Monthly Archives: July 2021

Earnings, Multiples, & Untold Truths About Forward Valuations

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Earnings up, multiples down. Such seems to be a straightforward rationale for why investors should pile into markets as it enters a “new phase.” 

Such was the suggestion made recently by Yahoo! Finance anchor Myles Udland.

The stock market is entering a new phase. Investors right now are faced with a simple question: how much? How much do they want to pay for earnings growth that continues to blow away expectations but might also be peaking?”

It’s a good question. 

With wealth investors expecting to earn 17% average annual returns, there currently does seem to be little concern about valuations.

“According to a new survey from Natixis that surveyed households that have over $100,000 in investable assets in March and April of 2021. Those same investors report they expect to earn 17.3% above inflation in 2021, which, while high, may be understandable.

However, to assess “how much,” we need to understand what it means when the media makes comments about “forward earnings” and “future multiples.”

Not A New Cycle

We need to start by dispelling the myth that begins the article. The market is “not” entering a “new phase.” Yet, in a rush to pitch the bullish case for stocks, the media has continued to suggest the March 2020 decline was a “bear market cycle.” Such would support the idea a new “bull market cycle” has started.

However, as discussed in “Confusing Bear Markets & Crashes,” March was a “correction” within a “bull market cycle.” To wit:

“As Sentiment Trader notes, the 20% rule is arbitrary. The question is, after a decade-long bull market, which stretched prices to extremes above long-term trends, is the measure still valid? “

If a 20% decline is arbitrary, what measures accurately define a “bull” or “bear” market? To answer that question, let’s clarify the premise.

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

The chart below provides a visual of the distinction. When you look at price “trends,” the difference becomes both apparent and valuable.

Correction Bear Market, #MacroView: March Was A Correction, Bear Market Still Lurks.

This distinction is vital for investors, particularly when discussing the starts of “new market cycles.”

  • “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.

The decline in March did not meet any of the criteria necessary to be classified as a “bear market.” 

  • The decline was unusually swift and did not break the prevailing bullish price trend. 
  • The recovery to new highs occurred quickly; and,
  • Valuations did not revert from previously elevated levels.

Stocks Are Eating Earnings

As noted, the correction in March did not revert the overvaluation in the markets that existed in February of 2020. While earnings declined, the price advance was so fast it kept valuations elevated throughout the “economic shutdown.” Thus, while valuations did not get more expensive, they did not get cheaper either.

“The chart, which came from Credit Suisse equity strategist Jonathan Golub, showed that while stock prices had been in rally mode for months, the market wasn’t getting more expensive.” – Myles Udland

In other words, the rise in prices “ate the recovery” in earnings. If this had been a “real bear market,” investors would have shunned stocks keeping prices depressed as earnings recovered, thereby lowering valuations.

That is also another characteristic of “bull market correction” and a “real bear market.” Following a “bear market,” investors do not rush back into the riskiest of assets. 

Most importantly, you don’t see investors piling into leverage at the beginning of a new “bull market cycle.”

The Problem With Lower Forward Valuations

However, here is the “ugly truth” of “forward valuations.” Let’s start with Myles’s analysis as a baseline.

“Right now, the S&P 500 currently trades at roughly 22x forward earnings. You might hear this referred to as the market’s multiple or its valuation. The terms are roughly interchangeable. And we say roughly because there are always exceptions. 

So a simple way of thinking about the earnings multiple for the market is how much you need to pay as an investor for $1 of earnings power.”Myles Udland

The S&P 500 recently traded at 4,353. According to the latest data from S&P, earnings estimates for the index at the end of 2022 are $189. Divide the index level by the expected annual earnings for the index, and you get the earnings multiple. In this case, 4,353 divided by 189 is 23.03. So, for every $22.03 you put into the S&P 500, you can expect to get back $1 in earnings based on today’s estimates.

Read that again.

23-Years To Get Your Money Back

While investors take this to mean the market will be cheaper in the future, therefore using that rationalization to “buy stocks,” such is not the case.

The correct way to interpret valuations of 23x earnings is to realize two things. 

For earnings in the future to catch up with the market’s current price, price returns over the next 18-months must be ZERO. 

If stocks continue to appreciate during the period, valuations can decline if earnings growth is faster than the price of appreciation. However, such does not necessarily resolve the overvaluation of the market.

Secondly, and to Myles’s last point, while it may seem like a “bargain” to pay $23 for each $1 of earnings, that is not precisely what that means. Here is the math:

“If you pay $23 for $1 in earnings, and the company distributes that $1 of earnings to you each year, it will only take you 23-years to get your money back.

All of a sudden, that doesn’t sound like such a good deal.

Valuations Are Astronomical

In 2013, valuations on stocks were around 19x trailing earnings. While certainly expensive, valuations had not yet eclipsed previous “bull market” excess of 23x earnings. As shown below, even if we assume no increase in the index price, the market will remain well above 20x earnings over the next two years assuming analyst estimates are correct.

I recently quoted Carl Swenlin on earnings. As Carl noted, there is nothing normal with GAAP earnings. But, of course, today, most companies report “operating” earnings which obfuscate profitability by excluding all the “bad stuff.” 

The following table shows the expectations for reported earnings growth:

  • 2020 (actual) = $94.13 / share
  • 2021 (estimate) = $161.62  (Increase of 71.69% over 2020)
  • 2022 (estimate) = $189.48  (Increase of 101.29% over 2020)

The chart below uses these earnings estimates and assumes NO price increase for the S&P 500 through 2022. Such would reduce valuations from 41x earnings currently to roughly 22x earnings in 2022. (That valuation level remains near previous bull market peak valuations.)

However, as stated above, investors always bid up prices as earnings increase. With earnings expected to double over the next two years, if we reduce wealthy investor return assumptions to just 15% annually, the picture changes. Instead of valuations declining, the increase in price keeps valuations hovering near 27x earnings.

Potentially Disappointing Outcomes

Given that markets are already trading well above historical valuation ranges, such suggests that outcomes will likely not be as “bullish” as many currently expect.

“Historically, price has usually remained below the top of the normal value range (red line); however, since about 1998, it has not been uncommon for price to exceed normal overvalue levels, sometimes by a lot. The market has been mostly overvalued since 1992, and it has not been undervalued since 1984. We could say that this is the ‘new normal,’ except that it isn’t normal by GAAP (Generally Accepted Accounting Principles) standards.” – Carl Swenlin

Siegel Stocks 30%, #MacroView: Siegel On Why Stocks Could Rise 30%

The hope, as always, is that earnings will rise to justify the over-valuation of the market. However, when earnings are rising, so are the markets.

Most importantly, analysts have a long and sordid history of being overly bullish on expectations of growth which fall well short. Such is particularly the case today. Much of the economic and earnings growth was not organic. Instead, it was from the flood of stimulus into the economy, which is now evaporating.

Conclusion

While Myles’ analysis is typical for mainstream media, it is essential always to consider the context in which it gets structured.

Throughout history, overvaluations of markets have never been resolved by earnings catching up with the price. Secondly, the two-fold problem of the temporary nature of the stimulus and inflation leaves the market vulnerable to a downshift in earnings expectations over the next couple of quarters. As noted, Wall Street has ratcheted up expectations to try and justify current prices.

However, a bit of analysis suggests that over-estimating earnings will lead to a price correction when it becomes realized. While that is something we do not expect immediately, we think markets will likely wake up to this reality in the last half of the year.

While monetary interventions allow market participants to ignore the reality of the economic ties to the market, such does not preclude hair-raising volatility and significant declines, as we saw in March 2020.

In 2021 and 2022, earnings are likely to come in once again lower than analyst’s exuberant estimates. But such shouldn’t be a surprise since they are never accurate historically. More importantly, if the Fed backs off, whether by its design or due to inflation, slower economic growth, or massive debt overhead, rich valuations will matter.

The risk of disappointment is high. And so are the costs of investing based on analysis without all of the facts.

Bulls “Buy The Dip” But Is The Risk Really Over?

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In this 07-23-21 issue of “Bulls Buy The Dip But Is The Risk Really Over?”

  • Bulls Buy The Dip & The Next Minsky Moment
  • Trading Sardines
  • The Fed Is Deflationary
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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


Are you worried about the potential for a market correction, a surge in inflation, or are you unsure how to invest for your retirement? We can help. If you are not yet a client and would like to discuss your portfolio construction, please schedule a time to meet with one of our advisors below.

Q2 Peak Reporting 07-02-21, As Good As It Gets. Will Q2 Mark Peak Reporting? 07-02-21


Bulls Buy The Dip

Last week, we discussed that as the market hit new highs and the index returned to more extended and overbought conditions, a correction was likely. To wit:

“Analysts have set a very high bar for the markets to hurdle, given already lofty valuations. With indices already well-stretched above their historical means, there is much room for disappointment. With the currently very overbought short-term market, a 3% to 10% correction this summer remains likely.”

Earnings Markets 07-16-21, Earnings Kick Off With Markets Priced For Perfection 07-16-21

Well, between Friday and Monday, the market did sell-off by 3% to touch the 50-dma. However, at that point, “dip buyers” emerged to chase the market back to new highs. While this does indeed negate any short-term bearish action, it is worth noting two things (shown below):

  • The volume of the rally was extremely light; and,
  • The sell-off was too shallow to reverse the underlying technical concerns.

The good news is that the lack of real progress over the last couple of weeks did work off most of the “money-flow sell signal,” which preceded the selloff. If the market can continue to maintain its more bullish posture, this should reverse our signals as early as next week.

While the upside remains somewhat limited, given the already substantial advance this year, it will alleviate downside concerns momentarily. However, with that said, the extremely low level of volatility this year is reminiscent of 2017. The reason is that “stability” is fragile. In other words, stability ultimately leads to instability.

Economist Hyman Minsky argued that during long periods of bullish speculation, the excesses generated by reckless, speculative activity eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

The Next Minsky Moment

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

One way to view “leverage” is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to take on excess leverage (borrow money) to invest, which leaves them with “negative” cash balances.

While “margin debt” provides the fuel to support the bullish speculation, it is also the accelerant for the reversal when it occurs. Periods of low volatility, and steadily rising prices, lead to market complacency. As noted, the last period where we saw similar levels of low volatility was 2017.

Of course, that low-volatility period in 2017 didn’t last long. The “Minsky Moment” arrived in 2018 and lasted through 2020 as price swings punctuated the markets. While this current low-volatility regime can certainly last a while longer, it is likely naive to believe the next “Miskey Moment” will be any less punishing than the last.

The last time I wrote about a “Minsky Moment,” here was my conclusion.

Professor Minsky taught that markets have short memories and they repeatedly delude themselves into believing “this time is different.” Sadly, judging by today’s market exuberance, once again Minsky is likely to be proven correct.

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

An unexpected recession would more than likely do to trick.”

That was February 2020, one month before the recession began.



Trading Sardines

“In ‘Margin of Safety,’ Seth Klarman tells a story about the market craze in sardine trading. One day, the sardines disappeared from their traditional habitat off of the Monterey, California, shores. Due to their scarcity, commodity traders bid up the price of sardines. Prices soared.

Eventually, along comes a gentleman who decides to treat himself and opens up a can of sardines and eats them. He immediately gets ill and tells the seller the sardines are no good. The seller quickly responds, ‘You don’t understand. These are not eating sardines; these are trading sardines!'” – Doug Kass

On Monday, the market sold off over fears of the “Delta variant.” (Someone ate the sardines.) On Tuesday, as the market touched the 50-dma, computer algorithms furiously “traded sardines.”

Such is not an investor’s market. Rather, it is a market fraught with speculative frenzy as investors fear “missing out” more than “losing capital.”

In the short term, speculation seems “normal.” However, as the price advances, the underlying valuations become an inherently more significant drag on outcomes. Currently, those valuations exceed levels rarely witnessed in history. (Table courtesy of Tavi Costa of Crescat Capital)

If you are a long-term investor, it is becoming more critical to understand the risk you are undertaking. Likewise, if you are a trader, it is essential to determine what type of trader you are. As Doug concluded:

“In terms of trading, more than ever, it’s important to remember that there are two kinds of traders:

  • Those who are humble.
  • Those who are going to be humbled.

Remember those words because, despite the appearance of the many talking heads in the business media who regal in the reversal of Monday’s losses and consecutive winning trades. The stock market is likely to grow more difficult and narrow in the months ahead.”

The Fed’s Power

Over the past few years, Michael Lebowitz and I have written many articles discussing the perils of excessive monetary policy. These perils range from slower economic growth, excessive speculation, the formation of asset bubbles, and wealth inequality. The last point is most important.

Wealth inequality is the catalyst behind the calls for socialism, the increase in riots, and racial tensions. When individuals cannot make “ends meet,” they begin to lash out at those who are prospering at their expense. Such is not new but rather a consequence of similar periods of inequality throughout history. Notably, the wealth gap is directly related to the Federal Reserve monetary interventions.

The speculative retail frenzy in the financial markets is further evidence of the Fed’s monetary mistake of creating “Moral Hazard. As Charles Mackay noted in his book on “The Madness Of Crowds:

“Essential is the understanding of the role psychology plays in the formation and expansion of financial manias. From the 1711 ‘South Sea Bubble’ to the 2000 ‘Dot.com crash,’ all bubbles formed from a similar ‘panic’ by investors to chase ongoing speculation.”

On Thursday, Michael Lebowitz and I discussed the ongoing problems of the Fed’s monetary interventions in much greater detail. This discussion includes 10-clips from various Fed members, Jeremy Grantham, Mohammed El-Erian, and Howard Marks, to support our views.

The problem for the Fed, as discussed, is they have now inflated multiple asset bubbles from which they cannot extricate themselves. If they try and “taper” monetary policy, the markets panic. With the entirety of the financial ecosystem more heavily levered than ever, the Fed’s most significant risk is the “instability of stability.” 

Ultimately, the Fed can choose to reverse monetary policy and navigate the fallout. Or, some exogenous event will eventually do it for them.


In Case You Missed It


The Fed Is Deflationary

On Thursday, Mish Shedlock penned an excellent post on Lacy Hunt and the inflation argument. While I suggest reading it in its entirety, the following except supports our recent views on why Monetary Policy Is Not Expansionary.”

When debt is already at extreme levels, a further increase in debt leads to an increase in the risk premium on which a borrower will default suggesting that the bank or other lender will not be repaid.

In terms of the impact on monetary activities, a drop in the LD ratio means that more of bank deposits are being directed to the purchase of Federal, Agency and state and local securities in lieu of private sector loans. The macroeconomic result is that funds are shifted to sectors that are the least productive engines of economic growth and away from the high multiplier ones.” – Dr. Lacy Hunt

The shift in “risk preference” by banks is evident. Each time the Fed engages in QE programs, banks “hoard” those reserves as the “risk/reward” of loaning money into the economy is not justified. 

Monetary Policy Expansionary, #MacroView: Monetary Policy Is Not Expansionary.

As we repeatedly stated previously, disinflation is more likely than accelerating inflation. 

With the base effects now exhausted, the cyclical, structural, and monetary considerations suggest inflation will decline by year-end. Thus, the “inflationary psychosis” gripping the bond market is already reversed as the realization of slower economic growth and disinflation occurs.

Given that wages are not keeping up with inflation currently, consumers’ ability to continue expanding their consumption “sans stimulus” will become problematic.

Given we already see cracks in the housing and auto markets, there is likely a deflationary “payback” coming much sooner than expected.

As Mish concludes

“QE sponsors bubbles and central banks are addicted to it.”

The problem with addictions is the eventual “withdrawal.”


Portfolio Update

We have not made tremendous changes to our portfolio models as of late. We still maintain a nearly fully allocated equity allocation in our models along with a bond portfolio that remains fairly short-duration.

As we have been recommending over the last couple of weeks, we have followed our basic rules of portfolio risk management. We took actions to:

  • Take profits in positions that rose sharply and exceeded our portfolio allocation sizing limits.
  • Reduce positions that were underperforming but still maintain strong fundamental underpinnings.
  • Rebalance sector allocations to aligns with our portfolio benchmarks as needed.

About three weeks ago, we noted that we started to increase the duration of our bond portfolios, expecting a peak in economic activity. Over the last week, the bond market came to agree with our views, and that increased duration provided a hedge against equity risk. So on Thursday, we increased our duration again as the 10-year Treasury rate touched and held the 200-dma.

By the end of this year, we expect that we will likely see treasury rates fall below the 1% level once again as the markets realize artificial short-term economic growth is not the same as real growth.

However, in the short term, we remain focused on our equity exposure. After next week, the bulk of the S&P 500 will have reported earnings. Such leaves the market vulnerable to August and September’s seasonally weak tendencies.

As we have noted over the last several weeks, it has been an exceptionally long period without a 5% correction, or more, in the market. While such does not mean it “MUST” occur, the probabilities of such an occurrence outweigh the possibilities it won’t.

Have a great weekend.

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” are oversold. The current reading is 88.81 out of a possible 100.


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.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 75.50 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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.
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

From the main body of this week’s newsletter:

“We have not made tremendous changes to our portfolio models as of late. We still maintain a nearly fully allocated equity allocation in our models along with a bond portfolio that remains fairly short-duration.

As we have been recommending over the last couple of weeks, we have followed our basic rules of portfolio risk management. We took actions to:

  • Take profits in positions that rose sharply and exceeded our portfolio allocation sizing limits.
  • Reduce positions that were underperforming but still maintain strong fundamental underpinnings.
  • Rebalance sector allocations to aligns with our portfolio benchmarks as needed.

About three weeks ago we noted that we started to increase the duration of our bond portfolios expecting a peak in economic activity. Over the last week, the bond market came to agree with our views and that increased duration provided a hedge against equity risk. On Thursday, we increased our duration again as the 10-year Treasury rate touched and held the 200-dma.

We expect that by the end of this year, we will likely see treasury rates fall below the 1% level once again as the markets realize artificial short-term economic growth is not the same as real growth.

However, in the short term, we remain focused on our equity exposure. After next week, the bulk of the S&P 500 will have reported earnings. Such leaves the market vulnerable to further corrective action as we move into the seasonally weak summer months of August and September.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

This morning we added 1% DUK to the equity model bringing the exposure to Utilities to 2%. This action aligns the Equity Model with the ETF Model in terms of Utility exposures.” – 07/22/21

Equity Model

  • Buy 1% of the portfolio in DUK

“We are adding to our existing TLT (20-year Treasury Bond) holding today to increase our exposure on this recent pullback in rates. With economic growth likely to have peaked, we feel there is more downside pressure on yields to come by year-end. Given we are very underweight our benchmark in bonds, the minor addition of duration moves us in the right direction.” – 07/21/21

Equity & ETF Models

  • Increase TLT from 2.5% of the portfolio to 3.5%.

“This morning we are reducing exposure slightly in portfolios particularly in the Nasdaq-related areas which is extremely overbought relative to the S&P 500 index. As has been the case with our actions as of late, we continue to tweak exposures to reduce overall risk while still maintaining our core positions.” – 07/20/21

Equity Model 

  • Reduce ADBE by 1% of the portfolio
  • Sell 1% of AAPL as it has run well ahead of earnings.
  • Reduce UPS by 1% of the portfolio
  • Sell down AMLP from 3.5% to 2% of the portfolio.

ETF Model

  • Reduce XLV by 1% of the portfolio. 
  • Reduce XLK by 1% of the portfolio. 

As always, our short-term concern remains the protection of your portfolio. Accordingly, we have shifted our focus from the election back to the economic recovery and where we go from here.

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.


401k Model Performance Analysis

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 Model Performance Analysis

Have a great week!

Technical Value Scorecard Report For The Week of 7-23-21

image_printPRINTER FRIENDLY VERSION

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 will find more detail on the model and the specific tickers below the charts.

Commentary 7-23-21

  • The same themes from the last few weeks continue. Growth sectors remain overbought versus the S&P 500, while cyclical sectors are generally underperforming. Healthcare and Technology continue to be the two hottest sectors. Realestate (XLRE) gave up 3% to the S&P 500, which pushed its relative score back toward fair value. It was the most overbought sector in the prior week.
  • The third graph below shows each sectors excess returns versus the S&P 500. Of note, the most current 10 day period shows that staples and utilities are finally green. Conversely, energy has had a few abysmal weeks versus the market. Looking at the longest time frame, 240 trading days (approximately 1 year), staples and utilities are still down signficantly versus the market. Financials and transportation stocks have the largest gains over that period. If we look back to February 19th, the pre-pandemic peak, only utilities and energy are still lower over that period.
  • The factor/index relative value graphs also show that growth, in particular the NASDAQ (QQQ), are the only equity factor/index trading with a positive relative score. All of the factors/indexes with negative scores became a little less oversold over the last week.
  • On the absolute series of charts, the cyclical inflationary sectors all improved on the week and are back to, or near fair value. Technology continues to move deeper into overbought territory. This coming week will feature earnings reports for many of the technology companies. Even if they report strong earnings, they may have lackluster gains given their run up over the past month. Technology is now over 2 standard deviations above its 200 dma and about 1.5 above its 20 and 50 dmas.
  • The absolute factor/index graph shows that everything has a higher score this week versus last week except for emerging markets (EEM). EEM is sitting on its 200 dma and about 1 standard deviation below its 50 and 20 dmas.
  • The S&P continues to hover in modestly overbought territory as do all of the bond sectors.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis 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. At times 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 one of many tools we use to manage our portfolios. 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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Shortest Recession In History Sets Up Next Recession

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It’s now official that the recession of 2020 was the shortest in history. 

