recent studies outline how more than 75% of Americans are now retirement insecure. David Blanchett, head of financial planning for Morningstar, estimates that only 18% of retirees have enough retirement wealth to maintain pre-retirement spending levels using a relatively conservative replacement metric.

Jim has written a practical and timely guide to retirement income success, and I am excited to share the lessons with RIA readers.

1. Watch For Emotions In Planning Assumptions.

Planning assumptions are complicated enough without investor sentiment or emotions muddying the analysis. It can’t be denied that animal spirits or emotions play a part in market trends.

However, recency bias, where human brains place greater importance on short-term events, wreak havoc on future asset class returns assumptions, and consequently, the future viability of client financial plans.

Jim outlines how investors use exuberant assumptions during bullish trends and conservative ones after significant corrections. Specifically, when markets are in a bullish trend, they tend to extrapolate positive returns far into the future.

The same goes for when markets are bearish, and investors forecast negative returns. Unfortunately, future market return assumptions have a way of vacillating with emotions.

Rules Must Override Emotions.

Planners require rules to update future asset class returns. I have always used Shiller’s PE or the CAPE 10 and other factors to validate or update future asset class return estimates.

In 2003, I employed a blended portfolio model and lowered overall stock exposure. In 2010, I expanded my forecast for stock returns. My rules aren’t perfect, but they have allowed me comfortable, positive, and more productive conversations with clients than discussions around the postponement of financial milestones such as retirement.

With the CAPE 10 exceeding 32X in 2018, we adjusted our financial planning software variables to reflect lower future returns for every asset class. This isn’t rocket science. Any intuitive, studied advisor can help retirees identify and navigate a long-term valuation head or tailwind.

Retirees are especially vulnerable to market volatility. Keep in mind, per Jim’s analysis, a ten-percent drawdown, even if only for one year, may never be recovered in a distribution portfolio or at a time when a client seeks to recreate a predictable paycheck in retirement.

2. Recognize the Flaws of Monte Carlo Simulation.

Monte Carlo is considered a multi-line forecasting tool. A baseline or average growth rate is employed. Then, a series of randomly-generated simulations revolve around the baseline hundreds, perhaps thousands of times. For example, RIA’s planning program conducts more than a thousand trials.

Is Monte Carlo more effective than a single-return forecast? Yes. However, an investor must ask – Is market behavior always random? Far from it

In the spirit of mathematician, father of fractal trend analysis, Benoit Mandelbrot believed market price changes are not as random as preached in financial orthodoxy; stock prices possess a memory that drives positive or negative momentum.

Modern finance systems are built on cleanly-calculated outcomes that don’t match actual market behavior or, in many cases, a retail investor’s experience. Life and markets are much more complex and fraught with risk. If well-read and invest on your own or work with a financial partner, odds are your wealth has succumbed to one or several rotted chestnuts of suspect calculations.

A popular conjuring is the Efficient Market Hypothesis, which states that stock prices reflect all relevant information and that a random walk is the best metaphor to describe such markets.

Mandelbrot’s focus was more on observation, and not abstract theories stretched to mollify fear and act as a false “Snuggie” so ostensibly, most people spend their investment experiences breaking even.

The widely-accepted modern portfolio theory, which advocates a blind buy & hold philosophy, provides the financial industry (and subsequently you) a misguided sense of comfort or smoothness of risk that mostly falls within explainable, bell-curve shaped boundaries.

Monte Carlo simulation can fool investors to minimize the effects of outliers or Black Swans on wealth.

Per Jim:

The Achilles heel of the Gaussian universe is “random” because MC simulations work
accurately only if the market behavior is always random. A more in-depth analysis of the monthly market behavior over the last century shows that in only about 94% of the time, the equity index moves randomly, which we call “normal”. In about 6% of the time, the equity index is outside this “normal” (some mathematicians call this non-random area “fractal”).

Six-percent may not sound like a big deal, but outliers greatly affect plan results. Think about it: How many negative outliers are necessary to be financially devastated?

Only one!