According to the National Bureau of Economic Research, the contraction lasted just two months, from February 2020 to April 2020. However, during those two months, the economy fell by 31.4% (GDP), and the financial markets plunged by 33%. Both of those declines, as shown in the table below, are within historical norms.

Here it is graphically. The chart shows the historical length of each recession and the corresponding market decline.

However, while the effects of the “recession” were all within historical norms, the recession itself was not. 

Let me explain.

A Non-Standard Recession

The statement from the NBER is as follows:

“In determining that a trough occurred in April 2020, the committee DID NOT conclude that the economy has returned to operating at normal capacity. The committee decided that any future downturn of the economy would be a new recession and not a continuation of the recession associated with the February 2020 peak. The basis for this decision was the length and strength of the recovery to date.”

As I said, the recession was non-standard. Conventionally, the NBER defines a recession as two consecutive quarters of negative GDP growth. Notably, while the recession did technically meet the criteria after GDP fell 5% in Q1, recessions tend to last more than three months historically.

The difference was the massive interventions of 20% of GDP beginning in Q2, which created an “artificial growth surge” in the economy by pulling forward consumptive activity. That led to an explosive recovery in GDP in Q3 of nearly 30%.

It is essential to note that the NBER stated that any subsequent downturn would get labeled as a “new” recession. That view accounts for the recovery driven by massive interventions even though that growth is not sustainable.

As such, the “next recession” may not be as far off as many currently expect.

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

Why Recessions Are Important

Our discussion must begin with a basic concept: “recessions” are not a “bad thing.” 

It is a given you should never mention the “R” word. People immediately assume you mean the end of the world: death, disaster, and destruction. But, 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.

Ask yourself this question: “Why California has so many wildfire problems?” 

Is it just bad luck and negligence? Or, is it 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.

No Tolerance For Recessions

Following the century’s turn, the Fed’s “constant growth mentality” not only exacerbated rising inequality but fostered 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 now more frequent.

Deutsche Bank strategists Jim Reid and Craig Nicol previously wrote a report that echos this analysis.

“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.

The Darwinian Process Of Recessions

As we discussed in our series on “Capitalism,” if allowed to operate, is a “Darwinian System.” As with Darwin’s theory of evolution, corporate evolution has the same essential components as biological evolution: competition, adaptation, variation, overproduction, and speciation. In other words, as an economic system, companies either adapt, evolve, and survive or become extinct. 

However, in 2008, the Government and Federal Reserve began a process of “bailing” out companies that should have been allowed to go “bankrupt.”  The consequence of that process is the failure to enable the system to “clear itself” of the excess debt, which diverts capital away from productive uses.

I have illustrated the continual increases in debt used to create minimal economic growth. Specifically, since 2008, the Federal Reserve and the Government have pumped more than $43 Trillion into the economy. But, in exchange, that debt generated just $3.5 trillion in economic growth, or rather, $12 of monetary stimulus for each $1 of growth. Such sounds okay until you realize it came solely from debt issuance.

Capitalism Equal Corporatism, #MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

As Ruchir Sharma previously penned:

“Modern society looks increasingly to government for protection from major crises. Whether recessions, public-health disasters or, as today, a painful combination of both. Such rescues have their place. Few would deny that the Covid-19 pandemic called for dramatic intervention. But there is a downside to this reflex to intervene, which has become more automatic over the past four decades. Our growing intolerance for economic risk and loss is undermining the natural resilience of capitalism and now threatens its very survival.”

Such is an important concept to comprehend. 

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.

Structural Fagility

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.

It is clear the Fed’s foray into “policy flexibility” did extend the business cycle. However, those extensions led to higher structural budget deficits. The cancerous byproduct of increased private and public debt, artificially low-interest rates, negative real yields, and inflated financial asset valuations is problematic.

Capitalism Equal Corporatism, #MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

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.

Capitalism Equal Corporatism, #MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

The Fed’s “Moral Hazard”

A growing body of research shows that constant government stimulus is a significant contributor to many of modern capitalism’s most glaring ills. Wealth inequality is the most obvious.

However, another more important but not noticeable side effect is that it keeps alive heavily indebted “zombie” firms. 

When a company is “kept alive,” it comes at the expense of startups, which typically drive innovation. All of this leads to lower productivity which is the prime contributor to the slowdown in economic growth and a shrinking pie for everyone. (See chart above.)

By not allowing “recessions” to perform their natural “Darwinian” function of “weeding out the weak,” it creates a macroeconomic problem. As previously noted by Axios:

“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.”

If “recessions” are allowed to function, the weak players will fail. Stronger market players would acquire failed company assets. Bond-holders would receive some compensation for their debt holdings. Shareholders, the ones who accepted the most risk, would get wiped out.

Furthermore, assuming capitalism was allowed to function, investors would require appropriate compensation for the risk when loaning money to companies. As such, credit-related investors would get compensated for their risk rather than the current state of abnormally low yields for junk-rated debt.

Capitalism Equal Corporatism, #MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

The consequence, of course, is that since the “Darwinistic process” of a recession did not occur, and the macroeconomic system is even more fragile than previously, the next downturn could happen sooner than later.

The Next Recession

While the interventions certainly salvaged the economy from a more prolonged recessionary event, they also made the economy more fragile. Furthermore, by dragging forward future consumption, the interventions only gave the appearance of economic activity. As excess stimulus fades and assuming interventions don’t repeat, the economy will return its pre-covid growth trend of 2% or less.

Such should not be a surprise given that economic growth is roughly 70% consumption. With wage growth well below inflationary pressures, consumption will get impacted by higher prices.

With Treasury yields dropping and the yield curve reversing, these are early warning signs that economic growth is indeed slowing.

While the NBER declared the 2020 recession the shortest in history, such does not preclude another recession from occurring sooner than later.

All the excesses that existed before the last recession have only worsened since then.

  • Excess Debt
  • High Stock Market Valuations
  • Investor Complacency
  • Financial System Fragility
  • Weak Economic Underpinnings
  • Declining Monetary Velocity
  • Low Interest Rates Detering Productive Activity
  • Financial Liquidity Required To Keep Asset Prices Elevated

Given the dynamics for an economic recession remain, it will only require an unexpected, exogenous event to push the economy back into contraction.

Such is why the NBER is clear in saying they will classify the next downturn as a separate recession.

If you are quick to dismiss the idea, remember no one expected a recession in 2020 either.

But we did warn you about it in 2019.

Viking Analytics: Weekly Gamma Band Update 7/26/2021

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

Gamma Band Update

The S&P 500 (SPX) had a volatile week, with Monday down sharply, followed by four days of strength.  We entered the week with a full allocation to the SPX.  The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking the Gamma Flip and other related levels. When the daily price closes below “Gamma Flip” level (currently near 4,335), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below what we call the “lower gamma level” (currently near 4,140), the model will reduce the SPX allocation to zero.  When implied volatility spikes (as it did last week), the Gamma Flip level will tend to increase.

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

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report). With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown.

Please visit our website to learn more about our daily reports and ETF algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. 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.


Technically Speaking: Hedge Funds Ramp Up Exposure

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The “Fear Of Missing Out” has infected retail and hedge funds alike as they ramp up exposure to chase performance.

We have previously discussed the near “mania” of retail investors taking on exceptional risk in various manners. From increasing leverage, engaging in speculative options trading, and taking out personal loans to invest, it’s all evidence of overconfident investors.

However, that “risk appetite” is not relegated to retail investors alone. Professional managers, institutions, and hedge funds are “all in” as well.

Money Flows Are Huge

The evidence of “professional investor” exuberance is the massive inflows of capital. The first half of 2021 outpaced every year since the Financial Crisis lows.

That surge in inflows came from a rotation of foreign investors. The inflows are a function of expectations for more robust economic growth in the U.S. relative to their home country. The divergence in performance between the “Rest Of The World” and the U.S. represents the performance chase.

One issue is the extreme overbought and deviated conditions of the U.S. market. Such conditions, when coupled with a deterioration of participation of stocks, remain a concern. (Bottom panel)

A Mental Formation

Nonetheless, given the $120 billion a month in “Quantitative Easing” by the Federal Reserve, it is not surprising to see the “performance chase” in action. As noted in “Market Will Soon Reach 4500,” it all comes down to the “psychology” of QE:

“The key to navigating Quantitative Easing! and Fed policy in general is to recognize that their effect on the stock market relies almost entirely on speculative investor psychology. See, as long as investors get inclined to speculate, they treat zero-interest money as an inferior asset, and they will chase any asset with a yield above zero (or a past record of positive returns). Valuation doesn’t matter because investors psychologically rule out the possibility of price declines in the first place.” – John Hussman

In other words, “Quantitative Easing” is a mental formation. Therefore, the only thing that alters the effectiveness of the Fed’s monetary policy is investor psychology itself.

Such was a point we made in the “Stability/Instability Paradox.”

“With the entirety of the financial ecosystem now more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the ‘instability of stability’ is now the most significant risk.”

Given professional managers are subject to career risk,” they get forced to “chase performance.”

Hedge Funds Are All In

Hedge fund managers are now extremely long “risk” exposure.

As stated, that “career risk” has professional managers chasing performance after suffering a rough start to the year. The need to make up lost ground, or risk losing assets to better-performing managers, rises with the market. Per the Wall Street Journal:

“Client notes from both Morgan Stanley and Goldman Sachs show fundamental stock-picking manager had negative alpha in the first half of the year.

Part of the challenge for professional stock pickers is that markets are heavily rotational. Markets this year whipped back and forth between growth and value stocks. Such makes it difficult for managers to find winning trades.”

Sentiment Trader had an excellent piece of data to this point:

“The latest estimate of Hedge Fund Exposure shows that funds are nearly 40% net long stocks, a quick rise from almost being flat a month ago. Over the past few years, after such large allocation increases, the S&P gave any further gains back.”

After any day since 2003 when Exposure was below zero, the S&P 500 returned an annualized 15.2%, versus only 1.4% when Exposure was above 25% as it is now. If we look at the period after the first reading above 35% the medium-term returns were unimpressive.Sentiment Trader

The point is that when professionals investors get “sucked” into performance chasing, it warrants being more “risk” aware.

As Bob Farrell once quipped:

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

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Smart Vs Dumb Money

None of this should be of any surprise. After more than a decade of monetary interventions, the psychology of QE is now thoroughly ingrained. The problem eventually is that with investors very “long” the market, there will be few “buyers” when it comes time to sell.

The chart below combines investor positioning from both retail and professional investors. While there is room for investors to get even more exposed to “risk,” such levels have historically not lasted long or ended well.

As discussed in “There Is No Way, This Doesn’t End Badly,” virtually every measure of fundamental analysis suggests the markets are expensive.

“10-year forward returns are below zero historically when the price-to-sales ratio is at 2x. There has never been a previous period with the ratio climbing to near 3x.”

However, in the short term, investors are trapped by the “fear of missing out.” While there is plenty of logic for sitting out of an overvalued, exuberant and stretched market, there is a consequence to “missing out.” While a bear market does indeed destroy capital, not participating in a bull market has an equal impact on ending results. 

It’s a terrible choice.

Conclusion

A correction is coming. I have no idea when or what will cause it.

However, the markets are currently in a very long advance without a 5% correction or more. So when it occurs, for whatever reason, it will “feel” worse than it is. That is due to the high level of complacency investors have developed in this market.

While we are only expecting a correction in the near term, you cannot dismiss a “real bear market” either.

It may not be today, next month, or even next year. But there is one truth in a market with all the signs of exuberance.

“Bull markets are built on optimism and die on exuberance.”

All bull markets die eventually. We never know the cause in advance. Ignoring history won’t make the damage any less catastrophic.

Historically, we find that when both valuations and prices have extended well beyond their intrinsic long-term trendlines, subsequent reversions BEYOND those trend lines have ensued.

Every Single Time.

Importantly, these reversions have wiped out a decade or more in investor gains. Think about this. If the next correction begins in 2022 and ONLY reverts to the long-term trendline, investors will reset portfolios to levels not seen since 2008.

A decade of gains will get wiped out.

Such tends to have a very negative impact on an individual’s retirement plans.

If you think that can’t happen, talk to anyone who was thinking about retiring in 2000 or 2008. I am sure they have an interesting story to share with you.

Knowledge Vs. Experience: Why Most Investors Wind Up Losing

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Knowledge vs. experience. When it comes to investing, such is what separates long-term success from failure.

Amid a “market mania,” retail investors believe they have “knowledge” as every investment they make seems to be successful. As the bubble inflates, continued success breeds over-confidence to the point where it is widely believed “this time is different.”

I previously discussed Charles Mackay’s book “Extraordinary Popular Delusions And The Madness Of Crowds.” As noted, that book was an early study in crowd psychology. To wit:

“Essential is the understanding of the role psychology plays in the formation and expansion of financial manias. From the 1711 ‘South Sea Bubble’ to the 2000 ‘Dot.com crash,’ all bubbles formed from a similar ‘panic’ by investors to chase ongoing speculation.”

For anyone who has lived through two “real” bear markets, the imagery of people trying to “daytrade” their way to riches is familiar. The recent surge in “Meme” stocks like AMC and Gamestop as the “retail trader sticks it to Wall Street” is not new.

It wasn’t long after the turn of the century that those with “knowledge” learned the stern “lessons of experience.”

Moore’s Law

There is a fable that explains how little we understand exponential moves.

“A king promised the inventor a reward for inventing the game of chess. The inventor asked for one single grain of rice on the first square of the chessboard, two on the second, four on the third, and so on.

The king thought this request was inexpensive to fulfill but he failed to understand the exponential law of compounding. Once the 64th square was reached, it required 18 quintillion grains. That amount exceeded the total production of the kingdom. Instead of getting his reward, the inventor was killed for fooling his king.”

For some context to the current market exuberance, look at the chart below.

The chart often gets put into a log scale to reduce the skewness towards large numbers. However, a non-log chart provides a better visual for this explanation. Pay attention to the exponential growth trend line.

In 1965, Gordon Moore postulated that the number of transistors on a microchip doubles every two years, though the cost of computers gets halved. Moore’s Law” suggests this growth is exponential. 

Along the way, Wall Street adopted this tenet to apply to the stock market, assuming that price trends will go on forever. Notably, the longer a trend goes on, the more permanent it seems to be.

“But for some reason, human beings always extrapolate current trends whether it is population growth or stock market rallies. We know from statements at historical tops like 1929, 1987 or 2000 that anyone, from politicians to investors at the time, believe that the trend will go on for ever and that the world has made a paradigm shift.

Many markets and investments are now going up exponentially and very few forecast an end to this euphoric state.” – Egon Greverz

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

Knowledge Vs. Experience

It isn’t just rising index prices that denote the existence of a “market mania.” It is also the “speculative” actions of investors which are coincident with manias that suggest one is present.

  • Due to commission-free trading and mobile apps, retail trading has exploded.
  • A surge in IPO’s
  • A record increase in SPAC’s
  • Investors paying record multiples and prices for money-losing companies
  • Option contract speculation has seen record increases
  • Margin debt at new highs and near-record annual increases.
  • A widely accepted belief “this time is different,” due to the “Fed Put.”

Again, these issues are not new. In one form or another, they have all been present at every prominent market peak in history. While all of this seems to be very common “knowledge,” it is the “experience” that links it together.

“Here is a simple chart that vividly illustrates my view.” – Doug Kass

“At times, the markets can be quite exciting. During the halcyon periods of prosperity and abetted by many (like the financial media who have no dog in the hunt) – traders who act like gamblers are encouraged to ‘play the trend’ and, increasingly do so en masse and as a ‘community.’ 

History proves this all ends badly and will result (as it did in the early and late 2000s) with an exodus of individual traders/investors out of the markets.

Most of these traders will fail to survive the current market cycle and will not be around in the next cycle.” – Doug Kass

Go back to the S&P 500 index chart above. Note that when the index trades well above the exponential trend line, the outcome was not good.

“Reversions to the mean” happen all the time on Wall Street.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

The Benefit Of Experience

Investors all start with knowledge. However, what “bear markets” teach is “experience.” Such is why every great investor in history has a defined set of “investment rules” they follow.

To understand why the “rules” are essential, one must first understand the definition of “risk” related to investing. Howard Marks previously penned a great piece on this concept.

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

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

What is critical about the “rules” is not what they tell us but how they came to be.

How do you avoid getting trapped by the devil? I’ve been in this business for over forty-five years now, so I’ve had a lot of experience.

In addition, I am not a very emotional person.In fact, almost all the great investors I know are unemotional. If you’re emotional then you’ll buy at the top when everybody is euphoric and prices are high. Also, you’ll sell at the bottom when everybody is depressed and prices are low. You’ll be like everybody else and you will always do the wrong thing at the extremes.

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

However, this is the point where a “can’t lose proposition” tends to be a loser.

A Man With Experience

There is an old WallStreet axiom which states:

“A man with money meets a man with experience. The man with the experience leaves with the money, while the man with money leaves with experience.”

Such is the truth about markets and investing.

Experience tends to be a brutal teacher, but through experience, we learn how to build wealth successfully over the long term.

As Ray Dalio once quipped:

“The biggest mistake investors make is to believe that what happened in the recent past is likely to persist. They assume that something that was a good investment in the recent past is still a good investment. Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.”

Such is why every great investor in history, in different forms, has one basic investing rule in common:

“Don’t lose money.” 

The reason is simple; if you lose your capital, you are out of the game.

Many young investors with “knowledge” today will eventually gain a lot of “experience” by giving back most of their gains. 

It is one of the oldest stories on Wall Street.

David Robertson: We’re Not In Kansas Anymore

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We’re not in Kansas anymore. The S&P 500 racked up another fine quarter with an 8.55% return, which brought the first half of the year to 15.25%. It has been easy to fill in the blanks with apparent reasons for the continued appreciation: Strong economic growth, easy financial conditions, the receding threat of Covid-19, etc. Still, it is hard to imagine the abyss the market was staring into just sixteen months ago.

This paradoxical combination of frightening crashes and eye-watering rebounds has come to dominate market behavior over the last several years. This pattern also differs noticeably from the past when markets traced out the business cycle more closely. The challenge for investors is to find a mental model that can help navigate this unfamiliar territory.

We’re Not In Kansas Anymore

As value investors are well aware, valuation does not make an excellent timing tool. Still, it is closely associated with future returns and therefore has proved helpful for long-term positioning. Since the financial crisis, however, not only has value underperformed consistently, but other investment tools have lost effectiveness as well. John Hussman recently described:

“In market cycles across a century of market history, there was always a ‘limit’ to speculation. The points where overvalued, overbought, overbullish syndromes were so extreme that an air pocket, or panic, or crash would regularly follow. However, quantitative easing made those ‘limits’ utterly unreliable.”

So, if past guidelines to theoretical limits have become ineffective, what guidelines should investors turn to? As it turns out, authors Tim Lee, Jamie Lee, and Kevin Coldiron pursued a similar course of inquiry in their book, The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis. For example, they wanted to know.

“Why have stock markets, over the past 25 years, experienced huge rises and crashes? Why did the US stock market, in particular, quadruple over the years following the 2007–2009 global financial crisis even though US economic performance was at best so-so?”

The Rise Of Carry

These are excellent questions indeed. The answer that best fits the evidence is the market has become one giant carry trade. To appreciate that conclusion and understand the implications. First, however, it helps to be clear about what a carry trade is.

“Carry trades make money when ‘nothing happens.’ In other words, they are financial transactions that produce a regular stream of income or accounting profits. Still, they subject the owner to the risk of a sudden loss when a particular event occurs or when underlying asset values change substantially. The ‘carry’ is the income stream or accounting profits the trader earns over the transaction’s life. In this sense, carry trades are closely related to selling insurance, an activity that provides a steady premium income but exposes the seller to occasional large losses.”

As it happens, carry is “a naturally occurring phenomenon” and “is not in itself wholly bad.” As the authors fairly note,

“The return that carry traders earn is, at least in part, compensation for providing liquidity to markets and for assuming risk.”

One of the unique elements of carry trades over the last twenty years or so is the increasingly active role of central banks. By dampening volatility, central banks have reduced the risk to traders and speculators putting on carry trades. That course of monetary policy has “helped carry returns become supernormal returns” and has “supercharged” the phenomenon of carry in the process.

Characteristics Of Carry

When we examine the characteristics of carry trades, it is easy to see their stamp on market behavior. Critical features include:

“Leverage, liquidity provision, short exposure to volatility, and a ‘sawtooth’ return pattern of small, steady profits punctuated by occasional large losses.”