Momentum on the downside begets more selling, momentum on the upside begets more buying.  Monte Carlo simulation, as constructive as it is, has flaws.

A financial professional who understands the limitations of Monte Carlo, studies market cycles, and adjusts the average or baseline growth rate accordingly, is invaluable to an investor’s planning process. Otherwise, the number of random trials run is meaningless.

To wit (from Jim):

Many users of MC models believe that running one million simulations instead of one thousand will produce more reliable outcomes. This is a misconception. It does not matter how many millions of simulations you run; if the underlying model does not fit, then its results will not reflect reality. If you run MC simulations, make sure to note clearly all its shortcomings. Furthermore, be wary of any conclusions from any research that uses MC simulations in its analysis.

3. Forget the 10 Best Market Days and Understand the Worst.

An investor has a better chance of hitting the Mega-jackpot lottery than timing the best and worst market days. When brokers lament how investors remain in stocks at all times or their returns will deteriorate, they conveniently avoid a conversation about how much damage the worst market days creates. Retirees need to comprehend the math of loss.

Keep in mind, euphoric and catastrophic events are out of our control and cannot be completely avoided. However, risk minimization through proper asset allocation coupled with a sell discipline can help savvy investors weather the storm. It’s crucial to keep emotions in check and avoid  ‘all or none’ investment decisions.

Keep in mind, there exists a formidable body of work that validates reducing equity exposure as markets break down. It’s not an ‘all-in, all-out’ story. It’s a surgical reduction saga. Sell until you can handle the motion.

If you must sell every stock in your portfolio to handle the market ride, then frankly, stock investing isn’t for you.

Andrew Lo, professor of finance at the MIT School of Management, creator of the Adaptive Market Theory and co-author of A Non-Random Walk Down Wall Street, outlines that stock price movements are all not random.

Today more than ever, stock prices balk at a random walk. With the proliferation of algorithms with big mathematical hooks that grab on to the latest trend (up or down), stocks herd on steroids.

An advisor can maintain a sell or risk reduction strategy based on rules. No system is perfect. As a client, it’s important to understand your financial partner’s philosophy and decide whether you agree with it. Also, a surgical sell discipline isn’t active trading. It’s risk management. 

4. Where One Retires in a Market Cycle is Luck – Plain and Simple.

The adage, ‘the trend is your friend,’ comes to mind. The ‘trend is your greatest enemy’ rings true, too.

Luck is an important determinant of retirement income success. Will there be a tailwind or headwind for asset prices at retirement? My thought is if you plan to retire this year or have retired as recent as 2018, you’re in a formidable decade-long headwind for stock prices and bond yields.  We estimate a sideways trend in stock prices that will result in  anemic annualized portfolio returns of 3% or less.

The Sequence of Returns Matters For Retirees.

The sequence of return risk or the persistent direction and volatility of a trend is the enemy of a successful retirement, especially for those who derive most of their income from variable assets such as stocks and bonds. A poor series of portfolio returns or a prolonged period of volatility requires ongoing monitoring of distributions.

This will be a frustrating period for those investing for retirement. For retirees who depend on their investment accounts to generate income, a headwind is more than frustrating; it can be devastating.

Every generation of retirees experiences a negative sequence of returns. If it occurs early in retirement, the long-term damage can be permanent.

Per Jim’s example, an investor withdraws $5,000 at the end of each year from a portfolio worth $100,000. 

A lucky start has portfolio growth entirely fund the first three years of the retiree’s distributions. In year four, the investor dips slightly into principal. For the unlucky retiree, withdrawals the first couple of years come directly from the original investment. In the case of a poor secular trend for returns or one that lasts generations, the withdrawals irreparably damage wealth.

What is our approach?

Our planning group examines portfolio withdrawal results over rolling three year periods and helps clients adjust distribution rates if necessary. Retirees must be open to change,  young accumulators need to adjust as well.

From now on, most investors in the accumulation of wealth phase will need to work longer, rethink retirement lifestyles, and strongly consider guaranteed lifetime income products such as annuities.