Perhaps the “sawtooth” pattern of returns is most notable – and pernicious – for investors. When markets seem reasonably calm and safe, something comes from nowhere to throw markets into a spin. Likewise, just as soon as it looks like markets will completely seize up, the skies magically clear, and it is smooth sailing again. This kind of progression of bubbles and crashes is what the authors refer to as a “carry regime.”

One of the fascinating characteristics of a carry regime is “a progressive de-anchoring of the structure of market prices from fundamental economic reality.” In other words, stock prices become driven by a financial market structure more than business and economic fundamentals. Such is precisely why valuation has been ineffective and why other conventional market metrics have also performed poorly. Thus, the carry regime is a financial phenomenon, not an economic one.

Another aspect of the current carry regime gets based in US markets. Such is because there is “greater liquidity and breadth of financial instruments in the US markets.” As such, the S&P 500 index “is at the center of the global carry trade.” Therefore, the carry regime outside the US is “more fragile,” and why emerging markets get hit hard when things turn south.

Carry Is About Power

Finally, carry is about power in a meaningful sense.

When markets go down, only those with strong balance sheets or close government connections survive. During the financial crisis, all major banks (except Lehman Brothers) got backstopped by the Fed. When volatility spiked in February 2018 in the Volmageddon event, retail investors in the XIV ETF got wiped out. 

“Long term, this leads to three critical outcomes. First, it makes prospering in financial markets less about competence and more about insider status. Insiders with weak balance sheets can survive crashes thanks to central bank action. Second, it reinforces wealth inequality by truncating losses for already wealthy investors who benefit from action to suppress volatility. Lastly, the distinction between economic recessions and financial market downturns becomes increasingly blurry. Recessions no longer cause severe asset price declines or bear markets; they are a function of the asset price declines.”

To sum up, then, carry trades are naturally occurring phenomena but have become supercharged due to central bank interventions that artificially moderate volatility. Insofar as central banks stay the course on interventions, a carry regime develops, which is comprised of a running series of carry bubbles and carry crashes. Because the drivers are financial, conventional economic and market-based metrics and decision tools lose effectiveness.

Adapting

One of the adaptations some investors have made is to “Buy the dip.” While this strategy is painfully simplistic, it has also been amazingly effective. While such robotic behavior may not seem worthy of earning excess returns, in a carry regime buying the dip provides liquidity and therefore does earn excess returns.

There are two problems with managing through carry regimes, though. One is carry crashes can occur suddenly and without warning. The authors describe,

“In the world of extreme carry, high financial asset prices do not guarantee that the economy is ‘good for now.’ The carry crash can occur suddenly—at the point when leverage has reached too great an extreme to be sustainable.”

Longer Than Logic Would Suggest

Another problem is carry regimes can last longer than one might guess, although they can’t last forever. Part of the reason is “The carry regime in itself is fundamentally deflationary over the long run, primarily because it exists in an economic environment of very high, and burdensome, debt levels.” Relatedly, a carry regime directs the course of the economy by “creating a pattern of economic growth driven by consumption and capital allocation driven by speculation, as opposed to a more healthy economy driven by the investment of the economy’s savings in future growth potential.” In other words, it is parasitic.

Over the long run, the carry regime de-anchors stocks from fundamentals, facilitate debt accumulation, weakens growth, and increases economic risk. It will end. But what will cause it to end, and what will follow in its stead?

When push comes to shove, and central bankers get forced to decide between tanking the economy by withdrawing monetary support or throwing the machinery into full inflationary gear, the authors assume the latter will happen. In their words:

“Governments together would implement extreme measures that would be outside the bounds of current law but gets deemed imperative to ‘save the world.’”

Indeed, this could include direct monetization of government spending.

Conclusion

In summary, the carry regime provides remarkable explanatory power to market behavior over the last twenty years or so. For example, it helps explain the sawtooth progression of bubbles followed by crashes, and it helps explain why the value style has underperformed.

As long as the carry regime persists, the easiest path to success is buying the dips. It is essential to note in doing so. However, one must have money to survive carry crashes and be on the lookout for the end of the regime.

It is also helpful to highlight the potential this environment has to wrong-foot all kinds of investors. Many investors will be comfortable riding out the carry crashes of the sawtooth pattern to ever-higher market highs. That will end when it all comes collapsing down once the carry regime fails. Others may prefer to buy the dips of the sawtooth. But they need a regular supply of capital to do so. Even then, it will be just as vulnerable to the outcome of the carry regime.

Still, other investors will prefer to sit out the carry regime or to remain underinvested through it. This strategy is notable for avoiding much of the potential for permanent losses of capital. However, it requires a great deal of patience. Further, since the carry regime will most likely end with inflation, appropriately sizing inflation hedges is a challenge.

The carry regime does not provide the kind of markets most of us would prefer to invest in, but we still need to contend with it nonetheless. At least by understanding its characteristics and developing an appropriate mental model. Then you can have a fighting chance to make the most of the market exposure you accept.

Shedlock: Inflation & Other Wildly Believed Economic Nonsense

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The CPI Measures Inflation and Other Widely Believed Economic Nonsense

The Fed, mainstream media, and others have a spotlight on the CPI and that’s the wrong spotlight.

Chart Discussion

In the chart above I plot the Case-Shiller national home price index, the Case-Shiller 10-city index, the CPI, Owners’ Equivalent Rent (OER), and the BLS Rent Index. 

I have produced this chart previously, but this month I added the BLS Rent Index. 

OER is the mythical price one would pay if one rented their own house from themselves, unfurnished and without utilities. 

Prior to the year 2000, housing, rent, OER, and the CPI all moved in sync. In 2000, home prices disconnected from the CPI, OER, and rent. 

In 2012 another disconnect developed in which both rent and OER also disconnected from the CPI.

If we plotted actual medical prices (not the BLS measures of them), we would see that the cost of healthcare disconnected from the CPI as well.  That happened because the CPI does not include prices paid on behalf of consumers (i.e. Medicaid, Medicare, or your group plan where you work). 

The two enormous bubbles (you do see them don’t you?) are the direct result of the Fed sponsoring bubbles. 

Debate Over the CPI

Debate Over the CPI

CPI Is Understated

I made the statement that the real CPI is understated. Actually, that’s not phrasing things properly.

More accurately, the CPI is a piss poor measure of inflation.  Which led to the comment “Housing prices lead rent, no?” 

Slaves to the CPI

The Fed and economists in general are slaves to CPI despite the facts

  • The CPI does not measure inflation
  • Consumer prices do not properly measure price inflation
  • The entire notion we need 2% inflation while ignoring asset bubbles that allegedly do not represent inflation is downright idiotic. 

Measured Price Inflation MPI

A better measure of inflation can be calculated by substituting actual home prices for OER in the CPI. 

To satisfy the purists who say that home prices are a capital expense, let’s not call the result “consumer” inflation but rather MPI measured Price Inflation.

I called it Case-Shiller CPI but will change the name next month to better reflect what it really is and to stop futile discussion of the word “consumer”.   

Those who want the CPI can have it. As an inflation measure, especially as used by the Fed, it’s proven useless anyway. 

The nice thing about Case Shiller is the index measure actual resales of the same house over time. We can debate the weights but OER is at least a reasonable place to start. 

Weights in the CPI 

CPI percentage weights 2020

Home Owners Equivalent Rent

Notice that OER is the largest component at 24.6% of the CPI and rent of primary residence is another 7.86%.

In the last year, home prices are up 14.59%, the CPI is up 5.39%, but OER only 2.34% and Rent only 1.92%. 

OER and rent have held down the CPI considerably.

These inflation stats are understated because the latest CPI data is from June but the latest housing data is from April. 

I created the above charts using an assumption that home prices were flat in May and again in June although we know prices went up. 

CPI, CS-CPI Percent Change 

CPI, CS-CPI Percent Change 2021-06

The above chart shows the impact of substituting home prices for OER in the CPI. 

Real Interest Rates 

Real Interest Rates CPI as of 2021-06

Real rates are formed by subtracting various interest rates from the Fed Funds Rate, a minuscule 0.08%.

As such, real interest rates, factor in housing, and are about -7.5%. But that does not include home price increases in May or June. 

Real interest rates are more deeply negative than right before the housing crash. 

The Fed is purposely allowing inflation to run hot, and that does not count home prices at all, just rent.

Dow New Low, Markowski: Could The Dow See A New Low Before Recession Ends?

Monetary Inflation vs Price Inflation

Some say that the increase in money supply is inflation and prices follow. But money measures themselves are very distorted and people bicker over how to measure them too. 

I will discuss monetary inflation next week, so stay tuned.

Historical Perspective On CPI Deflations

In its March report, the BIS took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings.

Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.

Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.

Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period
. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.

CPI Spotlight Is Wrong!

The BIS clearly draws the line on asset bubbles and property bubbles and so do I. 

The data shows the Fed has made the same mistake again, insisting on 2% CPI inflation while ignoring asset bubbles on grounds they are not inflation.

The Fed has a spotlight on the ant, missing the elephant in the room that it created. 

I will update the charts again when the next Case-Shiller reports come out.

Earnings Season Kicks Off With Markets Priced For Perfection

image_printPRINTER FRIENDLY VERSION

In this 07-16-21 issue of “Earnings Seasons Kicks Off With Markets Priced For Perfection.”

  • Market Pulls Back As Signals Turn
  • Earnings Season Has A High Bar
  • Markets Priced For Perfection
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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


Are you worried about the potential for a market correction, a surge in inflation, or are you unsure how to invest for your retirement? We can help. If you are not yet a client and would like to discuss your portfolio construction, please schedule a time to meet with one of our advisors below.

Q2 Peak Reporting 07-02-21, As Good As It Gets. Will Q2 Mark Peak Reporting? 07-02-21


Market Pulls Back As Signals Turn

Last week, we discussed the market hit new highs with the index getting back to more extended and overbought conditions. To wit:

“While market volatility did pick up this past week, the index held its breakout support levels and closed at a new high. Such keeps the bullish bias intact. However, as shown, the money flow signals are now back to more elevated levels, which will provide resistance to higher prices short term.

The bulls are indeed in charge of the markets currently, but the clock is ticking.”

Not surprisingly, the market stumbled this past week as technology began to fade its recent outperformance. But, of course, investors have been piling into the trade as of late, pushing it to more overbought extremes. As noted by Sentiment Trader on Friday:

Of course, not surprisingly, investors are historically prone to “buying the most at the top.” With the seasonally weak trend of the Nasdaq approaching, with MACD’s triggering sell signals, there is likely to be some disappointment.

However, there are two reasons why investors are piling back into the 10-largest technology names:

  1. Portfolio managers need to be invested to generate performance, and the mega-cap Technology names are easy to “hide” in given the large daily trading volumes.
  2. These companies can generate earnings growth in a slowing economic environment.

The problem with the second point is that those top-10 mega-cap names generate the bulk of the earnings of the entire S&P 500 index. Such has only occurred at previous bull market peaks.

All of this suggests the risk of a correction remains elevated, particularly with the market priced for perfection.



Earnings Season Has A High Bar

Over the last few months, the rush of analysts to upgrade earnings estimates for the S&P 500 is one for the record books. According to Factset:

“If the S&P 500 reports year-over-year growth in earnings of 69.3% in Q2, it would mark the highest (year-over-year) earnings growth rate reported by the index since Q4 2009 (109.1%).”

Of course, given the expectation of robust earnings growth for Q2, analysts still predict a double-digit price increase for the S&P 500. To wit:

“Industry analysts in aggregate predict the S&P 500 will see a price increase of 11.2% over the next 12 months. The bottom-up target price is calculated by aggregating the median target price estimates (based on company-level estimates submitted by industry analysts) for all  companies in the index. On July 8, the bottom-up target price for the S&P 500 was 4803.62, which was 11.2% above the closing price of 4320.82.” FactSet

(Of course, it is worth noting the S&P NEVER matches its bottom-up price target. In other words, estimates are always too high compared to reality.)

Analysts have set a very high bar for the markets to hurdle, given already lofty valuations. With indices already well-stretched above their historical means, there is much room for disappointment.

With the currently very overbought short-term market, a 3% to 10% correction this summer remains likely.


In Case You Missed It


Markets Priced For Perfection

While earnings estimates are soaring on exuberant hopes of an indefinite economic boom, revenue may be telling a much different story. I noted this point earlier this week:

Investors should not dismiss the above quickly. First, revenue is what happens at the top line. Secondly, revenue CAN NOT grow faster than the economy. Such is because revenue comes from consumers, and consumption makes up 70% of the GDP calculation. Earnings, however, are what happens at the bottom line and are subject to accounting gimmicks, wage suppression, buybacks, and other manipulations.

Since 2009, corporate operating earnings grew cumulatively by 339%. Yet, during that same period, the cumulative growth of revenue is only up 63%. It is through “accounting magic” that revenue gets multiplied to the bottom line. Out of each dollar of earnings, 82% is from accounting “management,” and just 18% is from revenue.

SP500-Price-Earnings-Revenue-2009-Present-071521

The majority of the rise in “profitability” came from various cost-cutting measures and accounting gimmicks rather than actual increases in top-line revenue. While tax cuts certainly provided the capital for a surge in buybacks, revenue growth, the result of a consumption-based economy, remains muted.

The Valuation Problem

The problem is the market surged higher due to the ongoing liquidity injections from the Federal Reserve. While liquidity drives asset prices higher, it does not foster economic activity, which creates corporate revenue. Currently, the price-to-sales (revenue) ratio is at the highest level ever. As shown, the historical correlation suggests outcomes for investors will not be kind.

Price To Sales Ratio Correlation-2

Of course, given that revenue can only grow roughly as fast as the economy, the market-capitalization to GDP ratio is very important. While the “price” of the market can outpace economic growth in the short term, it can’t do so indefinitely. Thus, at 2.4x economic growth, the market is highly overvalued relative to what the economy can generate in revenue growth.

Buffett-Inidcator-Market-Cap-GDP-062521

Lastly, with markets currently perched near all-time highs, both operating and reported earnings will fall in Q2 versus Q1 as economic growth peaks. (We have repeatedly warned of this issue.)

SP500-Index Op and Reported Earnings 071521

Note that as of Q2-2021, operating earnings (earnings without all the bad stuff) will only be 10% higher than they were in 2018. Yet, the market is currently trading 48% higher.

Even with the “sharpest recovery in earning in history,” the market continues to expand its valuation multiple. (Chart below uses current estimates for Q2-2021) So much for earnings catching up with the price.

As I said, investors have priced the market for perfection. Therefore, any disappointment could lead to poor outcomes for investors taking on excess risk.

Portfolio Update

I wanted to wrap up today’s note with some comments from my colleague Doug Kass on “Lessons Learned & Relearned.” As investors, the market has a habit of teaching us we aren’t as smart as we think.

* We learn from history, which usually rhymes.

* Liquidity is an overriding market force and influence as markets are a function of demand versus supply. The size of the Fed’s balance sheet will have an overriding impact on the markets. But the reduced supply of equities also is an important part of the investment equation. (There are about half the listed companies compared to what existed two decades ago. Of the companies still listed, more than 25% of outstanding shares are retired).

* A market in motion tends to stay in motion. Higher valuations usually beget higher valuations (and vice versa). A bona fide (and correct) contrarian view is a low probability practice. But, when the contrarian is correct, it can deliver large payoffs.

* Markets and emotions often go to extremes. Importantly, mean regression is a powerful force and consistent feature in the market.

* Seek precision when playing chess but not when investing.

* The notion, held by some, that the direction of the broad markets is a function of the health of speculative stocks is grossly incorrect. Crap doesn’t lead except for brief periods of time.

* It is fine to take chances and make mistakes. However, while it might work briefly, it is foolish to trade stocks with admittedly little value simply because they are moving higher.

* Avoid “group stink” as it can be harmful to your investment well being

The risk of a correction is high but not necessarily immediate.

Manage your risk accordingly.

Have a great weekend.

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” are oversold. The current reading is 80.76 out of a possible 100.


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.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 85.37 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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.
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

Not much to update from this past week. As noted:

“With our money flow signals returning to peaks, which typically precede a pickup in volatility, we took the opportunity to reduce our index trading positions. That action raised our cash levels by 5% to provide a bit more of a cash cushion for now.”

Over the next 3-weeks, we will enter the heart of earnings season for the S&P 500. As discussed in the main body of this week’s newsletter, earnings appear to have peaked with economic activity in Q2, so the valuation question will become much more important going forward.

However, in the short term, the psychology of “Fed liquidity” continues to override the fundamental underpinnings of the market. So, for now, we will continue to let our positions participate with the underlying momentum until it requires a change.

Regardless, we continue to monitor the markets closely. If our signals become aligned, we will take further action to reduce risk exposures accordingly. As stated last week, there are no “red flags,” but if things change, we will change as well.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“This morning, we took some profits in LIT in the sector model as it is overbought and replaced it with XLB, which got oversold. Both trades were for .5%. The trade will slightly reduce net exposure as LIT was overallocated and XLB slightly under-allocated versus the model.” – 07/12/2021

ETF Model

  • Reduce LIT to 2.5% of the portfolio.
  • Increase XLB to 2% of the portfolio.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we have shifted our focus from the election back to the economic recovery and where we go from here.

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.


401k Model Performance Analysis

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 Model Performance Analysis

Have a great week!

Technical Value Scorecard Report For The Week of 7-16-21

image_printPRINTER FRIENDLY VERSION

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 will find more detail on the model and the specific tickers below the charts.

Commentary 7-16-21

  • Bad market breadth was in play again this past week. There were only four sectors that beat the S&P 500. Of note, the two most oversold sectors over prior months finally woke up. XLU and XLP beat the S&P 500 by 1.74% and 1.29% respectively. Their improvement can also be seen on the first relative set of graphs as they are not among the most oversold sectors anymore. If you think the reflation trade is dead, these sectors should continue to gain on the S&P and other sectors in the coming weeks and months.
  • The reflation sectors continue to lag the market. Energy and transportation are the most oversold sectors. Financials are struggling due to the flattening yield curve accompanying lower yields and reduced inflation expectations.
  • The bond market continues to push lower in yield, warning economic growth and inflation may be peaking. If bond traders have this right, the technology and healthcare sectors should continue to lead. Further, staples and utilities have ground to catch up and such an environment should be relatively friendly for them.
  • The relative factor/index graph also shows the stunning divergences between the S&P and other indexes. The NASDAQ (QQQ) is the only equity factor/index above fair value versus the S&P. Small-cap, mid-cap, and emerging markets are in deeply oversold territory and might bounce on any signs the reflation the trade is back on. Over the last four weeks, small caps have given up 6% to the S&P and emerging markets a little over 5%.
  • The absolute graphs tell a similar story of which sectors are leading and lagging. The market has been generally drifting higher leaving energy, transportation, and materials as the only oversold sectors. They are not deeply oversold, so the trends can easily continue. Real estate and technology are moving into deeply overbought territory so caution is advised especially going into earnings reports in the last week of July for many tech companies.
  • The S&P 500 is overbought, but in its recent value range as shown in the bottom right of the second set of graphs.
  • All bond sectors are overbought on an absolute basis. However, on a relative basis versus the 5-7 year UST ETF (IEI), TLT and investment-grade corporates (LQD) are the only overbought sectors. Junk bonds, mortgages, and TIPs have been lagging IEI. Also, note on the chart our proprietary inflation/deflation index is decently oversold. Since June 16th, one month ago, the inflationary sectors have given up almost 10% to the deflationary sectors. A listing of the constituents in each index can be found at the bottom of this report.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis 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. At times 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 one of many tools we use to manage our portfolios. 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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Monetary Policy Is Not Expansionary.

image_printPRINTER FRIENDLY VERSION

Monetary policy is not expansionary despite widespread belief otherwise.

The general assumption by the Federal Reserve is that by providing excess reserves to the banking system, the banks would then lend to businesses and individuals to expand economic activity. Furthermore, as discussed previously, the Federal Reserve’s entire premise of inflating asset prices was the subsequent boost to economic activity from an increased “wealth effect.”

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”Ben Bernanke

However, after more than a decade of “monetary policy,” there is little evidence that supports those claims. Instead, there is sufficient evidence that “monetary policy” leads to greater wealth inequality and slower economic growth.

Prima Facie Evidence

The only reason Central Bank liquidity “seems” to be a success is when viewed through the lens of the stock market. Through the end of Q2-2021, using quarterly data, the stock market has returned almost 198% from the 2007 peak. Such is more than 8x the GDP growth and 3.9x the increase in corporate revenue. (I have used SALES growth in the chart below as it is what happens at the top line of income statements and is not AS subject to manipulation.)

Unfortunately, the “wealth effect” impact has only benefited a relatively small percentage of the overall economy. Currently, the top 10% of income earners own nearly 90% of the stock market. The rest are just struggling to make ends meet. Thus, the impact of the Fed’s monetary interventions on the equity value of the top 1% is evident.

While short-term ongoing monetary interventions may appear to be expansionary, it creates negative incentives to economic activity and monetary velocity.