Teresa Ghilarducci, a labor economist, expert on retirement security and professor of economics at The New School Lab for Social Research, believes that 50% of Americans 55 and older will retire poor when they reach age 65.  Her definition of ‘poor’ is a person 65 or older who lives on less than $20,000 a year.

She believes older workers require a six-month emergency fund. At RIA, we have been stressing the importance of a cash cushion before the pandemic began.

Working Americans should think beyond an emergency reserve and build a financial vulnerability cushion or twelve-months’ worth of living expenses in cash because of the ongoing pandemic effects.

Ultimately, the creation of lifetime retirement income will require effort. As a result,  retiree investors must think about portfolio construction differently. To clarify, with real bond yields (adjusted for inflation), negative for the foreseeable future, retirees will need to carefully spend down principal, work part-time, reset lifestyle expectations, purchase lifetime income products, use home equity conversion mortgages or a combination of all.

In Part 2, I’ll continue Jim’s enlightening analysis of retirement income reality.

The Federal Reserve Is Gaslighting America

The Federal Reserve’s Gaslighting of America

Man is the Reasoning Animal. Such is the claim. I think it is open to dispute. – Mark Twain

Around 350 BC, Aristotle was the first person to formally study logic and reason. Aristotle did not invent logic and reason any more than Isaac Newton invented gravity. He merely discovered and defined the rules already in place as a necessary condition for human beings to carry on meaningful discourse. He identified the principles of reasoning already built into our humanity.

Logic measures the relationship between ideas, premises, and propositions. It allows for two or more ideas to be compared to see if they are consistent and coherent or contradictory.

Logic is a necessary condition for meaningful communication and analysis. Logic is necessary for a healthy nation and economy. It is worthy of understanding amidst the multitude of incoherent and contradictory voices raging in our ubiquitous news feeds. As we will discuss, the Federal Reserve (Fed) is among the guilty.

Leadership without Integrity

As we assess the landscape of the cultural, political, environmental, and market news cycles, how do we reconcile what we hear with what we see? What role does logical theory play? How do we identify contradictions? Have we become too intellectually lazy to even bother?

Each year on September 11th, Americans mourn, acknowledge, and pray on the anniversary of the terrorist attacks. Like the Gettysburg Memorial, Pearl Harbor National Memorial, and others, the 9-11 Memorial in New York City is especially hallowed. As Americans, one can feel the souls there. Those were horrific events, but they are now part of our national fabric and an important part of the path of our country.

In 2020, some foolishly suggest that Americans must erase what we know to be true about certain historical leaders and episodes. Just as we cannot unread a book, nothing can change our past.

Telling history accurately, both the good and the bad is critical to the future. The only thing that is affected by trying to change the unchangeable is the erosion of our leadership’s integrity. Without integrity, the foundation of our system is at risk.

Not surprisingly, countries like China and Russia that lack integrity try to rewrite history and manipulate their narrative of events. They are decidedly not countries that value freedom and human rights.

Logic and Integrity are Essential

The integrity of any political, monetary, and free-market system is vital to its effectiveness. The logic behind that fact is clear. Exceptions are temporary, precisely because a healthy functioning system ultimately sustains itself on its integrity.

When technology stocks trade at a triple-digit price-to-earnings ratio, logic is lost. When home prices rise at a pace never before seen, and the mortgage system enables and rewards dishonesty in qualifying information, integrity is absent.

We know the restoration of logic and integrity brings forth a necessary correction. Accordingly, we know that today’s irrational markets face many very similar challenges.

Prior periods where the madness of men took control of markets are obvious in retrospect; tulips in the 17th century, the South Sea Company in the 19th century, and the stock market bubble in the roaring 1920s. More recently, we watched the tech stock bubble in 2000 and the housing bubble in 2007.

Those periods and many others ended with the restoration of logic and integrity.

#FEDGIBBERISH

Although reluctant to acknowledge their role in recent crisis episodes, the Fed is complicit in setting the stage and enabling market manias through undisciplined monetary policy.

Today, the Fed prints trillions of dollars to accommodate exploding government deficits and corporate malfeasance. Through self-evident Ponzi dynamics, they tell us it is prudent and a logical part of the monetary “toolkit.” Actions taken by a small group of unelected officials rationalize their decisions are well within the boundaries of what is authorized. That is patently false. Much of what the Fed is doing is not authorized or legal. They blur the lines between monetary and fiscal policy. They pick winners, and therefore also losers, by buying corporate debt.

We know from experience that holding interest rates too low for too long is bad policy. We also know from applying simple logic that purchasing trillions in public securities distorts asset prices. Meanwhile, Fed officials tell Congress and the public that what they are doing is not only legal but even noble. They deny even the possibility of harmful side-effects of their policy. These are contradictions for the ages.

Gaslighting

In 1938, English playwright and novelist Patrick Hamilton wrote the play Gas Light. In the story, a husband attempts to convince his wife that she is insane by manipulating small elements of their environment and insisting that she is mistaken, remembering things incorrectly, or delusional when she points out the changes. The play’s title alludes to how the abusive husband slowly dims the gas lights in their home, while pretending nothing has changed, in an effort to make his wife doubt her cognitive perceptions and awareness.

Logic is the policeman in the human brain. It tells us if what we are seeing or hearing makes sense. When it does not make sense, our conscience sets off alarms in our brains.

For example, we watch the news and see images of rioting, looting, beatings, and fires burning property in major cities. Meanwhile, news reports tell us that what we are observing are “peaceful protests.”

Fed Gaslighting

Similarly, the Fed often adjusts the “lights” in discussions around achieving an inflation target of at least 2%. They must, they say, keep policy accommodative in alignment with the “mandate” of stable prices. However, stable prices and a 2% inflation target are two different things. That is not only a contradiction but a lie. A zero-percent inflation target is a pure definition of “stable prices”.

“When asked at the July ’96 FOMC meeting the level of inflation that truly reflects price stability, he said, “I would say the number is zero, if inflation is properly measured.”   – David Rosenberg quoting Alan Greenspan

Additionally, prices that do not rise are beneficial for most Americans as they do not have to pay more for the things they need to live as their wages stagnate.

Meanwhile, a 2% targeted inflation rate benefits banks, corporations, and wealthy investors who deploy capital before the adverse effects of inflation. Everyone else suffers. We wrote about the winners and losers in a separate article entitled The Fed’s mandate to Pick Your Pocket.

Gaslighting a feckless Congress and the American public into believing that a 2% inflation target is in the best interest of the country erodes the integrity of the Fed. It is not true, and it could never be true. It is a contradiction and illogical. As described in the article, it exacerbates the wealth divide. Most importantly, it contributes to the civil unrest we see in America today.

Obfuscation

“It’s a language of purposeful obfuscation to avoid certain questions coming up, which you know you can’t answer and saying—“I will not answer or basically no comment is, in fact, an answer.” So you end up with when, say, a Congressman asks you a question, and don’t wanna say, “no comment,” or “I won’t answer,” or something like that. So, I proceed with four or five sentences which get increasingly obscure. The Congressman thinks I answered the question and goes onto the next one.” – Alan Greenspan

Any Fed governor or Fed president that follows Greenspan’s path is either intentionally disingenuous or intellectually unqualified. Unfortunately, Greenspan’s obfuscation seems to be the primary tactic in the Fed’s playbook.

The Fed cannot accurately measure inflation, so how can they know what the rate of inflation is? The measures they use are misleading and generally gamed to provide more latitude for the Fed to do whatever they choose.

Meanwhile, Congress, which has oversight of the Fed, is complicit by failing to ask the right questions. They apply no rigor in questioning the veracity of Fed claims. They have yet to challenge the Fed’s radical and extreme policy-settings since the financial crisis.

By definition, those abject failures mean Congress is not acting in the best interests of their constituents. That is part of the oath they take when they enter the office. An inflation target selectively benefits the wealthy and is oppressive for the lower and middle class – 95% of all Americans.