Bond yields, #MacroView: Bond Yields Send An Economic Warning

QE Has A Negative Incentive

As noted above, the Fed suggests that by providing excess reserves to the banking system, the banks will then “lend” those reserves. In turn, as businesses borrow money to expand production or consumption, the economy gets a lift.

However, in reality, it is precisely the opposite. Each time the Fed has engaged in QE programs, the banks “hoard” those reserves as the “risk/reward” of loaning money into the economy is not justified. For example, in early 2020, as the economy was “shut down” due to the COVID pandemic, companies tapped credit lines at their banks to ensure sufficient capitalization. After that initial surge in lending activity, banks reversed back into a more “protectionary” mode.

Another way to view the same is by looking at monetary velocity. Monetary velocity, or M2V, measures the rate at which money (M2) moves through the economy (GDP). As shown, velocity continues to plummet as the banks contract their lending.

Such is not surprising given that 80% of the population are living primarily paycheck to paycheck. The risk of repayment and defaults remains a disincentive to lend. For the banks, the risk preference is to hoard reserves for more profitable, less risky, investment banking activities.

Bond yields, #MacroView: Bond Yields Send An Economic Warning

Fed Actions Are Disinflationary

Another thesis that requires correcting was summed up well in a recent email question.

“Given the Fed is buying 100% of the Treasury bills plus other bonds at auction…I believe the Fed is manipulating bond yields lower.”T. Stephenson

The problem for the Federal Reserve is that the fiscal and monetary stimulus imputed into the economy is, in reality, “dis-inflationary.” 

“Contrary to the conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year end and will undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.” – Dr. Lacy Hunt

While the economic growth rate may be booming momentarily, inflation, which is destructive when not paired with rising wages, will be transient. Given the massive surge in prices for homes, autos, and food, the reversal will cause a substantial disinflationary drag on economic growth.

The most considerable risk is a divergence among Fed policymakers which possibly leads to a policy mistake of tapering too quickly or even hiking rates. 

Fed Buying Drives Rates Higher

The majority of the inflation and economic growth pressures are artificial, stemming from the stimulus injections over the last year. However, with those inputs fading as year-over-year comparisons become more challenging, the “deflationary” impact could be more significant than expected.

There is also one other point about the Fed tapering the purchases. As shown in the chart below, rates rise during phases of QE as money rotates from bonds to stocks for the “risk-on” trade. The opposite occurs when they start to taper, suggesting a decline in rates if “taper talk” increases.

Such is because, after more than a decade of monetary interventions, the Fed has created a “psychological” link between “QE” and the equity markets. As a result, the liquidity provision creates an asset preference of “risk-on” assets, equities, versus “risk-off” assets, bonds.

(It is also worth noting the massive current deviation of the equity market from the liner growth trend.)

The result is that during QE programs, interest rates rise due to the psychological impact of asset preference.

Bond yields, #MacroView: Bond Yields Send An Economic Warning

Fed Requires Debt Issuance

Of course, the Federal Reserve requires debt issuance by the Government to facilitate Quantitative Easing. Since the “Financial Crisis,” total Government interventions surpassed $43 Trillion into the economy to keep it “afloat.”

Capitalism Equal Corporatism, #MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

I say “afloat” rather than “growing” because, since 2008, the total cumulative growth of the economy is just $3.5 trillion. In other words, for each dollar of economic growth since 2008, it required $12 of monetary stimulus. Such sounds okay until you realize it came solely from debt issuance.

Government Spending Has A Negative Multipler

Here is the problem. Excess “debt” has a zero to a negative multiplier effect. Such was shown in a study by the Mercatus Center at George Mason University by economists Jones and De Rugy.

“The multiplier looks at the return in economic output when the government spends a dollar. If the multiplier is above one, it means that government spending draws in the private sector and generates more private consumer spending, private investment, and exports to foreign countries. If the multiplier is below one, the government spending crowds out the private sector, hence reducing it all.

The evidence suggests that government purchases probably reduce the size of the private sector as they increase the size of the government sector. On net, incomes grow, but privately produced incomes shrink.”

Notably, politicians spend money based on political ideologies rather than sound economic policy. Therefore, the findings should not surprise you. However, the conclusion of the study is most telling.

“If you think that the Federal Reserve’s current monetary policy is reasonably competent, then you actually shouldn’t expect the fiscal boost from all that spending to be large. In fact, it could be close to zero.

This is, of course, all before taking future taxes into account. When economists like Robert Barro and Charles Redlick studied the multiplier, they found once you account for future taxes required to pay for the spending, the multiplier could be negative.”

Monetary policy, in its current form, is not helping the economy. As a result, the Federal Reserve has lost the ability to influence economic growth.

Bond yields, #MacroView: Bond Yields Send An Economic Warning

Conclusion

The Federal Reserve has no real options unless they are willing to allow the system to reset painfully.

Unfortunately, we now have a decade of experience of watching monetary experiments only succeed in creating a massive “wealth gap.” 

Most telling is the current economists’ inability to realize the problem is trying to “cure a debt problem with more debt.”

In conclusion, the Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40 years.

The reality is that monetary policy is not expansionary but rather contractionary. Unfortunately, deflation remains the most significant threat as permanent growth doesn’t come from an artificial stimulus or debt.

But such is a lesson that has yet to get learned.

Undermining Capitalism with Unreal Values and Crass Distortion

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Undermining Capitalism with Unreal Values and Crass Distortion

“Compared to What,” a classic jazz tune written in 1966, became famous in 1969 by Les McCann and Eddie Harris at the Montreux Jazz Festival. Over 200 artists made covers of the song. The song (LINK) is a protest about Vietnam, crime, and economic and social inequality.

Fifty years later, there is no Vietnam war to protest, but social and economic inequality is again front-page news.

After casually listening to the song, one line “Unreal values, Crass distortion” hit us over the head.  The quote would have been perfect for several articles we have written to describe the economy and markets.

Alas, those words also accurately describe the Fed’s role in redefining “capitalism,” the topic of this article. 

Don’t Blame Capitalism

It has become popular to blame capitalism for today’s economic inequality issues. We wholeheartedly disagree. The fault lies heavily in Washington DC for redefining capitalism.

Corporations own Capital Hill and the Oval Office. Their ability to fund elections ultimately allows them to pick our leaders. Candidates unwilling to take corporate money have little chance of winning elections. Once a politician is bought, the laws are mainly written to benefit corporations.

The nation is stumbling into an odd mixture of corporate socialism as a result. Companies flourish to the detriment of the people.

Just as corporations increasingly define the government’s fiscal role, the Federal Reserve increasingly dictates investment and speculative behaviors via monetary policy.

This article leaves political problems for another day and focuses on the Fed’s machinations and their harmful effects.

Wicksell Recap

The cost of money lies at the heart of free markets, and free markets are a core foundation of capitalism. The cost of money, or level of interest rates, is a primary factor in helping savers and borrowers determine the best uses of money. When interest rates appropriately reflect the economic growth rate, capital tends to gravitate toward its most productive uses. The more productive the economy, the more economic growth, and the better wealth is distributed to the entire population.

When the Fed interferes in the rates markets by setting interest rates and buying bonds, interest rates do not reflect the economy’s actual supply and demand for money.

In Wicksell’s Elegant Model, we wrote- “Per Wicksell, optimal policy should aim at keeping the natural rate and the market rate as closely aligned as possible to prevent misallocation. But when short-term market rates are below the natural rate, intelligent investors respond appropriately. They borrow heavily at the low rate and buy existing assets with somewhat predictable returns and shorter time horizons. Financial assets skyrocket in value while long-term, cash-flow driven investments with riskier prospects languish.

Simply, money tends to flow to non-productive uses when rates are too low. 

Bernanke Agrees with Wicksell

If you think Wicksell’s message is lost on the Fed, it’s not. They choose to ignore it.

Consider the following quote from Ben Bernanke.

“Paul Samuelson taught me in graduate school at MIT, if the real interest rate were expected to be negative indefinitely, almost any investment is profitable. For example, at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades.”

Said differently, non-productive, or even poor investments, have increasing value as rates decline, especially as they fall below zero.

We have shown on numerous occasions how the real rate, or yield, on U.S. Treasuries has been negative for the better part of the last decade. Over the last few months, the real rate for a wide assortment of risky loans turned negative. The incentive for corporations to level the Rocky Mountains has never been higher.

Fed Induced Distortion on Display

Over the last year and a half, the Fed has purchased nearly four trillion Treasury, mortgage, and corporate bonds. The reduction in the stock of investible bonds along with the Fed’s zero-rate interest rate policy has further warped interest rates for all types of lending. As Wicksell postulates, lower than normal interest rates are yielding a highly speculative environment. Productivity is languishing as a result.

The graph below highlights how Fed policy distorts corporate bond yields. Corporate junk bonds offer investors a means to earn an above-average yield, albeit by taking on inflation and default risk. As shown below, yields on BB and B-rated junk bonds are now below the inflation rate, and CCC-rated bonds are not far from it.

Even if we assume zero defaults, which is impossible for an index of junk-rated bonds, investors will still lose money on an inflation-adjusted (real) basis.

Over the last 25 years, on average, junk bond investors were paid a premium over inflation of 4.7%, 6.5%, and 12.3% for holding B-, BB-, and C-rated bonds, respectively. Such yields offset inflation and, typically, the risk of default. 

It’s not a leap to say interest rates are now well below their natural rate.

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

Summary

Society is paying a dear price for policies that most citizens have little understanding of. Forcing the price of money to absurdly low or even negative rates is slowly but constantly detracting from economic progress and ripping the social fabric of our nation. While there are many to blame, the Fed and their warped ideas around interest rates and economic growth should be among the first.

If only a famous musician today could stoke the public into action with a catchy song about the Fed’s role in dismantling capitalism.

Technically Speaking: Bubbles Are Evident After They Pop

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Bubbles are evident and only get acknowledged after they pop. Such is because, during the inflation phase of the market bubble, investors rationalize why “this time is different.” 

We have seen many examples of this rationalization over the last couple of years. Such as stocks are cheap based on economic growth, low-interest rates justify high valuations or the “moral hazard” of the “Fed put.” Other examples come from the analysis of stock prices, such as this tweet recently.

While the analysis is correct, average stock prices do not solely define a bubble.

Such is where we need to start.

What Is A Bubble?

According to Investopedia:

“A bubble is a market cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. Typically, what creates a bubble is a surge in asset prices driven by exuberant market behavior. During a bubble, assets typically trade at a price that greatly exceeds the asset’s intrinsic value. Rather, the price does not align with the fundamentals of the asset.

This definition is suitable for our discussion; there are three components of a “bubble.” The first two, price and valuation, as noted above, are get dismissed or rationalized during the inflation phase. That rationalization is due to investor psychology and the “Fear Of Missing Out (F.O.M.O.)

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

Everyone Sees Bubble, Technically Speaking: If Everyone Sees It, Is It Still A Bubble?

However, we are most interested in the “third” component of “bubbles,” which is investor psychology.

Charles Kindleberger noted that speculative manias typically commence with a “displacement” that excites speculative interest. Then, the speculation becomes reinforced by a “positive feedback” loop from rising prices.

Such ultimately induces “inexperienced investors” to enter the market. As the positive feedback loop continues and the “euphoria” increases, retail investors then begin to “leverage” their risk in the market as “rationality” weakens.

During the mania, speculation becomes more diffused and spreads to different asset classes. New companies come to market to take advantage of the euphoria, and investors leverage their gains using derivatives, stock loans, and leveraged instruments.

This activity also aligns with the historical cycle of market bubbles.

Evidence Of A Bubble

There are several psychological phases investors go through during a “full market cycle.” 

Near peaks of market cycles, investors become swept up by the underlying exuberance. That exuberance breeds the “rationalization” that “this time is different.” So how do you know the market is exuberant currently? In “Warning Signs,” we discussed the following graphic from Sentiment Trader.

“This type of market activity is an indication that markets have returned their ‘enthusiasm’ stage. Such is characterized by:

  • High optimism
  • Easy credit (too easy, with loose terms)
  • A rush of initial and secondary offerings
  • Risky stocks outperforming
  • Stretched valuations”
Warnings, Technically Speaking: Warnings From Behind The Curtain

Let’s run through that list.

Exuburance? Check.

Warnings, Technically Speaking: Warnings From Behind The Curtain

Easy Credit & Leverage? Check.

According to a recent survey from Magnify Money:

  • Many consumers have taken on debt to invest, with Gen Zers leading the charge. 40% of investors said they have taken on debt to invest, including 80% of Gen Zers, 60% of millennials, 28% of Gen Xers, and 9% of baby boomer investors.
  • Personal loans were the most popular choice among those who took on debt to invest, followed by borrowing from friends or family. 38% of those who went into debt to invest took out a personal loan, while 23% borrowed from friends or family.
  • When it comes to taking on debt to invest, many went big. Of those who took on debt to invest, nearly half (46%) borrowed $5,000 or more.

Rush Of Initial Or Secondary Offerings? Check.

Warnings, Technically Speaking: Warnings From Behind The Curtain

Investing In Risky Stocks? Check.

Stretched Valuations? Check.

Warnings, Technically Speaking: Warnings From Behind The Curtain

There is little doubt the psychology of a bubble is present. But does that mean the markets will “crash” immediately?

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Bubbles Last Until They Don’t

John Maynard Keynes once quipped the markets can remain irrational longer than you can remain solvent.

Such is the problem with trying to “time” a bubble, as they can last much longer than logic would predict. George Soros explained this well in his theory of reflexivity.

Financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, the markets are far from equilibrium conditions.

Every bubble has two components:

  1. An underlying trend that prevails in reality, and; 
  2. A misconception relating to that trend.

When positive feedback develops between the trend and the misconception, a boom-bust process gets set into motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception get reinforced. Eventually, market expectations become so far removed from reality that people get forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow, and more people lose faith, but the prevailing trend gets sustained by inertia.George Soros

In simplistic terms, Soros says that once the bubble inflates, it will remain inflated until some unexpected, exogenous event causes a reversal in the underlying psychology. That reversal then creates a reversion in psychology from “exuberance” to “fear.”

What will cause that reversion in psychology? No one knows.

However, the important lesson is that bubbles are entirely a function of “psychology.” The manifestation of that “bubble psychology” manifests itself in asset prices and valuations.

Conclusion

‘I have no idea whether the stock market is actually forming a bubble that’s about to break. But I do know many bulls are fooling themselves thinking a bubble can’t happen when there is widespread concern. In fact, one of the distinguishing characteristics of a bubble is just that.” – Mark Hulbert

Whether you agree a bubble exists is largely irrelevant. Every investor approaches investing differently.

However, if you’re nearing or are a retiree, your investment horizon is shorter than those much younger. Therefore, given you are less able to recover from the deflation of a market bubble, it may be wise to consider the possibility.

So, what can you do to navigate the bubble?

  • Avoid the “herd mentality” of paying increasingly higher prices without sound reasoning.
  • Do your own research and avoid “confirmation bias.” 
  • Develop a sound long-term investment strategy that includes “risk management” protocals.
  • Diversify your portfolio allocation model to include “safer assets.”
  • Control your “greed” and resist the temptation to “get rich quick” in speculative investments.
  • Resist getting caught up in “what could have been” or “anchoring” to a past value. Such leads to emotional mistakes. 
  • Realize that price inflation does not last forever. The larger the deviation from the mean, the greater the eventual reversion will be. Invest accordingly. 

The increase in speculative risks, combined with excess leverage, leaves the market vulnerable to a sizable correction. But, unfortunately, the only missing ingredient is the catalyst that brings “fear” into an overly complacent marketplace.  

Currently, investors believe “this time IS different.” 

“This time” is different only because the variables are different. The variables always are, but outcomes are always the same.

When the bubble pops, the media will tell you “no one could have seen it coming.”

Of course, hindsight isn’t very useful in protecting your capital.

Viking Analytics: Weekly Gamma Band Update 7/12/2021

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

Gamma Band Update

The S&P 500 (SPX) had two days of weakness yet rallied again on Friday to close the week at yet another all-time closing high. The Gamma Band model[1] attempts to summarize the impact that options trading can have on volatility in the SPX. When the daily price closes below “Gamma Flip” level (currently near 4,305), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below the lower gamma level (currently near 4,120), the model will reduce the SPX allocation to zero.

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

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a free sample report). With stocks continuing to extend historically high valuations, risk management tools are more important than ever to manage the next drawdown, whenever it may come.

Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. 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.


Infrastructure Spending Could Be Good, But It Won’t Be.

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Infrastructure spending can be economically beneficial. But, unfortunately, the type of “spending” the Democrats are proposing will not be.

We must begin our discussion with the textbook definition of “infrastructure.”

“Infrastructure is the general term for the basic physical systems of a business, region, or nation. Examples of infrastructure include transportation systems, communication networks, sewage, water, and electric systems. These systems tend to be capital intensive and high-cost investments, and are vital to a country’s economic development and prosperity.” – Investopedia

Now, we must break that definition down into its most essential points:

  • Basic Physical Systems
  • Transportation, Communication, Sewage, Water, and Electric
  • Capital Intensive
  • High-Cost Investments

The fourth point is the most important – “investments.”

So, what is the definition of “investment.”

“An investment is an asset or item acquired with the goal of generating income or appreciation.” – Investopedia

Therefore, a good definition of infrastructure is:

“An investment into the basic physical systems of the nation with the goal of generating income to pay for the capital intensive expenditure”.

Biden’s “Big Money” Infrastructure Plan

There is considerable debate in Washington over the full “infrastructure” spending plan. As shown in the chart below, the original proposal contains just 25% that could get classified as “infrastructure.” The other 75% increases the social welfare net.

As Fortune recently lamented:

“Like all humongous-scale legislative efforts, the Biden administration’s new $2.2 trillion infrastructure plan contains surprises—unrelated provisions that are hitching a ride on a juggernaut. In this case, they’re not like barnacles on a giant ship. Some of these surprises are surprisingly large.”

At the moment, there is a smaller bipartisan infrastructure bill in the works. However, Democrats are looking to use the “reconciliation” process to pass the full “social spending plan” noted above.

“The Senate may work into its August recess to pass both a bipartisan infrastructure plan and a budget resolution that would allow Democrats to enact a range of priorities without Republican support, Senate Majority Leader Chuck Schumer said Friday.

In a letter to his caucus, the New York Democrat said senators are working with the White House to turn the $1.2 trillion infrastructure framework into legislation. The Senate Budget Committee is also crafting a measure that would allow Democrats to pass a sprawling child-care, health-care and climate policy plan without a GOP vote.” – CNBC

Regardless of which bill passes, our focus is on “infrastructure” spending in general.

Debt & More Debt

As the Cato Institute noted concerning the original bill.

It moves entirely in the wrong direction by increasing subsidies and centralizing power. A better approach would be to end federal subsidies and decentralize infrastructure ownership and decisionmaking.”

However, one of the essential points overlooked by both the Heritage Foundation and the Cato Institute is the entire plan must get funded by a further expansion of debt.

Let’s revisit our definition of “infrastructure.”

Since the onset of the pandemic-driven economic shutdown, the Government has intervened with a massive expansion of debt. The hope was the increase in debt would keep the economy from slipping into a deeper economic recession.

However, debt was already rising sharply since President Obama took office in 2009. The irony is that the continued expansion of government interventions did not lead to organic economic growth. On the contrary, the more the debt increased, the more debt it took to sustain weak economic growth rates.

Debt Versus Growth

As stated above, since we must use debt to fund “infrastructure” spending, the debt must pay for itself. In other words, every project must generate a stream of cash flows through fees, taxes or duties, to repay the debt-funded capital investment over time.

Dr. Brock is an economist who holds 5-degrees in Math and Economics, and the author of “American Gridlock” explained this well using the following example of two countries.

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

Country B spends $4 Trillion and receives $3 Trillion income. However, the $1 Trillion of excess, which got financed by debt, gets invested into projects, infrastructure, that produces a positive rate of return. Therefore, there is no deficit as the rate of return on the investment funds the “deficit” over time.

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

Social Welfare Is Not Infrastructure

For debt-funded government spending to be effective, the “payback” from investments made with debt must yield a higher rate of return than the debt used to fund it. While Biden’s plan has a hint of investment, it is primarily social welfare.

As noted by Dr. Brock, government spending has shifted away from productive investments, like the Hoover Dam, that creates jobs (infrastructure and development) to primarily social welfare and debt service, which has a negative rate of return.

As shown in “Biden’s Stimulus Won’t Solve Poverty:”

“According to the Center On Budget & Policy Priorities, in 2020, roughly 75% of every tax dollar went to non-productive spending.

‘In the fiscal year 2019, the Federal Government spent $4.4 trillion, amounting to 21 percent of the nation’s gross domestic product (GDP). Of that $4.4 trillion, federal revenues financed only $3.5 trillion. The remaining $984 billion came from debt issuance. As the chart below shows, three major areas of spending make up most of the budget.'”

Biden Stimulus Poverty, Biden’s Stimulus Will Cut Poverty By 40% – For One Year.

“Think about that for a minute. In 2019, 75% of all expenditures went to social welfare and interest on the debt. Those payments required $3.3 Trillion of the $3.5 Trillion (or 95%) of the total revenue collected.