It’s Not Just the Fed

The problem goes well beyond the Fed and Congress. Their actions seem to abet others in promoting irrational decisions. For example, do these facts make sense?

  • Tesla, a company that makes a tiny fraction of the cars in the U.S. and loses money, has a market cap that is four-times larger than the big three automakers combined
  • Apple stock is up 70% in 2020, and nearly 500% since 2015 with a market cap of $2 trillion. The tremendous gains come despite a slight decline in earnings growth since 2015.
  • Jeff Bezos and his now ex-wife are worth $200 billion
  • CEO’s in the United States, on average, make more than 300 times the average wage of workers
  • Household net worth just hit new all-time highs, but 70% of Americans have less than $1,000 in savings, and 45% have nothing
  • It now costs the average worker a record 114 hours of pay to buy one share of the S&P 500
  • Despite high unemployment, a recession, and acute levels of uncertainty about the future, stock markets are new record highs

Regarding the last bullet point, we share the graph below courtesy Cornerstone Macro.

These are just a few examples, but there are dozens more. Many experts tell us in a serious tone and with silver-tongued articulation why they are occurring. The problem is their explanations defy logic. Apparently, appearing on television in a suit and tie is all that is required to make irrational claims of “insight”.

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

Summary

Congress and the public are being “gaslit” by the Fed. The Fed plays the role of the husband in the Patrick Hamilton script. Their upside-down logic dims the lights to justify their actions. Congress politely asks unobtrusive questions that reflect their poor grasp of the facts. Relying on elected officials, the public is unwilling or unable to question Fed logic. Meanwhile, we sense that something is wrong.

Years of extreme monetary policy is disfiguring and warping markets. Market prices (all market prices such as stocks, bonds, houses, cars, and food) are no longer set by the bid or offer of an arms-length buyer and seller. Prices are being deformed by trillions of dollars being digitally printed by central banks and flooding into what were once free markets. You will not hear that from the “suit” on TV. His or her wealth depends on compliance with and support of the warped system. They are pawns in the game.

The Fed chooses corporate winners and losers today just as they did with criminal banks in 2008. The only big loser is the public to whom the Fed claims they are beholden. That, however, is a provable lie.

Logic as a necessary condition for meaningful communication and analysis is being aborted. Our unelected elites think that they are better informed than the public and billions of global buyers and sellers. Like the reflection from a funhouse mirror, zero-bound rates and quantitative easing (QE) warps the perception of reality. As has already been tried, stepping away from the mirror is difficult and painful.

A genuinely free market can only return when logic and integrity return. Trust in the Fed’s platform will eventually be rejected. It is a frightening thought, but that day will inevitably come. It always does.

Sector Buy/Sell Review: 10-06-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 10-06-20

Each week we produce a “Sector Buy/Sell Review” chartbook of the S&P 500 sectors to review where the money is flowing within the market as a whole. Such helps refine decision-making about what to own and when. It also guides what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

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

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

We added 2- and 3-standard deviation extensions from the 50-dma this week. Currently, markets and sectors are back to “stupid” overbought on many levels. We advise caution.

SECTOR BUY/SELL REVIEW: 10-06-20

Basic Materials

  • As stated last week, the “relation trade” is likely over. More importantly, with 10-year Treasury yields popping higher recently, such will put a crimp on economic growth.
  • Looking at XLB, you will see the same in Industrials and Transportation, which bounced on Monday, but there hasn’t been enough correction in the sector for a good entry point.
  • The relative performance has also weakened, which keeps us cautious.
  • Trading positions are reasonable with a stop at the 50-dma and profit-taking at previous highs. 
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: Trading positions only. 
    • Stop-Loss moved up to $60
  • Long-Term Positioning: Bearish

Communications

  • Communications also bounced on Monday, as the sector had become oversold short-term.
  • We suggested taking profits and reducing risks, and that correction has now happened. 
  • XLC did regain the 50-dma, so trading positions are still intact. 
  • Traders can add positions with a very tight stop at $56.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: We added to communications last week. 
  • Long-Term Positioning: Bearish