Given the decline in economic activity during 2020, those numbers become markedly worse. As a result, for the first time in U.S. history, the Government will issue debt to cover mandatory spending.”

As Dr. Brock noted above, the U.S. is now “Country A.” 

“Today we are borrowing our children’s future with debt. We are witnessing the ‘hosing’ of the young.’” – Dr. Brock

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

Infrastructure Won’t Grow The Economy

While the Biden Administration promises the “infrastructure” plan will create jobs and grow the economy, it most likely won’t.

As noted by the Mises Institute:

“There is a fallacy that government spending, on infrastructure or anything else, creates jobs or economic growth in the aggregate. Murray Rothbard addressed the issue in great detail in his article ‘The Fallacy of the Public Sector.’’ In summary, there is no such thing as the Infrastructure Fairy that takes government spending and magically turns it into economic growth.”

As the Mises Institute points out, Government spending is ultimately a “zero-sum” game given the money gets borrowed and, eventually, gets repaid through the collection of taxes.

“The money spent on infrastructure must get borrowed, taxed, or printed (a tax not called a tax) out of the non-government economy. One minus one equals zero. That’s not conservative economics or liberal economics. It’s not Democrat economics or Republican economics. It’s just economics.”

As shown, there is no evidence that more money borrowed and spent by the Government will lead to more robust economic growth rates or prosperity.

A Major Diversion

The biggest problem with the proposed “infrastructure” spending is that it diverts jobs and investment away from the private sector.

“The Tax Foundation found that Biden’s proposed tax increases would reduce private investment by more than $1 trillion. In addition, Biden’s proposed green and labor union regulations would further undermine infrastructure investment.

Corporations are already investing in activities favored by the Biden administration, such as electric vehicles, renewable energy, and broadband. Rather than subsidizing, Biden should reduce regulatory barriers to infrastructure investment and cut corporate taxes to increase investment incentives.

If we dig deeper into the realities behind government spending, however, we can see that an ‘infrastructure stimulus program’ would probably make matters worse than they are. After all, private investment is made with the goal of producing something that consumers want to buy, at a price that will generate a profit. These activities, if successful, would enable continued reinvestment in the same enterprise, and continued employment of the individuals therein.” – Cato Institute

The government, via taxation, produces something that the consumers have not already chosen to buy. If they were already producing and buying such things, no government intervention is “necessary.” 

Not A “New New Deal”

While the media is quick to fawn on Biden’s stimulus plan, claiming it to be the 2nd coming of FDR, it isn’t.

FDR’s “New Deal” did have many “social programs” embedded in it, including the beginning of the social welfare safety net. However, FDR backed those social programs with massive works projects from the Hoover Dam’s building to the Tennesse River Valley Authority. Not only did the spending on these projects create jobs, but they were also productive investments repaying the debt used to fund them.

Ultimately, spending on infrastructure no more “creates wealth” than any other kind of government spending. Like all government spending, it’s taking money from some people to give to others. The money taken from the taxpayers must get subtracted from the money spent, leaving no net gain. Of course, after the politicians and the government contractors take their cut, they’ll do pretty well. The rest of us won’t be so lucky.

The Real Solution

The honest answer is to allow the private sector to do what it does best: efficiently allocate capital for profitable outcomes.

We would get a real revolution in infrastructure by adopting reforms from abroad to privatize passenger rail, airports, seaports, air traffic control, water systems, and other facilities. There is no need to subsidize infrastructure if it can be moved out of the government and supported by user fees. Rather than spending $2 trillion, we should privatize infrastructure where feasible and cut taxes and regulations on the rest.” – Cato Institute

There is one easy definition for “infrastructure” that politicians should adopt – if it requires a tax credit or incentive to encourage people to use it, it isn’t infrastructure. But this is the long and unprofitable history of the government selecting winners and losers in the economy. If there is a product, service, or need, the private sector will figure out how to produce it profitability. If it isn’t viable, it will die a natural death. That is the “Darwinian” nature of capitalism.

But this is a lesson dismissed by politicians who are more worried about winning the next election than creating economic prosperity for all.

Yields Plunge. Dollar Surges. The Reflation Trade Unravels.

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In this 07-09-21 issue of “Yields Plunge Dollar Surges The Reflation Trade Unravels.

  • Market Pulls Back As Signals Turn
  • Yield Plunge, Dollar Surge
  • The Reflation Trade Unravels
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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


Are you worried about the potential for a market correction, a surge in inflation, or are you unsure how to invest for your retirement? We can help. If you are not yet a client and would like to discuss your portfolio construction, please schedule a time to meet with one of our advisors below.

Q2 Peak Reporting 07-02-21, As Good As It Gets. Will Q2 Mark Peak Reporting? 07-02-21


Market Stumbles But Rallies Back

Last week, we discussed the market hit new highs with the index getting back to more extended and overbought conditions. To wit:

“The technical backdrop is not great. With the market back to 2-standard deviations above the 50-dma, conviction weak, and investors extremely bullish, the market remains set up for additional weakness.

However, we are in the first two weeks of July, which tends to be bullishly biased. After increasing our equity exposure previously, we will give the market the benefit of seasonality for now.”

While market volatility did pick up this past week, the index held its breakout support levels and closed at a new high. Such keeps the bullish bias intact. However, as shown, the money flow signals are now back to more elevated levels, which will provide resistance to higher prices short term. 

We are still within the seasonally strong period of July, which tends to last through mid-month. However, August and September are typically more challenging for returns. As we stated last week:

“The bulls are indeed in charge of the markets currently, but the clock is ticking.”

The market is also weak from a breadth perspective. While large-cap stocks have done better as of late, the rest of the markets have not. I discuss this in more detail in Friday’s 3-minutes video.

The critical point, as noted in the video, is there has been a definite rotation out of the “reflation trade” (small, mid, emerging, and international markets) into the large-cap names (primarily technology), which is the “deflation trade.”

As we will discuss, the reflation trade ran well ahead of reality. Over the next couple of months, the test will be to see if earnings can support the surge in prices and valuations.

Yields Overbought

We will discuss the “yield warning” momentarily. However, in the short term, yields have gotten very overbought. We suspect we could see a retracement in yields short-term, but such will likely be an opportunity to increase bond exposure in portfolios as we head further into the year. 

As shown, previous overbought conditions (indicators get inverted concerning yields) lead to retracements to resistance. Currently, a retracement to 1.5% would be likely. Ultimately, a break below 1.25% will suggest much lower yields are coming. 

From a positioning standpoint, we increased our bond duration several weeks ago. However, while we want to increase our exposure eventually, we need to wait for the short-term overbought condition to reverse. 

Longer-term, as we will discuss next, we believe yields are potentially headed lower as economic growth and inflationary pressures wane.


Yield Plunge, Dollar Surge

In our #MacroView this week, we discuss the warning sign that yields are sending in more detail. However, importantly, the plunge in yields is suggestive that something in the market is becoming strained. As discussed in that article, when interest rise, and peak, such has corresponded with more negative market outcomes.

Is the current rise in rates signifying the next market downturn? Historically, sharp spikes in rates have done so by slowing economic growth more than expected. However, as we noted previously in our Commitment Of Traders report:

“The number of contracts net-long the 10-year Treasury already suggests the recent uptick in rates, while barely noticeable, maybe near its peak.”

Stage Set Volatility, Technically Speaking: COT Report Shows Stage Set For Volatility

Some of the pressure in bonds has come from the market bracing itself for some large auctions of new bonds next week. A lot of the action on Friday was the shift in focus to next week’s auctions. On Monday, there will be $38 billion in 10-year notes and $24 billion in 30-year bonds on Tuesday.

However, as noted by Zerohedge on Friday:

“But those who are betting on a continued rise in yields may get disappointed for one key technical reason. As Morgan Stanley’s derivatives strategist Chris Metli notes, CTAs – those mindless trend-followers who just ride on momentum waves until they crash, are still short bonds and at current yields have to buy $95bn notional of TY-equivalent duration over the next week.

As Morgan Stanley notes such ‘could continue the bond rally and put pressure on stocks as equity investors fear the bond market knows something they don’t about future growth prospects.'”

The dollar is also confirming the same.


In Case You Missed It


The Dollar Is Confirming The Same

We specifically noted that the dollar was about to rise sharply. To wit:

The one thing that always trips the market is what no one is paying attention to. For me, that risk lies with the US Dollar. As noted previously, everyone expects the dollar to continue to decline, and the falling dollar has been the tailwind for the emerging market, commodity, and equity risk-on trade. So, whatever causes the dollar to reverse will likely bring the equity market down with it.”

While the dollar rally is still young, there was a successful test of the “double bottom” with higher lows. The break above the 50- and 200-dma also suggests the rally is just getting started. A further rally in the dollar will get fueled by additional short-covering.

Stage Set Volatility, Technically Speaking: COT Report Shows Stage Set For Volatility

There is a significant difference between a “recovery” and an “expansion.” One is durable and sustainable; the other is not.

Dollar & Rates Are Warning Signs

Those expecting a significant surge in inflation will likely be disappointed for the one reason which seems to get mostly overlooked.

“If the economy were growing organically, which would create stronger rates of wage growth and inflation, then there would be no need for zero interest rates, continued monetary interventions by the Federal Reserve, or deficit spending from the Government.”

The obvious problem is that not all “spending” is equal. Pulling forward consumption through stimulus is indeed short-term inflationary but long-term deflationary. Moreover, since 1980, there has been a shift in the economy’s fiscal makeup from productive to non-productive investment. 

As we have pointed out previously, you can not overstate the impact of psychology on an economy’s shift to “deflation.” When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers change their primary orientation from expansion to conservation.

  • Creditors become more conservative and slow their lending.
  • Potential debtors become more conservative and borrow less or not at all.
  • Investors get increasingly conservative, and they commit less money to debt investments.
  • Producers become more conservative and reduce expansion plans.
  • Consumers become more conservative, and save more, and spend less.

As we have been witnessing since the turn of the century, these behaviors reduce the velocity of money. Consequently, the decline in velocity puts downward pressure on prices. Moreover, given the massive increases in debt and deficits, the deflationary drag increases as the stimulus fades from the system.

Likely, the dollar and rates already figured this out.

The Reflation Trade Unravels

The importance of this analysis relates to a potential change in investor positioning in the market. To wit:

“The unraveling of the inflation/reflation trade has accelerated over the past week. US 10y bond yields continue to decline and have now broken a crucial technical level. Such could see the rally accelerate sharply, and with it, the continued unraveling of both cyclicals and commodities.” – Albert Edwards

Albert’s comment aligns with our views previously that such would likely be the case.

I believe that the pandemic recession allowed policymakers to cross the Rubicon of fiscal rectitude. They have reached a new land where existing monetary profligacy can now get coupled with fiscal debauchery.

In that respect, I am very much in the inflation/reflation camp. But I think it is a secular theme that will play out later in this cycle. The problem is the markets have been too early in betting on the reflation trade and have gotten set up for a huge disappointment.”

We have previously discussed the change in the deflationary credit impulse. But, importantly, the bond and dollar markets are now reflecting that deflation.

Does such mean the markets will crash tomorrow? No.

What is critical to recognize is that the market is well ahead of what reality will turn out to be. As such, when overly exuberant earnings and economic growth expectations fade, the justification supporting overpaying for assets will run into trouble.

https://riapro.net/home

Portfolio Update

There is something “not quite right” with the market currently. As discussed previously, the problem with technical indicators is that they do not distinguish between a consolidation, a correction, or more. Therefore, we have to pay attention to warnings, much the same as driving a car.

A yield sign is a warning. We have a choice to blow through yields signs and may get away with it 100 times. However, the 101st time leads to a devastating crash. In the markets, the warning signs suggest reducing our “speed” in the portfolio slightly, watching for risk, and then returning to speed once the danger has passed. 

After increasing our bond duration in portfolios to hedge risk, we removed our index trading positions this past week and lowered our equity exposure to hedge risk further. (We slowed down.)

With our money flow “sell signals” approaching high levels, taking some action could be beneficial. 

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

Minor adjustments can make significant differences to outcomes when you can avoid “the wreck.”

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” are oversold. The current reading is 91.91 out of a possible 100.


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.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 84.20 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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.
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four 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

Fundamental Growth Screen

Aggressive Growth Strategy


Portfolio / Client Update

With our money flow signals returning to peaks, which typically precede a pickup in volatility, we took the opportunity to reduce our index trading positions. That action raised our cash levels by 5% to provide a bit more of a cash cushion for now.

As discussed in the main body of this week’s newsletter, one of the more significant concerns is the sharp drop in yields over the last two weeks. Such suggests there is a problem brewing somewhere in the market. While that problem isn’t evident at the moment, such doesn’t mean it doesn’t exist.

We are monitoring the markets closely. If our signals do get triggered, we will take further action to reduce risk exposures accordingly. In addition, we are watching all of our positions for violations of support or a change in fundamental underpinnings. At the current time, there are no “red flags,” but if things change, we will change as well.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“Given the plunge in yields, there is something not “quite right” with the market. We are taking our DIA trading position off for now at a minimal loss to reduce our overall equity exposure. If the current sell-off begins to gain some traction, we will take further risk reduction actions” – 07/08/21

Equity & ETF Model

  • Sell 100% of DIA

“In the equity model, we sold NXPI as it performed poorly versus the tech sector and its weakening from a technical perspective. As we discussed this morning the tech sector is overbought as well. In the sector model, we reduced XLY and XLV by 1% each to reduce exposure to overweight sectors that are overbought.” – 07/09/21

Equity Model

  • Sell 100% of NXPI

ETF Model

  • Reduce XLY by 1% of the portfolio.
  • Reduce XLV by 1% of the portfolio

As always, our short-term concern remains the protection of your portfolio. Accordingly, we have shifted our focus from the election back to the economic recovery and where we go from here.

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.


401k Model Performance Analysis

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 Model Performance Analysis

Have a great week!

Technical Value Scorecard Report For The Week of 7-09-21

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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 will find more detail on the model and the specific tickers below the charts.

Commentary 7-09-21

  • The first set of relative value charts show technology, discretionary and healthcare are leading the market charge higher almost singlehandedly. Real estate, communications, and financials are at fair value and the remaining six sectors are decently oversold. This condition is in line with a few charts and words we posted in the dashboard and weekly newsletter describing our concern about the poor breadth of the market despite a string of all-time highs.
  • Energy, finally broke down into oversold territory after having a positive relative score since April. The sector gave up 4.73% versus the S&P over the last week. It appears to be catching down to the other inflationary stocks that have recently performed poorly versus the market.
  • The factor/index relative graphs also tell a story of bad market breadth. Technology is slightly overbought while every other factor/index is decently oversold. Of note, emerging and developing markets are strongly oversold versus the S&P 500. Over the last 20 days emerging markets underperformed the S&P 500 by 6.35 and developed foreign markets by 4.98%. On a relative basis, we might see these sectors outperform, especially if the recent deflationary bias eases. Higher bond yields would signal such a circumstance.
  • On the relative fixed income graphs, TLT (long duration USTs) is the most overbought sector versus (IEI 5-7 yr UST) while the inflationary sectors (TIPs and our inflation index) along with mortgages are the most oversold. Mortgages are trading weaker due to market concerns the Fed will begin to taper MBS purchases shortly.
  • The scatter plot shows a very high confidence score (.8041) meaning the scores are accurately portraying their relative performance.
  • 7 of the 12 sectors are trading below their 50 dmas despite the market hitting a record high on Wednesday. All sectors remain above their 200 dmas.
  • The divergence of the underlying sectors is also seen in the absolute series of graphs. Technology, Realestate, Healthcare, and Discretionary are decently overbought. Transports (XTN) are the most oversold sector but not to a degree that might signal a reversal.
  • Despite Thursday’s decline, the S&P 500 (bottom right graph in the absolute charts) remains decently overbought. As we noted earlier, foreign markets are oversold on an absolute basis but like transports, not to a degree that might signal an imminent reversal.
  • The third graph shows the excess returns by sector for four different time frames. The poor breadth is clearly evident.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis 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. At times 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 one of many tools we use to manage our portfolios. 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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Bond Yields Send An Economic Warning

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Bond yields are sending an economic warning as this past week 10-year Treasury yields dropped back to 1.3%.  With the simultaneous surge in the dollar, there is rising evidence the economic “reflation” trade is geting unwound.

Such is despite overly exuberant expectations of strong economic growth by the mainstream media. As we suggested in 2019, bonds generally have the outlook correct more often than stocks.

Such is not surprising as the long-term correlation between economic growth and rates remains high.

We remain in the camp that, due to the rising debt and deficits, rates must remain low. However, given most people don’t understand bonds, we will recap our previous analysis. 

, Stocks Vs. Bonds: Why We Own Them & You Should Too

If you don’t understand what bonds are and what they can do for your portfolio, you may be missing out on something really big. And not just if you’re a retiree either.

Why Bonds Correlate To Economic Growth & Inflation

As stated in “bonds are not overvalued:”

“Unlike stocks, bonds have a finite value. At maturity, the principal gets returned to the “lender” along with the final interest payment. Therefore, bond buyers are very aware of the price they pay today for the return they will get tomorrow. As opposed to an equity buyer taking on ‘investment risk,’ a bond buyer is ‘loaning’ money to another entity for a specific period. Therefore, the ‘interest rate’ takes into account several substantial ‘risks:’

  • Default risk
  • Rate risk
  • Inflation risk
  • Opportunity risk
  • Economic growth risk

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.)

As noted, since bonds are loans to borrowers, the interest rate of a bond is tied to the prevailing rate environment at the time of issuance. (For this discussion, we are using the 10-year Treasury rate often referred to as the ‘risk-free’ rate.)”

There are some caveats to this analysis related to the secondary market, which we cover in the linked article.

However, the critical point is that bond buyers compensate for both what the market will pay in terms of interest rates, but also ensure they get paid for the various risks they take.

Yields Vs. Economic Growth

Given that analysis, it should not be surprising that interest rates reflect three primary economic factors: economic growth, wage growth, and inflation. But, again, the relationship is not unexpected as the “rate” for lending money must account for varoius risks.

We created a composite of the three underlying measures to get a more direct relationship. For example, the chart below combines inflation, wages, and economic growth into a single composite and compares it to the 10-year Treasury rate.

Again, the correlation should not be surprising given rates must adjust for future impacts on capital.

  • Equity investors expect that as economic growth and inflationary pressures increase, the value of their invested capital will increase to compensate for higher costs.
  • Bond investors have a fixed rate of return. Therefore, the fixed return rate is tied to forward expectations. Otherwise, capital is damaged due to inflation and lost opportunity costs. 

As shown, the correlation between rates and the economic composite suggests that current expectations of sustained economic expansion and rising inflation are overly optimistic. At current rates, economic growth will likely very quickly return to sub-2% growth by 2022.

The disappointment of economic growth is also a function of the surging debt and deficit levels discussed previously.

Bonds Are Sending A Warning

The differential between yields also confirm our concerns that expectations for economic growth and inflation are overly optimistic. The yield curve continues to flatten over the last few months as opposed to steepening with strong economic expectations.

(Importantly, a flattening yield curve only suggests growth and inflation will be weaker than expected. However, an inverted yield curve is what will predict the next bear market and recession.)

If yields are correct, then investors should be heeding its warning as lower yields will translate into slower earnings growth. In “Warning Signs,” we discussed the more extreme detachment of stocks from the underlying economy.

“The market is currently trading more than twice what the economy can generate in revenue growth for companies. (There is a long-term correlation between the rate of economic growth and earnings.)”

Warnings, Technically Speaking: Warnings From Behind The Curtain

Investors currently “hope” that earnings will catch up with the price of the market. Such would reduce the valuation problem. However, while such is certainly possible, it has never previously happened in history.

Yields are suggesting this time will not be different.

Why We Own Bonds

As we often discuss in our weekly newsletter (subscribe for free,) we continue to opportunistic bond buyers to hedge against risk.

There is little doubt the market is currently in “risk-on” mode as investors throw “caution to wind” due to the Fed’s ongoing interventions. But, for now, that “psychology” works well.

However, when that psychology changes, for whatever reason, the rotation from “risk-on” to “risk-off” will find Treasury bonds as a “store of safety.” Historically, such is always the case during crisis events in markets.

For most investors, it was a mistake to discount the advantage of owning bonds over the last 20 years. By reducing volatility and drawdowns, investors could withstand the storms that wiped out large chunks of capital.

With stocks again grossly overvalued, a significant drawdown is probable in the coming years.

Over the next decade, the prospect of low stock market returns, possibly approaching zero, seems much less appealing than the positive return offered by a risk-free asset.

Given that we are in the most extended bull market cycle in history, combined with high valuations and weakening fundamentals, it might be time to pay more attention to what bonds can offer you.

Bonds are sending a warning once again.

Disregarding the warning has historically been costly.

3-Steps To Increase 401k Plan Employee Engagement

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As a business owner, there are 3-steps to increase 401k plan employee engagement.