Energy

  • As we noted last week: “Energy is deeply oversold and due for a bounce. However, there is not much support for the sector currently.” 
  • The sector did bounce on Monday. However, it has done little to change the overall trend or establish a bottom at this point. Stay clear for now. 
  • Short-Term Positioning: Bearish
    • Last week: Hold positions
    • This week: Hold positions.
  • Stop-loss violated.
  • Long-Term Positioning: Neutral

Financials

  • Financials continue to underperform and remain a sector to avoid currently.
  • XLF bounced yesterday on hopes of more fiscal stimulus but was weak relative to the index.
  • Financials remain constrained by the 200-dma. Earnings start next week, so that will be their best chance to break out. 
  • Banks remain out of favor. 
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • As noted, like materials, XLI rallied sharply on Monday under the premise of more fiscal support. Such could be disappointing. 
  • We have grossly reduced our exposure to the sector and are looking for a better opportunity to add back to our position. We haven’t seen an excellent oversold entry point yet.
  • As suggested previously, take profits and rebalance risk. 
    • Short-Term Positioning: Bullish
    • Last week: No change.
    • This week: No change.
  • Long-Term Positioning: Bearish

Technology

  • Technology stocks, and the Nasdaq, found some buying yesterday after a fairly brutal correction over the last couple of weeks. 
  • While the sector remains has worked off some of its overbought condition, it is now running into the previous uptrend resistance. 
  • Such is still the sector investors will likely chase for now as the momentum trade continues. 
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: Added to our Technology holdings.
  • Stop-loss set at $105
  • Long-Term Positioning: Bullish

Staples

  • Over the last couple of weeks, we have discussed the correction of XLP. 
  • That correction came and has pushed XLP down to its 50-dma, where it did hold support. 
  • However, the rally yesterday was a bit disappointing relative to the index. 
  • Rebalance holdings and tighten up stop-losses on any rally for now.
  • The sector has gotten oversold enough for a rally, but we need to see relative performance improve.
  • We are moving our stop-loss alert to $60 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Real Estate

  • There is still a lot of risk to the real estate space, specifically in the Commerical side. However, investors are back to chasing the yield and ignoring the danger. 
  • On Monday, XLRE rallied back above resistance and is now testing its previous resistance. Such is a good time to take profits and rebalance this sector. 
  • With XLRE oversold, use rallies to rebalance exposures and make sure you are in the right REIT areas. 
  • Short-Term Positioning: Neutral
    • Last week: No change.
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Utilities

  • XLU had been struggling with resistance at the 200-dma. However, over the last couple of sessions, and opposed to the 10-year yield rising, XLU has surged back to very overbought conditions.
  • Performance has been disappointing, so take profits and rebalance accordingly. 
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Health Care

  • XLV broke below its 50-dma but recovered it on Monday, keeping support intact. 
  • We stated previously; there was an opportunity to add exposure, which we did. 
  • The 200-dma is now essential price support for XLV.
  • We are moving our absolute stop to $100
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Added to Healthcare holdings.
  • Long-Term Positioning: Bullish

Discretionary

  • XLY has corrected back to its 50-dma and is holding support for now. 
  • On Monday, the sector rallied but underperformed the market as a whole. 
  • The sector has not gotten oversold yet, which suggests a limit to the upside at the moment. 
  • Without more fiscal support, the money flows into discretionary stocks could well see some weakness.
  • Stop-loss moved to $135
  • Short-Term Positioning: Bullish
    • Last week: No changes.
    • This week: No changes.
  • Long-Term Positioning: Neutral

Transportation

  • Transportation rallied on Monday, but that rally underperformed other sectors of the market.
  • The sector is not oversold, and the “buy signal” remains very extended. Much of the sector also maintains relatively weak fundamentals. 
  • We took profits in the sector and are waiting for a better entry point to add to our holdings.
  • Maintain an absolutely stop-loss at $56
  • Short-Term Positioning: Neutral
    • Last week: No change
    • This week: No change
  • Long-Term Positioning: Bearish