I get it! The last thing that most employees want to do is talk about retirement. It seems so far into the future that it does not connect with their current priorities. It is also frustrating that you spend so much time managing something not taken advantage of by the people it means to serve.

Again…I get it!

Here are three simple steps to increase engagement amongst your staff:

Connect to Their Current Situation:

Retirement is such an exoteric concept, and most people underestimate what their needs will be in the future. $500,000 sounds like a lot of money. But what if I told you that a $500,000 account balance would safely support a $25,000 per year income replacement? Holy cow! It changes people’s perceptions.

An alternative approach to increase employee engagement is to show them what their current 401(k) balance means in terms of a bi-weekly or monthly paycheck. That is how most people think of their current income anyway. We all get the notification from our bank that a deposit of $XX has hit our bank account. What if we did the same on our monthly or quarterly 401(k) statements as well as action steps to get them back on the right track?

Such can get done with different service providers in the industry. Therefore, we will see more and more of this type of communication with participants in the future.

Dedicate a Day to Corporate Wellness:

Unlocking the productivity of your workforce is an art. That is why we spend money on human resources and develop strategies that evolve around performance, workplace culture, and overall wellness. By having healthy employees, both mentally & physically, you can increase their productivity by increasing their focus on their jobs.

One solution is devoting a day to speaking to the needs of your workforce outside of their day-to-day duties. Not only will it show you as being a dedicated employer that cares about the well-being of their employees, but it will also build camaraderie amongst your leadership and those they are supposed to lead to move your company’s mission forward. Making it a part of your culture will make it become a habit for your employees.

Such can include healthy activities like exercise, stress management, team building, and financial fitness. In addition, many different specialists can come in and address the needs of your workforce.

Revisit Your Company’s 401(k) Plan Design

Successful employee participation is a delicate balance between incentivizing and “nudging,” a term popular by University of Chicago behavioral economist Richard Thaler.

The best incentive employers have to increase participation is to offer a company match. Industry-standard is a matching between 4-6% of employee compensation. When you are in the middle of budget planning, you can incorporate the matching contribution as part of labor. The good news is that you can also attach a vesting schedule out to 6 years on all matching contributions, which can help you save money over time.

You can also look into “automatic features” like automatic enrollment and automatic escalation. Such is the “nudge” I was referring to earlier. By building enrollment into your employee onboarding process, your workforce can start saving immediately and set the expectation that financial wellness and retirement planning are a priority of your company.

The only caveat I will mention with “automatic features” is that it IS NOT as automatic as it gets pitched. Certain service providers do a better job at helping the plan administrator at the employer manage the automatic enrollment and escalation process, but most will not. That means that you must have great internal controls in place to make sure you are managing, tracking, and enrolling participants on time. In addition, there could be penalties associated with having certain participants fall through the cracks, so make sure you know how your service provider can assist and what processes you need to have in place.

Need Assistance?

If you seek assistance from an independent fiduciary plan advisor, you can always schedule a free consultation by calling 855-RIA-PLAN. We are more than happy to discuss options to help get you and your plan on the right track.

If you are interested in a no-obligation assessment of your company’s 401(k) plan and how RIA Advisors can help you level up, feel free to contact me directly.

Three Money Lessons From George Washington.

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Three money lessons from George Washington? Seriously?

Well, who better to inspire us to keep Fourth of July in our thoughts all month long? I decided to revisit the fortuitous saga of Washington, a solid reminder of the blood spilled and sacrifices made to form our nation.

Naturally, I turn everything into a money lesson!

Long ago, a boy yearned to be a British officer. Instead, while other children were at play, doing what children do, Washington gravitated to the rigorous study of famous battles. Studying was recreation to him.

He lived the victories and defeats.  With extraordinary precision, a young George envisioned and documented battle strategies he would have taken to turn the tide and win losing engagements.

Washington possessed an indomitable fire fed by love for his home country. In his view, Britain was an honorable, unstoppable world force. Early on in childhood, the plan was to be an English patriot: He was ready, perhaps even anxious, to fight and die for king and country.

What changed Washington’s mind? What turned him?

So, what series of events occurred that drenched a searing heat of unstoppable love, dedication, and passion for a home country into the ice of disappointment? How did a boy and young man eager to die for king and country turn and become the father of a free nation?

 

This is the fiber of memorable films!

How does a passionate believer morph into a combatant against his first and greatest love? What does that do to a person inside? Did Washington mourn? Resolve his inner conflicts? I have so many questions. The man’s love turned into hate, eventually dispassion, and he was motivated to fight against a country he perceived as an oppressor of people he loved. The inner turbulence is the stuff of great moviemaking!

Virginians were recruited first. Then the movement grew to a scraggy mess of compatriots. They were the Americans who took on the fight to slay a beast 100x the size. The recruits sacrificed all to keep the cause alive until the French arrived.

Listen, I couldn’t create a fictional drama character or develop a protagonist for a full-length feature film as perfect as the circumstances which forged Mr. Washington’s dramatic need.

A change of heart so striking, men with less resolve would have folded or disappeared into private life, never to be heard from again. Washington did indeed do just that for a period. Then, at 27, he retired from military service to Mount Vernon to become an innovator at agricultural techniques founded by farming expert Jethro Tull.

What was Washington’s motivation?

He was a man who believed a false truth about England. Subsequently, he encountered a series of adverse circumstances (some emotionally devastating), continually confronting and breaking down his beliefs. Concurrently, an alternate view began to stir. This man didn’t want to admit the truth at first and denies it until that one, last devastating personal setback. So Washington retrenches, only to emerge different, beholden by a new truth.

Admittedly, this is the formula for every great fictional protagonist ever created. John Wick, Maximus from Gladiator, Benjamin Martin in The Patriot (still one of my favorite movies!). Every fictional story is, in some part, another’s reality. I’m sure we all know people who have overcome obstacles that would have broken others.

Speaking of fiction:

The stock market is great fiction. Prices of stocks are based on stories and those who get sucked into them. Supply and demand of stories, possibilities, hopes. Some homework but today mostly fiction.

So, how and why did Washington change so radically? What can we learn from his experiences?

Washington understood the value of retreat, recovery and resiliency. 

The strategist in him embraced retreat. George Washington avoided major engagements until he felt the opportunity was right. On occasion, it was never right, and he needed to re-group and find an alternative plan to victory. There was no ego in the decision-making. It was all about the ultimate victory. Self-preservation and those of his men were paramount. Live to fight another day. Ostensibly, small victories, consistent flanking attacks forged morale for a ragtag army that at times didn’t even possess shoes.

Britain scorned Washington numerous times, turning him down for major battles. A tremendous disappointment.

In 1754, British leaders galvanized against Washington. At the Forks of Ohio not far from Fort Duquesne (occupied by the French), Washington, an officer in the British Army along with men, marched through the mountainous and dangerous terrain of Maryland and Pennsylvania and met up with a band of Iroquois to confront a French party of 35 men, fifty-five miles from the Forks.

Washington suffers a big setback.

What Washington perceived as his contribution to the first battle between two of Europe’s greatest empires turned out to be an eventual well-publicized massacre of diplomatic messengers. One of the messengers named Jumonville was carrying a letter which was to be delivered to English authorities declaring Ohio Country as French territory. Instead, he was the first to be slaughtered by the Iroquois.

The attack was particularly gruesome and later didn’t write well in periodicals back in the home country, especially due to the brutality of the Indians who split open French scalps with tomahawks and rinsed their hands in victims’ brains.

As Russell Shorto wrote in his impressive tome – Revolution Song, – “The event, the series of fateful missteps by an inexperienced provincial officer, whose signatures carried the official weight of the British Empire, meant that for the first time an event in North America would trigger a war in Europe.”

Back to the battle: It was only a matter of time before more than 1,000 French soldiers back at the Fork would know of the combat and seek to attack. Washington retreated with 400 men to a wide meadow and built a makeshift fort in the middle of it to await the next encounter.

The French militia head-up ironically by the brother of Jumonville, passed through the gruesome massacre, now even more motivated to confront Washington and his men. With a swift and diligent attack, the French took positions behind trees, rocks and precisely began to pick off Washington’s group. They killed more than 100, forcing Washington’s hand to surrender. 

Military protocol at the time required George Washington to surrender in writing. The French drafted a document. Washington signed it.

What the father of our country didn’t understand was that he was placing his name on a document that referenced the “assassination” of Jumonville. Washington believed the document referenced the death of the French leader, not an assassination. Unfortunately, it was probably due to the lack of skills by a novice interpreter. No matter. Washington signed a document of admission to the assassination, which made the battle even more repulsive to the British.

To make matters worse (can you imagine?), a letter Washington wrote to his brother bragging about the encounter, referencing how the whistle of bullets to be a “charming sound,” was exposed and published in London Magazine.

A prominent writer portrayed Washington as foolish and the consequences dire – “The volley fired by a young Virginian in the backwoods of America set the world on fire.”

I’m not sure about you, but this series of events would have convinced me to leave the military and never be seen or heard from again. And Washington did indeed do so. For a bit. He went straight to the earth and pondered a new life as a gentleman farmer. He learned to grow tobacco on a commercial scale. A voracious reader, Washington grew to be a student of several heady topics, including the law.

So, how do we take in what Washington experienced, how he reacted and reinvented? Obviously, he was a Stoic in the making—also, a student of the German philosopher Nietzsche without knowing, either.

It was just who he was.

Nietzsche described human greatness as:

“Amor Fati or love of fate. Don’t bear what is necessary but love it.”

Marcus Aurelius said:

“A blazing fire makes flame and brightness out of everything that’s thrown at it.”

Epictetus lamented:

“Do not seek for things to happen the way you want them to; rather, wish that what happens happen the way it happens. Then you will be happy.”

Washington was an empath.

He felt the pain of others. Britain’s Stamp Act and taxation forced oppression upon his brethren and denied him and his fellow man the freedom to prosper.

Thus, the rest is history. The man who loved and wanted so much to be loved by the British found a new and greater love, a bigger mission, a higher calling. Mostly from a great setback. Just like those incredible characters in films and series we are hooked on.

A non-fictional American story that resonates today.

At the time of his death in 1799, Washington’s estate was worth roughly $780,000, and that doesn’t include the valuation of his 7,000 acres at Mount Vernon. He was ranked as one of the richest colonialists. However, that wasn’t always the case. His finances dramatically ebbed and flowed. There were times in his life Washington was “land rich, cash poor.”

So, what lessons can we take from Washington’s life, good and bad? Here are 3 to consider.

Washington yearned for social status and went broke several times to keep up with the “Joneses.”

It was all about appearances. The finest clothing, expensive, outlandish accessories brought in from London designers. He borrowed (at 6%) to maintain his lifestyle for many years. Unfortunately, it appears many Americans take after our first president when it comes to the use of credit to maintain standards of living.

Well, many Americans will return to using credit as stimulus wanes and their cash balances drain. Once transfer payments are subtracted, as revealed in Lance’s chart below, disposable personal income has not recovered to pre-pandemic levels. At RIA, we expect DPI to slowly creep higher, which portends to the return of credit usage to meet daily needs.

Consumer credit per capita accelerated post-financial crisis as wage growth continued to suffer and job losses mounted. Unfortunately, unlike Washington, who yearned to ride carriages with purple velvet-tufted seats and ivory handles, Americans increasingly utilize credit to pay for the basics. Although we hear of rising wages in the media, overall they have not been sufficient enough to keep up with today’s rising costs. Certainly, most inflation does appear to be transitory. However, I am concerned about how the costs of consumer goods have increased overall, and core inflation rates will be sustainably higher post-pandemic.

According to the Pew Research’s Survey of American Family Finances, 46% of respondents reported making more than they spend; only 47% said they predictable household bills and income from month to month. In addition, more than a third of those surveyed have suffered income volatility (a year-over-year change in annual income of 25% or more) in 2017.

Washington was a strong believer in education and the benefits of mathematics.

He was also a gifted student throughout his life in agricultural sciences and the law.

A young Washington was fascinated with military strategy along with an aptitude for mathematics and geography. He was on the payroll of land baron Lord Fairfax at age 16 as a land surveyor of 5 million Virginia acres that was to be prepared for tenants arriving from across the Atlantic.

We are faltering as a country when it comes to math, science, and reading proficiencies. I wonder how the following comparisons will change due to pandemic-related school shutdowns?

In a 2015 Pew Research Center report, only 29% of Americans rated their country’s K-12 education in science, technology, engineering, and mathematics as above average or the best in the world. As parents, we must help our children embrace these subjects. A Cleveland Fed study discovered that advancing past Algebra II strongly correlates with college graduation and thriving financially in the workforce.

Washington was a master at networking.

America’s first president and one of its bravest leaders believed in the power of connections. He was not born into a rich family. Nevertheless, he made connections, was a savvy social climber, and married Martha Curtiss, one of the wealthiest widows in Virginia. Not that we all can marry wealthy, mind you!

Empirical studies outline how children who are better at socializing have above-average reading scores and better literacy skills. Likewise, according to the Brookings Institute, social and emotional competence is critically important in the workplace. Traits that employers value in employees include self-esteem, goal setting, pride in work and interpersonal skills, and teamwork.

Regardless of political affiliations, Americans should easily agree upon the respect for or relate to a trait or skill they admire when it comes to George Washington, the resilient leader of a new nation.

Perhaps we should embrace history and not be so anxious to throw it all on the scrap heap.

There are many good lessons to remember.

The Backward K and Coming Earnings Surprises

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The Backward K and Coming Earnings Surprises

The broad economic shutdowns and psychological impacts of the pandemic, along with massive doses of fiscal stimulus doled out directly to consumers greatly altered consumer and business spending habits.

As we approach the second-quarter earnings season, we are likely to see a good number of surprises, especially on a year-over-year basis. In the second quarter of 2020, some companies were struggling to keep the lights on.  Others were having trouble producing products fast enough to keep up with insatiable demand.

As our friend Peter Atwater correctly predicted in early 2020, the pandemic and its recovery would affect the economy in a K-shaped fashion. Essentially, there will be winners and losers.

With the pandemic abating and economic and consumer spending habits normalizing, some of those divergences from last year are reversing. Might we say the K is turning into a backward K?

This piece compares two companies to appreciate how and when the pandemic affected their revenues and stock price. It then looks forward to the question we face over the coming quarters; how and when earnings and share prices normalize. The analysis will allow you to prepare for earnings announcements from a host of greatly affected companies.

Graphing Distortions

Before presenting the two companies, it is worth sharing a few graphs. While just the tip of the iceberg, the graphs highlight the massive distortions caused by the pandemic and stimulus. We separate the charts between the Haves and the Have Nots.

The Haves:

The Have Nots:

Clorox

Clorox started in 1913 as the Electro-Alkaline Company. The company sells a wide range of popular consumer products, focusing on cleaning and disinfecting products.

Clorox Wipes were worth their weight in gold during the early days of COVID. It was common to find empty shelves in the supermarkets where Wipes should have been. As a result of surging sales of Wipes and Bleach, and other disinfectant products, CLX stock price jumped in the spring of 2000.

Today store shelves are fully stocked, and concerns about getting COVID from surface-born germs are fading quickly. Per Lisah Burhan, CLX Investor Relations: “The lower shipments are a result of demand normalization in bleach and Pine-Sol relative to the year-ago period when consumers turned to these products given the persistent out-of-stocks in wipes and sprays at the onset of the pandemic.”

With the normalization process underway and pandemic conditions abating, we compare some fundamental data for CLX before the pandemic and during the pandemic. This analysis allows us better to evaluate CLX’s price and potential for earnings surprises.

Fundamentals CLX

The graph below charts CLX revenue and income over the last 30 years. The pandemic-related spike in revenue and income is evident. From 2012-2019, revenue and income grew by 1.6% and 6.4%, respectively, on an average annualized basis. From 2020 through the first quarter of 2021, they rose 17.7% and 10.3% on an annualized basis. The pandemic was great for CLX’s bottom line.

The pandemic equally benefited shareholders. From January 2020 to August 2020, CLX shot up 60%. Compare that eight-month gain to the average annualized return of 8.4% for the three years before the pandemic.

Because of the predictable trending nature of CLX’s sales, we compare its current share price to expected sales to help us arrive at a fair value. We can then value the stock assuming revenue and Price to Sales (P/S) ratio reverts to its pre-pandemic trend.

As shown below, the bump in quarterly revenue and stock price during 2020 and the partial normalization is clear. The dotted blue line indicates the revenue trend from 2015 through 2019.

CLX revenues will likely return to trend as the demand for their products normalizes. Accordingly, we should expect revenue to decline from $1,781 to $1,591. In the fourth quarter of 2019, its P/S ratio was 12.65. At its current price and trend revenue ($1,591), CLX has a P/S ratio of 14.06.

CLX is trading at an 11% premium if we assume its revenue and P/S ratio return to pre-pandemic trends.

Sysco

Sysco (SYY) is an acronym for the Systems and Services Company. SYY is involved in the marketing and distribution of food products and kitchen equipment to restaurants and other institutional foodservice clients. Sysco is not as well known by the public as CLX as they predominately service businesses. Regardless, SYY has a market cap of $40 billion, about twice that of CLX.

Not surprisingly, SYY struggled during the pandemic. Many of its clients were either shut down or relegated to a fraction of their prior business. With people eating out again and offices opening back up, SYY is on the road to recovery.

CEO Kevin Hourican made the following comments during their latest earnings call in May of 2021: “We see tremendous pent-up demand in the food-away-from-home sector. Our data confirms that consumers are eager to eat at restaurants as soon as restrictions are reduced. Strong sales results and long wait times are common in restaurants operating within geographies that have limited restrictions. The third quarter can be aptly described is difficult at the beginning and robust at the end.”

As we did with CLX, let’s compare fundamental data for SYY before the pandemic and during the pandemic.

Fundamentals SYY

The graph below charts SYY revenue and income over the last 30 years. The pandemic-related reduction of revenue and income is startling. From 2012-2019, revenue and income grew by 5.4% and 4.8%, respectively, on an average annualized basis. From 2020 through the first quarter of 2021, revenue shrunk 22.4% on an annualized basis, and net income, which was running $6.7 billion per year, went negative.

The pandemic was painful for SYY shareholders. Between January and March of 2020, the stock price was cut in half, falling to a price last seen in early 2016.  Before the pandemic, SYY was returning 15% per year on average.

Like CLX, SYY is in a relatively stable and predictable business with dependable revenue trends. The reliable trending nature of their business allows us to do the same analysis we did with CLX.

The following graph zooms in on the data in this analysis. The drop in quarterly revenue and stock price during 2020 and the partial recovery are apparent. The dotted blue line is the revenue trend from 2015 through 2019.

If SYY sales return to normal, we should expect revenue to increase sharply from $11,824 to $16,278. In the final quarter of 2019, its P/S ratio was 3.27. At its current price and with trend revenue, its P/S ratio is 2.37.

SYY is trading at a 27% discount if we assume its business and valuations return to pre-pandemic trends.

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

Summary

SYY shares are about 10% below their value on 12/31/2019. At the same time, the S&P 500 Index is up about 25%. SYY’s revenue and income remain well off the levels of 2019. How and when SYY recovers is challenging to estimate. However, if they return to 2019 earnings levels more quickly than expected, the share price has significant upside potential. A strong earnings report will likely accompany a surge in the stock price.

Conversely, CLX will try to maintain higher revenue and sales despite what is likely a trend back to pre-pandemic norms. CLX share prices run the risk normalization occurs quicker than expected, and the pandemic premium vanishes in a short period.

SYY and CLX are just two examples of companies that can surprise investors with upcoming earnings announcements. The point is not to single out companies and make predictions but to highlight there are a host of companies with a potential for earnings surprises, positively and negatively. Economic activity a year ago was irregular and economic activity this last quarter is equally unusual.

Understanding what has transpired may open the door to several opportunities and a few stocks to stay away from.

Good luck in what is likely to be a widely divergent earnings season.

Viking Analytics: Weekly Gamma Band Update 7/6/2021

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

Gamma Band Update

The S&P 500 (SPX) had a nice rally to close out a pre-holiday week. The Gamma Band model[1] remained fully long last week and entered the week with a 100% allocation to SPX. When the daily price closes below “Gamma Flip” (currently near 4,275), the model will reduce exposure in order to avoid price volatility and sell-off risk. If the market closes on a daily basis below the lower gamma level (currently near 4,090), the model will reduce the SPX allocation to zero.

Investors who keep an eye on various gamma-related levels are more aware of when market volatility is expected to increase.  One application of Gamma Bands is to maintain high allocations to stocks when risk is expected to be lower.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report. With stocks continuing to extend historically high valuations, risk management tools are more important than ever to manage the next drawdown, whenever it may come.

Please visit our website to learn more about our daily reports and quantitative algorithms.

The Gamma Flip – Background

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

Gamma Band Model – Background

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

Disclaimer

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

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

Authors

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

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. 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.


Technically Speaking: Is The Retail Investor Rampage Over?

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Is the retail investor rampage over?

Since the crash in March 2020, the “retail investor army” marched propelled by chat rooms and social media channels. As discussed previously in “Blind Leading The Blind:”

  • In all, 46% have used social media for investing information in the past month.
  • 22% of Gen Z investors say they were younger than 18 when they started investing, versus 8% of millennial investors. 
  • Only 36% of young investors plan to use that money for retirement. 35% will make additional investments, while 19% will use the funds to pay for a major purchase.

“Considering that many of these individuals have never seen an actual ‘bear market,’ such is the very definition of the ‘blind leading the blind.’”

Of course, with fresh stimulus checks in hand, and sports betting shut down along with the economy, the stock market became the “casino of choice.”

Long confidence short experience, Retail Investors Are Long Confidence And Short Experience

However, something seems to be changing.

A Loss Of Interest

With sports betting back in action and stimulus checks running out, there seems to be a waning interest in the market. Recent google trend searches show some interesting trends.

Learn How To Trade Stocks

For beginner investors with a fresh stimulus check in their hands, a search for learning how to trade or invest stocks faded along with the money.

Invest In Stocks

Even the more speculative traders looking to leverage their returns seem to have lost interest.

How To Trade Options On Robinhood

That loss of interest also shows up in the areas where retail investors were most focused.

How To Invest In Dogecoin

AMC Theatres (AMC)

The Reddit website of the “Wall Street Bets” army has gone quiet in recent weeks as the stimulus support faded from the markets.

WallStreet Bets

It all reminds me of what Yogi Berra once quipped:

“Nobody ever goes there anymore – it’s too crowded.”

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

The Death Of WallStreet Bets

When I was growing up, my brother and I regularly had “BB gun” wars. Of course, there was no such thing as safety equipment, helmets, or goggles. It was him, me, and a bunch of kids armed with brass BB’s and pump-action guns going after it. Of course, I can still hear my mother’s warnings:

“It’s all fun and games until someone gets an eye put out.” 

Fortunately, we all survived. That in itself is quite a feat considering we rode in cars without seatbelts, drank from garden hoses, rode bikes without helmets, and regularly settled our differences behind the school. And, it all had to happen before the street lights came on.

Today, everyone is looking for someone else to blame. That is the story of Wall Street Bets.

“But since January, the success of WallStreetBets has become an albatross, with the board’s moderators coming under fire for what many of the board’s 10.6 million users saw as inconsistent enforcement of the rules and a growing sense that the moderators were playing it too safe in fear of angering Wall Street and regulators.

There is also rampant speculation that the size and popularity of WallStreetBets made it susceptible to bad actors trying to create pump and dump schemes by spamming old conversation threads with ticker-specific posts that give the appearance of new social media interest in that stock.” – MarketWatch

Interestingly, it was Wall Street Bets which led to an exodus of users from the Robinhood trading app. Now the tables have turned as investors lost money, the excitement died, and having to go back to work for a paycheck crashed the party.

Stimulus

Remote Jobs

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Retail Investors Are All In

As Sam Stovall once quipped:

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

Such is currently the problem for the markets in the near term. Investors are exceedingly optimistic about future market returns as we noted last week:

Wealthy Americans are pretty optimistic about their long-term investment returns, expecting to earn average annual returns of 17.5% above inflation from their portfolios. That’s according to a new survey from Natixis that surveyed households that have over $100,000 in investable assets in March and April of 2021.”

Market Rallies Fed 06-25-21, Market Rallies To All-Time Highs As Bulls Dismiss Fed 06-25-21

With allocations to equities as a ratio to the disposable income at a record peak, such suggests there is little buying power left.

Market Rallies Fed 06-25-21, Market Rallies To All-Time Highs As Bulls Dismiss Fed 06-25-21

Such becomes more problematic as real disposable incomes return to more normal levels.

Of course, as liquidity dries up, the demand from retail investors which has made up nearly 20% of trading volumes this year also evaporates. The problem of “liquidity” becomes an important concern when markets are historically elevated from long-term means.

The chart below shows the deviation from the 3-year moving average, CAPE valuations, and RSI. These are levels never seen historically.

In other words, it’s all fun and games until someone gets their eye put out.

Bear Markets Matter, #MacroView: Bear Markets Matter More Than You Think (Part-2)

Looking For Someone To Blame

Some things don’t seem to change.

Currently, there seems to be no end to the rally. However, such is always the case just before it ends. In February of 2020 sentiment was much the same before a hair raising 35% plunge. Furthermore, those that chased the markets took on excess risk, and leveraged up to do it, will look for someone to blame for their losses.

“History repeats itself all the time on Wall Street”  – Edwin Lefevre

Unfortunately, investors are faced with a terrible choice. Invest in extremely overvalued, extended, and bullish markets and hope they can navigate the eventual turn. Or, they can sit on the sidelines waiting for the eventual correction to take on equity risk.

In both cases, investors will wrong. The ones that pile in now will fail to navigate the turn as the “Fear Of Missing Out” keeps them allocated all the way down to the next bottom. Those that wait to get in will see the crash, and then stay out expecting stocks to continue to go lower. In the end, those that stayed in will eventually see their portfolio value recover, and those hoping to get in will still be on the sidelines.

Such is the psychology of investing, and eventually, individuals wind up looking for someone to blame.

Is the retail investing rampage over yet? Maybe. Maybe Not.

However, when the eventual unwinding occurs a new generation of investors will learn the brutal lessons of excess risk, speculation, leverage, and greed.

It is the oldest story on Wall Street.

Patrick Hill: Persistent Inflation Threatens the Recovery

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Persistent Inflation Threatens the Recovery

Our company has had to deal with import delays due to backlogged West Coast ports, higher domestic freight costs, and a labor shortage at distribution centers that has prompted wage increases.  Earlier this year, we thought, or maybe we hoped, that some of the industrywide supply-chain issues would have started to settle down by now. But that clearly hasn’t happened. In fact, the whole global supply situation seems to have gotten maybe even a little bit worse.”

John Crimmins, chief financial officer of Burlington Stores Inc., 5/27/21

Crimmins’s observation summarizes how business costs are driving persistent inflation due to multiple factors.  Labor shortages are severe in the manufacturing, warehousing, retail, leisure, and hospitality sectors.  Lack of workers drives wages up across thousands of businesses forcing management to raise prices to end customers and consumers.  Leasing and rent costs have skyrocketed for warehousing-dependent manufacturers, e-commerce, and transportation companies.  Container cargo from Asia to the U.S. has been bottlenecked since the pandemic began in the spring of 2020.  Analysts think a mismatch of demand in Asia and the U.S. has caused too many empty containers in low-demand ports. Shipping bottlenecks forced manufacturers to buy more inventory than they needed to maintain sales.  The hoarding is triggering price increases for many raw materials and finished goods.

Federal Reserve Forecast of Transitory Inflation Seems More Unlikely

At the June FOMC meeting, Federal Reserve Chairman Jerome Powell repeated his forecast that inflation is rising but will be ‘transitory’ as supply systems meet demand. Demand from workers returning to the office, shoppers returning to buying, and people traveling will ensure companies add production capabilities. Yet, supply bottlenecks and commodity shortages are causing long-term inflation. Sales are increasing dramatically in pandemic impacted sectors like hotels and restaurants as consumers resume traveling and eating out.  Labor shortages are forcing many restaurant and hotel operators to open partially until they achieve full staffing.  The shift to remote work has empowered workers to seek jobs from home at present or higher wages in other sectors.  Plus, consumers are reeling from new and used car prices rapidly rising. Regardless of Fed forecasts of transitory inflation, executives and consumers in the real economy are experiencing persistent inflationary pressures.

In this post, we will examine these labor and supply-side trends embedding inflation into the economy. We’ll start by reviewing labor shortages in several industries.

Labor Shortages Drive Wage Gains

Wage gains can lead to embedded inflation.  Workers will not settle for salary cuts.  During a recession, executives may cut salaries to hold onto workers. Management hoping the pandemic would be short-lived furloughed workers.  But the pandemic continued through 2020, forcing worker layoffs.

The fast vaccination rollout has jump-started consumer spending and economic growth.  However, payroll growth and hiring have not kept up with hiring demand. The following chart shows a projection of baseline of payroll growth pre-pandemic versus where hiring is today.  About 4.5M workers have been rehired though there is still a 10M worker gap versus baseline levels.

 Source: The Daily Shot – 6/15/21

In May, Indeed reported that job openings have increased by 25% from February of 2020.  But there are still 14.5M workers receiving continuing unemployment. There is a vast gap of hundreds of thousands of unemployed workers to jobs in hospitality in part due to hiring by Amazon, Federal Express, and UPS totaling 500k positions last year. In addition, there is a significant mismatch between thousands of unemployed worker skills and new jobs in high-growth sectors like software systems. Other reasons for lack of hiring are worker hesitancy related to COVID infection risk, lack of childcare, and poor wages.

Many Sectors Have Fewer Than One Unemployed Worker Per Job

The labor shortage is exemplified by the unusually few number of workers unemployed per job. This situation is made worse because 2.5M workers retired from the work force and about 1.7M women have not returned due to career changes and lack of childcare.  The worst imbalance of jobs to unemployed people in the following chart is seen in leisure – hospitality, professional services, education – health and manufacturing.

Sources: Oxford Economics, Bloomberg – 6-30-21

To resolve the mismatch will require investments in job training, career development, and counseling on a significant scale.  The process of matching workers to jobs is likely to take years, not months.  Many workers are not going back to their old jobs after having a good experience working from home.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Workers Feel Empowered After Working from Home

When the pandemic hit, workers examined their jobs, family life, and tradeoffs with the income and hassle of commutes.  We noted in a recent post on massive job churn that 37% of all workers changed jobs. Of that total, 26% of job changers moved to new employers. Many people changed industries to be able to work from home or have more family time. Newly empowered workers are driving a new set of job expectations with management.  The rise in the quits rate reveals newfound confidence in workers’ ability to find the job they want on their terms.  Lockdowns forced implementation of remote work on 70% of the workforce, providing them with the opportunity to explore new job options.  The high number of job openings supports their reluctance to accept any job, not on their terms. 

Quits Rate Indicates Higher Employer Costs Are Coming

The Department of Labor reports that the quits rate is the highest it has been in 20 years. The following two charts show how the quits rate is a leading indicator of a rise in the Employer Cost Index (ECI).  The ECI leads to price increases that companies expect to pass along to customers.

Job seekers rejecting job offers forces employers into a hiring bind.  To close the job search, companies sweeten their offers. Sweetened job offers may include increased wages, benefits, bonuses, and remote or hybrid work arrangements. Hard-pressed recruiters are dangling remote work as a sign-on bonus. Bret Taylor, COO of Salesforce, says employees are calling the shots, “There’s like a free market of the future of work, and employees are choosing which path that they want to go on.”

Labor Shortages Create Supply Bottlenecks Resulting in Price Increases

Supply shortages that economists are calling transitory maybe actually turn into persistent inflation.  Supplier delivery times are at the worst level since 1951! 

Sources: Arbor Research, Bloomberg, The Daily Shot – 6/23/21

Supply bottlenecks are in part caused by two, three, four steps or more in manufacturing processes to the final product.  Companies selling to successive businesses face delays due to materials. Often, they are short on labor to fabricate, assemble, and deliver their product to the next-level manufacturer. Much of the increase in prices is due to input ‘upfront’ loading of inventories by manufacturers to have supplies available as materials continue to be scarce.  The scarcity of intermediate goods causes input price increases that manufacturers pass along to customers.

Commodities Price Increases Drive Inflation

Prices for raw materials needed for manufacturing, processed goods, and energy are rising to record levels in the commodities price chart below.  The Bloomberg Commodity Index includes prices for 23 futures contracts of physical commodities in energy, agriculture, and metals.  Some commodity prices have declined due to consumer demand easing, yet the index has bounced back recently. 

Source: Bloomberg – 6/28/21

Oil prices have risen to the highest level since 2018 as drivers return to traveling and go on summer vacations. Limited supplies of raw materials are due to pre-pandemic tariffs, extraction company worker layoffs during the pandemic, and shipping bottlenecks.  Last year lumber prices rose 75% from pre-pandemic levels but are still about 60% above February 2020.  New home prices rose 20% in the previous year in part due to the high rise in lumber prices. Adding to the demand for homes is the 5.5M lack of housing inventory. However, housing demand has slowed over the past few months due to increasing interest rates and surging prices.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Reopening Drives Consumer Demand & Commodity Prices

Reopening economies worldwide have triggered a surge in demand for a variety of consumer goods. Diverse consumer products companies like Sherwin-Williams, Masonite International, Levi Strauss, and Conagra Brands have announced price increases. As high prices reduce demand, commodity prices may decline, though it is unclear if they will return to pre-pandemic levels. The planned $1T in infrastructure spending bill now before Congress will add to demand for commodities as well. 

Warehouse Rents Soar

Ecommerce demand for more warehouse space is driving the cost of large warehouses, particularly near coastal metro centers.  The most significant increases are for 500k sq. ft warehouses as noted in the following chart at 13.2% in the last 12 months.

Source: CBRE – 6/25/21

Tenants taking rent prices surge due to multiple offers. Base rents are rising above asking rent prices in areas like Northern New Jersey, where prices jumped 33%, and Southern California at 27%. Coastal locations are in hot demand to deploy same-day delivery services in major markets.

The concern with soaring rent increases is that leases are set of 3 – 5 years and establish a baseline fixed cost for retail and distribution companies.  Building leases are unlikely to be re-negotiated unless there is a significant recession.  So, these rent increases are likely to drive persistent inflation for several years. Consumers are seeing major rent increases as well.

CPI Housing Component Is Forecast to Rise Significantly

Rent costs comprise about 40% and owner equivalent house prices of the Consumer Price Index (CPI). CoreLogic-Case-Shiller reported a 14.5% year-over-year price increase for homes in April.  Due to the significant component housing plays in CPI, it is helpful to monitor the direction of inflation for the next several years. Here is a chart noting the CPI impact of housing and rent costs for recent movers.

Sources: Macrobond, Nordea, The Daily Shot – 6/14/21

Erica Brescia, an economist at Fannie Mae, comments on the impact of housing on CPI into 2022:

“Due to the heavy weight given to shelter, housing could contribute more than 2 percentage points to core CPI inflation by the end of 2022 and about 1 percentage point to the core PCE. Both would be the strongest contributions since 1990.”

In her estimate, housing will drive inflation into 2022, that trend seems to be long-term inflation.  House prices may moderate in a slowing economy, but they rarely come down. Rents are rising across the country as well.

Rent Prices Rise Across the U.S.

Rents are rising in suburban, exurban, and spread-out cities like Denver, Dallas, and Los Angeles.  These rent increases are primarily due to landlords looking to recoup losses from unpaid rent debts totaling about $70B during the pandemic. Offsetting the expected rise in rents across most households are rent declines of 11-14% in commuter-oriented cities like New York, Chicago, and San Francisco. States like California are planning on reimbursing landlords for 100% of their debt incurred during the pandemic using federal funding. Federal agencies in charge of the reimbursement process have been slow in delivering the funds.  If funding delays continue, landlords will be forced to raise rents on lease price options.  New move-in renters will experience higher rent prices as well.

New & Used Car Sales Prices Skyrocket

Workers from cities moving to suburbs and exurbs need cars. These relocated workers are buying cars at a quick pace.  Used car prices rocketed up 27% in April, with forecasts to rise by 30% in May. J.D. Power reports that in 2021 75% of all new car sales were at MSRP or above. The following charts show the dramatic climb in prices.

Sources: BLS, UBS, J.D. Power, Wolfstreet – 6/28/21

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

A key reason used car prices have soared is the declining inventory of new cars.  Computer chip shortages caused car manufacturers to reduce production.  Dealers chose to raise prices on existing inventories and used vehicles on their lots. Computer chip shipments to auto manufacturers have fallen due to a shift in chip deliveries to electronic and computer system firms. Semiconductor chip manufacturers responded to pandemic lockdowns by closing plans. Then as the economy reopened, they are finding fewer job applicants. 

Before the pandemic, U.S. tariffs on Chinese imports implemented by the Trump administration caused chip supply disruptions. Meantime, China has focused on building its semiconductor manufacturing capability to control innovation and boost its domestic car market. U.S. chip manufacturers are investing in new plants. But it will take years to balance chip supplies with auto industry demand. Chip prices will continue to rise for several years due to shortages.

FOMC Begins to See Increasing Inflation

We have reviewed how significant labor shortages, commodity price increases, chip shortages for cars, industrial and consumer rent increases are becoming embedded into the economy. While Fed Chairman Jerome Powell reiterated his forecast for transitory inflation, the Federal Open Market Committee (FOMC) sees persistent inflation emerging. At that meeting, FOMC participants’ inflation forecast shows their concern about rising inflation.

Sources: Federal Reserve, The Daily Shot – 6/28/21

Also, the FOMC saw an increasing level of uncertainty on whether inflation will rise or fall. If interest rates are kept extremely low, and liquidity is maintained, inflation is likely to build combined with possible further infrastructure spending.  Already, monetary injections and fiscal spending combined are at the highest level since WWII as a percentage of GDP.  The Federal Reserve’s characterization of inflation as ‘transitory’ is becoming less likely. In an op-ed article, Mohammed El-Erian, economic advisor at Allianz S.E., noted the FOMC participants’ weakening forecast for transitory inflation.  Data trends continue to show persistent inflation factors building putting the recovery at risk.  El- Erian advocates tightening monetary policies sooner and concludes:

Most important, however, relative to what is needed, the Fed continues to fall further behind the curve, compounding an unnecessary risk facing a recovery that needs to be strong, long, inclusive, sustainable and not vulnerable to unsettling financial market instability.”

Author

Patrick Hill is the Editor of The Future Economy, https://thefutureconomy.com/, the site hosts analysis of the real economy, ideas on a new economy, indicators, and posts to start a dialog. He writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like H.P., Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677, email: patrickhill@thefutureconomy.com

As Good As It Gets. Will Q2 Mark Peak Reporting?

image_printPRINTER FRIENDLY VERSION

In this 07-02-21 issue of “As Good As It Gets Will Q2 Mark Peak Reporting?

  • Market Rallies To Start Q3
  • As Good As It Gets
  • Fully Invested Bears
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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


Are you worried about the potential for a market correction, a surge in inflation, or are you unsure how to invest for your retirement? We can help. If you are not yet a client and would like to discuss your portfolio construction, please schedule a time to meet with one of our advisors below.


Market Rallies To All-Time Highs

With the 4th of July weekend upon us, this week’s newsletter will be slightly shorter than usual. Such will ensure you “pitmasters” can get to work doing what you do best.

As we discussed last week, the market not only got off the mat and rallied back to new highs. That action continued through this week.

The technical backdrop is not great. With the market back to 2-standard deviations above the 50-dma, conviction weak, and investors extremely bullish, the market remains set up for additional weakness.

However, we are in the first two weeks of July which tends to be bullishly biased. After increasing our equity exposure previously, we will give the market the benefit of seasonality for now. 

Complacency Concerns

With the “money flow buy signal” not yet back to a typical peak, such suggests another week or so of upside is likely. However, as noted, we suspect there is not much upside in the market for current levels.

Lastly, we discussed the high level of complacency in the markets previously. To wit:

“Currently, complacency has reached more extreme levels. As noted last week, the 15-day moving average of VIX, on an inverted scale, suggests a correction is likely. By this measure, the correction should begin somewhere around July 21st – August 10th.”

The same gets confirmed by the exceptionally high reading of the SKEW index. 

“One such indicator is the CBOE SKEW index. The index measures the perceived tail risk of the distribution of S&P 500 investment returns over a 30-day horizon. It is similar to the VIX index, but instead of measuring implied volatility based on a normal distribution, it measures the implied risk of future returns realizing outlier behavior.

A SKEW value of 100 indicates the options market perceives a low risk of outlier returns. Conversely,values above 100 reflect an increased perception of risk for future outlier events.” 

We are clearly above 100 currently.

Warnings, Technically Speaking: Warnings From Behind The Curtain

The bulls are indeed in charge of the markets currently, but the clock is ticking.


As Good As It Gets

There is much at risk in the market as we head into the 3rd quarter and begin Q2-reporting for the S&P 500 index. For clarity, we need to review the “second-derivative” effect.

“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.

Here is a simplistic example.

Assume the economy is $1000 in value in Year 1. Then, in Year 2, there is a 50% recession. However, in Year 3, the economy grows back to $1000. And, in Year 4, the economy remains at $1000.

The “second derivative” effect is evident in years 3 and 4. In year 3, the economy recovers by $500, a 100% increase from Year 2’s level of $500. However, in Year 4, the growth rate falls to zero as the economy remains at $1000.

A Coming Change

Why am I telling you this? Because we are at that point in the recovery cycle. Over the next couple of months, we will see the most significant numbers of the recovery cycle as we compare Q2-2021 to Q2-2020, which was the depth of the economic shutdown. As shown in the chart below, we will see a robust GDP report, but such will be the cycle’s peak.

The manufacturing activity indices have already peaked, which has a high correlation to the annual change in the S&P 500 index.

We will also see a peak in the annual rate of change in earnings as the economy slows. (Note: Current earnings estimates are exceptionally optimistic. By the end of 2021, the peak in earnings growth will likely move forward.)

With valuations highly elevated on a two-year forward basis, when earnings are eventually revised lower with slower economic growth, valuations will rise. (You will often see media types compare forward P/E’s to current reported P/E’s, suggesting markets are cheap. However, that is not apples to apples as you are comparing forward to trailing P/E’s. As shown, two-year forward P/E’s are at the highest level since the “Dot.com” peak.) 

The point here is that much of the growth in the economy is currently “priced in” to expectations. When things are as “good as they can get,” that is usually the point where things inevitably start to go wrong.

With no more stimulus coming from the Government and 9-million people coming off of unemployment benefits by September, a “fiscal cliff” is fast approaching. Such could well lead to a disappointment in expectations in a market currently priced for perfection.


In Case You Missed It


Fully Invested Bears

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

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

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

What you’ve had are fully invested bears.”

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

The reason I bring this up is because of this comment from the legendary Leon Cooperman.

The clip is fascinating because Becky Quick refers to Leon as a “fully-invested bear” as he states:

“You have to be in the market right now.”

The Two Big Risks

There are two inter-related risks to the market currently. The Fed and “inflation.” 

As Leon correctly notes, companies should be able to pass on inflated materials costs to their consumers:

“Everybody is worried about inflation. Inflation is a positive for common stocks because inflation in companies’ costs works its way into selling prices, which lift the nominal level of revenues and earnings.”

In theory, that is true, but as noted above, with the “fiscal cliff” approaching, there is a risk that consumers can’t absorb as much “inflation” as he hopes. Moreover, as I showed previously, the gap between CPI and PPI already indicates that companies are retaining inflation.

The other problem is the Fed. The markets will not react kindly to the Fed moving to curb inflationary pressures.

In either case, the risk to markets remains elevated. While I certainly agree you “have to be invested in the markets currently,” we are also fully aware of the risks.

Yes, that makes us “fully invested bears.” 

Portfolio Update

As noted above, the “buy signal” is back in play. With the markets bullishly biased, the seasonally strong first two weeks of July should lift asset prices. However, with the markets back to overbought, bullish, and deviated conditions, the upside is limited near term. 

As noted above, with portfolios back to near full-allocations, we are “fully-invested bears.” 

The biggest problem for investors is the “herding effect” and “loss aversion.”

As markets are rising, individuals believe that the current price trend will continue to last for an indefinite period. The longer the rising trend lasts, the more ingrained the belief becomes until the last of “holdouts” finally “buy-in” as the financial markets evolve into a “euphoric state.”

Once the market begins to decline, there is a slow realization it is more than a “buy the dip” opportunity.  As losses mount, the anxiety of loss begins to climb until individuals seek to “avert further loss” by selling.

Such is the basis of the “Buy High / Sell Low” syndrome.

However, by understanding what drives market returns over the long term, you can mitigate the risk of making psychological errors.

It is likely, given there is “no fear” of a market correction, an overwhelming sense of “urgency” to get invested, and a continual drone of “bullish chatter,” the markets are poised for an unexpected, unanticipated, and inevitable event.

What will that be? No one knows until after the fact.

Such is why applying “risk management” before the event is critical to the eventual outcome. After all, you don’t carry an “umbrella” after it rains, do you?

I hope you have a terrific 4th of July weekend, and I will see you again 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” are oversold. The current reading is 92.60 out of a possible 100.


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.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 84.20 out of a possible 100.


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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.
  • Table shows the price deviation above and below the weekly moving averages.


Weekly Stock Screens

Currently, there are four 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

Fundamental Growth Screen

Fundamental Growth Screen

Aggressive Growth Strategy

S&P 500, Portfolio, Technical, Market, Performance, 401k, Update, Risks, Analysis


Portfolio / Client Update

With our money flow signals switching back to a “buy,” we did increase exposures, as noted below. However, the rally has been feeble, and there is likely not a tremendous amount of upside currently. We expect that we will probably see a positive first two weeks of July, but August and September remain our targets for a bit of correction as we get through earnings season and all eyes to the Fed’s “Jackson Hole” confab.

The most significant risk to the markets remains a shift in the Fed’s monetary program. Given they have already started hinting about a potential taper and inflationary pressures are rising, the risk of a change remains elevated.

In the meantime, we continue to hold our positions and manage risk by adjusting holdings accordingly. As noted last week:

“There currently remain no ‘big red flags’ to make us significantly more active. But, should they appear, we assure you we will take action as needed.”

That remains the case this week.

Have a great 4th of July weekend.

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

We are reducing ADBE back to its original portfolio weight of 2% after a nice run lately that took the holding back to more extreme overbought conditions.

We are increasing AMLP to 2% of the portfolio in the ETF Sector model on the dip this morning to balance our Energy exposure and increase portfolio yield.” – 07/02/21

Equity Model

  • Reduce ADBE to 2% of the portfolio.

ETF Model

  • Increase AMLP to 2% of the portfolio.

“This morning we sold 1.5% of XOM  and replaced it with 1.5% of AMLP in the equity model. We are picking up extra dividends and the technical backdrop looks better on AMLP than XOM.” – 06/30/21

Equity Model

  • Sell 100% of XOM
  • Add 1.5% in AMLP

“We added 7.5% of GSY to both portfolios this morning. The purpose is to sop up extra cash and improve our yield in the fixed income portfolio until we decide to increase our duration.” – 06/29/21

Equity & ETF Models

  • Initiate a 7.5% position in GSY

“This morning we added a 5% trading position in DIA (Dow ETF) in all models. Our cash flow indicators signal an upward trend and historically the first two weeks of July are good for the markets. Beyond mid-July the market tends to consolidate or dip into the fall months, so we added a trading position now versus adding to individual holdings as it may likely be a short-term position.” – 06/28/21

Equity & ETF Models

  • Initiate a 5% position in DIA

As always, our short-term concern remains the protection of your portfolio. Accordingly, we have shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


401k Plan Portfolio Allocation Model

401k Plan Portfolio Allocation Model

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 Model Performance Analysis

401k Model Performance Analysis

Have a great week!

Technical Value Scorecard Report For The Week of 7-02-21

image_printPRINTER FRIENDLY VERSION

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 will find more detail on the model and the specific tickers below the charts.

Commentary 7-02-21

  • A quick glance at the charts below highlights a couple of noteworthy characteristics of recent market behavior. First, about three-quarters of the sectors and all but two of the factors/indexes are oversold versus the S&P. This condition is a sign that the market’s breadth is poor with only a few, predominantly FANG stocks, leading the way. We see similar signs of bad breadth in other indicators as well. Second, the changes from last week are minimal in almost all cases. While the market is slowly rising, the graphs point to a broader market, that for two weeks running, is lethargic. We are currently on a daily buy signal in our proprietary model but are closely watching it as we expect it to turn back to a sell signal in the next week or two. The second half of July, along with the following few months, are historically the weakest performing months of the year.
  • Utilities are the most oversold sectors on a relative basis, which is a little confounding given inflation expectations stabilized and yields are slowly declining. The inflationary sectors remain relatively weak except for energy, which is trading close to fair value. The rising price of oil seems to be supporting the sector. There are no sectors in deep overbought territory.
  • The factor/index graph shows the NASDAQ continues to be the index of choice as it is the only index above fair value versus the S&P 500. As the relative value graphs, the inflationary sectors like foreign and emerging markets, value, and the equally weighted S&P 500 are the most oversold.
  • The absolute graphs show only a few sectors are oversold, albeit not far below fair value. Healthcare, technology, communications, and discretionary are the most overbought sectors. Real estate (XLRE) has fallen back toward fair value as we suspected it would after it was grossly overbought for a few weeks running. XLRE underperformed the S&P 500 by 3.33% over the last ten trading days.
  • The third graph below breaks out each sector’s excess returns versus the S&P 500 over a wide range of trading days. The color-coding allows us to spot new trends as sectors turn from red/orange to yellow/green and vice versa. For instance materials and transports, which are oversold on a relative basis are not the worst performing sectors (bright red) as they had been. Conversely, real estate went from a nice string of green data points, but now is showing up as red in the last ten days. Utilities are showing consistently poor excess returns over all periods.
  • The S&P 500 remains overbought as shown in the bottom right on the second set of graphs. The correlation between our scores and excess returns has slipped since the very high readings of the past few weeks.

Graphs (Click on the graphs to expand)


Users Guide

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change trend. When the scatter plot in the sector graphs has an R-squared greater than .60 the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis 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. At times 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 one of many tools we use to manage our portfolios. 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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

#MacroView: Capitalism Does Not Equal Corporatism – Pt. 2

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In Part-2 of “Capitalism” does not equal “Corporatism,” we delve into why bailouts support corporatism and how to fix the system.

(Read Part 1 Here – The Repeal Of Glass-Steagall & Stock Buybacks)

Capitalism Is Darwinian

Capitalism, if allowed to operate, is a “Darwinian System.” As with Darwin’s theory of evolution, corporate evolution has the same essential components as biological evolution: competition, adaptation, variation, overproduction, and speciation. In other words, as an economic system, companies either adapt, evolve, and survive or become extinct. 

In 2008, the Government and Federal Reserve began a process of “bailing” out companies that should have been allowed to go “bankrupt.” Instead, a decision got made to stop “capitalism” from proceeding with its “Darwinian” process. It all began with the initial bailout of Bear Stearns.

To date, the Federal Reserve, and the Government, have pumped more than $43 Trillion into the economy to keep it “afloat.”

I say “afloat” rather than “growing” because, since 2008, the total cumulative growth of the economy is just $3.5 trillion. In other words, for each dollar of economic growth since 2008, it required $12 of monetary stimulus. Such sounds okay until you realize it came solely from debt issuance.

Fed Campaign Taper, Fed Starting Campaign To Taper Its Asset Purchases

Failure To Allow Capitalism To Operate

We need that bit of history to understand why “bailouts are ruining capitalism.” 

“Modern society looks increasingly to government for protection from major crises. Whether recessions, public-health disasters or, as today, a painful combination of both. Such rescues have their place. Few would deny that the Covid-19 pandemic called for dramatic intervention. But there is a downside to this reflex to intervene, which has become more automatic over the past four decades. Our growing intolerance for economic risk and loss is undermining the natural resilience of capitalism and now threatens its very survival.” – Ruchir Sharma

Sharma is correct.

Such was a point I recently discussed in “Recessions Are A Good Thing.” To wit:

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.”

The Fed’s foray into “policy flexibility” did extend the business cycle. However, those extensions led to higher structural budget deficits. The cancerous byproduct of increased private and public debt, artificially low interest rates, negative real yields, and inflated financial asset valuations is problematic.

Specifically to Sharma’s point:

“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.”

Fed Campaign Taper, Fed Starting Campaign To Taper Its Asset Purchases

The Fed’s “Moral Hazard”

“This is a dangerous form of denial. A growing body of research shows that constant government stimulus has been a major contributor to many of modern capitalism’s most glaring ills. Easy money fuels the rise of giant firms and, along with crisis bailouts, keeps alive heavily indebted “zombie” firms at the expense of startups, which typically drive innovation. All of this leads to low productivity—the prime contributor to the slowdown in economic growth and a shrinking of the pie for everyone.” – Sharma

By not allowing “recessions” to perform their natural “Darwinian” function of “weeding out the weak,” to Sharma’s point:

“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

Rescues Capitalism, #MacroView: The Rescues Are Ruining Capitalism

If capitalism were allowed to function, the weak players would fail. Stronger market players would acquire failed company assets. Bond-holders would receive some compensation for their debt holdings. Shareholders, the ones who accepted the most risk, would get wiped out.

Furthermore, assuming capitalism was allowed to function, investors would require appropriate compensation for the risk when loaning money to companies. As such, credit-related investors would get compensated for their risk rather than the current state of abnormally low yields for junk-rated debt.

Why is this currently the case? It is the direct result of the Fed’s creation of “moral hazard.” The definition of which is:

“A lack of incentive to guard against risk as investors believe the Fed is protecting them from the consequences of it.”

Why Wealth Inequality Is A Good Thing

Just recently, Aaron Back accidentally made a case for why we should foster “capitalism” over “socialism.” 

“The introduction of capitalist reforms to Communist China has lifted hundreds of millions out of poverty, but it had a drawback: rising income inequality.”

Aaron’s rush to jump on the “inequality bandwagon” exposed the benefits of capitalism. Let’s break down his statement:

  1. The introduction of capitalism lifts millions out of poverty. (This is a good thing)
  2. Yes, capitalism created inequality as those that took advantage of capitalism prospered versus those that did not. (How capitalism works)
  3. If capitalism helped lift millions out of poverty, such suggests everyone was previously poor under communism. 

Point 3 is the most important.

Capitalism gets its power—and has created the greatest increase in social welfare in history—from embracing human ingenuity and the positive forces of innovation, open markets and competition. Perhaps the greatest strength of free markets is their ability to nimbly adjust to new ideas and situations and find the most efficient system. Markets are always looking to do things better. We can apply that same logic to capitalism itself to improve capitalism further so that it can provide even greater social welfare.” – Daniel LaCalle

Let me clarify something for you.

The ‘American Dream’ isn’t going into debt to buy a home. The ‘American Dream’ is the ability for ANY person, regardless of race, religion, or means, to achieve success, and in many cases great success, through hard work, dedication, determination, and sacrifice.

Fed Campaign Taper, Fed Starting Campaign To Taper Its Asset Purchases

Capitalism Is The Worst, Except For All The Rest

One thing is for sure. Life isn’t fair.

“The rich have everything, and all I have is a mountain of student debt and a crappy job.”

Capitalism isn’t perfect, as Howard Marks recently noted:

Capitalism is an imperfect economic system, because differential performance in the pursuit of economic success – as well as luck – results in there being (a) some people who are less successful as well as some who are more and (b) a few who are glaringly successful.

I’m 100% convinced that the capitalist system has produced the most aggregate gains for our society, exceptional overall progress, and a better life for most. 

In the same way, I’m convinced that capitalism is the worst economic system . . . except for all the rest.”

Here is a hard truth for you.

“Capitalism is the only system that will provide you the ability to achieve unbridled success.”

Yes, the Government can pay for anything you want. The problem is that it requires those who are succeeding to pay for it.

Think about it.

Do you want to work hard, sacrifice, and take on an exceeding amount of risk to achieve success, only to pay for those who don’t?

Such is why socialism always fails.

The greater good can only be achieved by making the good greater.” – Daniel LaCalle

Fed Campaign Taper, Fed Starting Campaign To Taper Its Asset Purchases

Fixing What’s Broken

Is “capitalism” broken? No.

The problem is continuous interventions to halt the “Darwinian” function of “capitalism.” That brutal process must function; otherwise, it leads to “corporatism.”

While there is much complaining about “wealth inequality,” there is little “demand” to change it.

For example, if we were concerned about the monopolistic powers of companies such as Facebook, Twitter, and Google – we would stop using them. Without customers, these companies cease to exist.

However, we won’t do that because we want to conveniently complain about the injustices of the world on those platforms.

If we were upset about the executive compensation, we would stop buying Apple products. But if we did that, how on earth would we access Twitter and Facebook to complain about the inequalities in the world.

Of course, we could also stop making executives rich. In that case, we only have to stop investing in the financial markets, and more importantly, demanding immediate access to information via our computers and social media.

The demand for information immediacy, and the decimalization of Wall Street, have pushed companies to use proforma accounting, gimmicks, and share buybacks to beat Wall Street estimates. But let me ask you, is it essential that a company beats their earnings by a single penny? Does such change the long-term valuation of the investment?

If you wanted to fix “capitalism,” you have the power to do so.

The problem is that you are unwilling to make the sacrifice needed to force a change.

Instead, you want the Government to fix the problem for you.

Of course, that is how “socialism” and “communism” came to be in the first place.

The current state of “capitalism” may seem broken, but every other form of an economic system leads to worse long-term outcomes for the average American.

S&P 500 Monthly Valuation & Analysis Review – 06-30-21

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S&P 500 Monthly Valuation & Analysis Review: 06-30-21

Also, read our commentary on why low rates don’t justify high valuations.


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

Cartography Corner – July 2021

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

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

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

GTA Users Guide


June 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESU1) during June 2021. In our June 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                4512.00

o M1                4265.50

o PMH             4238.25

o M3                4230.50

o Close            4202.50           

o M2                4094.00

o MTrend        4054.64     

o PML              4029.25       

o M5                3847.50

Active traders can use M1: 4265.50 as the pivot, maintaining a long position above that level and a flat or short position below it.

Many clients asked why our isolated pivot was above May’s high price at M1: 4265.50.  We answered that we were focused on the reward-to-risk of possible entry points for being long-of risk.  It was clear that above M1: 4265.50 and there was no monthly resistance until M4: 4512.00, equating to a potential profit of 246.50 points.  Assuming an initial stop of one Average True Range, which was 50 points on June 1, the reward-to-risk ratio resulted in 4.93x (246.50 / 50.00).  However, had we isolated our pivot at PMH: 4238.25 then the result of our reward-to-risk mathematics would have been considerably worse.  Initial resistance at M1: 4265.50 inferred an initial profit of only 27.25 points.  The resulting reward-to-risk ratio would have been 0.55x (27.25 / 50.00).

Figure 1 below displays the daily price action for June 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The realized price action in June vindicated our math.  On the tenth trading session of June, the market price settled at 4245.75, above PMH: 4238.25.  Over the following five trading sessions, it proceeded to decline (119.00) points (June 21st intra-session low).

As our math would have it, Monthly Trend for July was then developing at roughly the same level as the June 21st low price.  As has been the case since November 2020, the market price immediately raced higher with the market-participants algorithms bulls successfully defending their positions (and intra-month shorts covering).            

On June 25th, the market price settled above our isolated pivot at M1: 4265.50.  With only three trading sessions remaining, the likelihood of M4: 4512.00 being realized was practically nil.  The market price settled the month of June at 4288.50.

Figure 1:

Canadian Dollar Futures

We continue with a review of Canadian Dollar Futures (6CU1) during June 2021.  In our June 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                0.8746

o M1                0.8496

o M3                0.8404

o PMH             0.8325

o M2                0.8288              

o Close             0.8274      

o PML               0.8096

o MTrend        0.8088       

o M5                0.8038

Active traders can use PMH: 0.8325 as the pivot, maintaining a long position above that level and a flat or short position below it.  

Figure 2 below displays the daily price action for June 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  A picture is worth a thousand words.

Figure 2:

July 2021 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESU1).  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Current Settle         4288.50        

o Daily Trend             4280.39

o Weekly Trend         4211.69        

o Monthly Trend        4169.94        

o Quarterly Trend      3875.31

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for five quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Trend Up”, settling eight months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”.

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  The signal was given the week of May 10th to anticipate a two-week high within the next four to six weeks.  That high was realized the week of May 31. 

Support/Resistance:

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

o M4                4559.25

o M3                4374.50

o M1                4350.25

o PMH             4294.25

o Close            4288.50           

o M2                4224.25

o MTrend        4169.94     

o PML              4126.75       

o M5                4015.25

Active traders can use M3: 4374.25 as the pivot, maintaining a long position above that level and a flat or short position below it.

UST 30Y Yield

For July, we focus on the U.S. Treasury 30-Year Yield (“30Y”).  We provide a monthly time-period analysis.  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Monthly Trend      2.236             

o Weekly Trend       2.115

o Daily Trend           2.097             

o Current Settle       2.086             

o Quarterly Trend    1.984

The relative positioning of the Trend Levels is bearish, denoting lower yields.    Think of the relative positioning of the Trend Levels like you would a moving-average cross.  As can be seen in the quarterly chart below, the 30Y is “Trend Up”, having settled above Quarterly Trend for three quarters.  Stepping down one time-period, the monthly chart shows that the 30Y is in “Consolidation”, having settled below Monthly Trend for one month.  Stepping down to the weekly time-period, the chart shows that the 30Y is “Trend Down”, settling below Weekly Trend for five weeks.

One rule we have is to anticipate a two-period low (high), within the following four to six periods, after an Upside (Downside) Exhaustion level has been reached.  The signal was given the quarter of 1Q2021 to anticipate a two-quarter low within the next four to six quarters (now, three to five quarters).  That low can be achieved this quarter with a trade below 1.638.  The signal was given the week of June 7th to anticipate a two-week high within the next four to six weeks (now, two to four weeks).  That high can be achieved this week with a trade above 2.218.  A rise in yield that satisfies the need for a two-week high may be a good opportunity to position for the anticipated two-quarter low.

Support/Resistance:

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

o M4                2.502

o PMH             2.330

o MTrend        2.236

o M1                2.236

o Close             2.086               

o PML              1.933         

o M3                1.909

o M2                1.708         

o M5                1.442

Active traders can use PMH: 2.330 as the upside pivot, maintaining a long position (yield perspective) above that level.  Active traders can use M3: 1.909 as the downside pivot, maintaining a short position (yield perspective) below that level.

Summary

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