Monthly Archives: November 2021

Portfolio Trade Alert – 11-29-21

Portfolio Trade Alert For 11-29-21

Top 10-Buys and Sells From TPA Research

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, Portfolio 11/22/2021

November 22, 2021

*** Portfolio Trading Alert ***  – Equity Model Only

We sold Verizon (VZ) in the equity model this morning for tax-loss harvesting. We have a lot of gains to offset this year from profit-taking.  While we like Verizon fundamentally, particularly the 4% yield, we think it could continue to trade weaker over the next couple of weeks as mutual funds and professional managers do the same. We will likely buy it back in a month as it should benefit from the infrastructure bill and a potential shift to value next year.

  • Sell 100% of Verizon (VZ)

Cyber Monday Stock Sales Entice Investors

Cyber Monday stock gains erased a good chunk of Black Friday’s losses. Fear of another high-powered Covid variant was tempered over the weekend, and investors, like shoppers, bought into Cyber Monday deals. Oil recovered some of its Friday meltdown rising 2.5%.

Despite the renewed optimism, there remains a little trepidation in the market. We can best see it in the travel and lodging sectors. For example, Bookings.com (BKNG) only picked up 1.25% of its 7% decline from Friday. Many of the largest resorts and casinos were red on the day. Technology led the way higher, as shown below, while healthcare and financials barely eked out gains.

S&P 500 sector performance stocks
Daily Market Commnetary

What To Watch Today

Economy

  • 9:00 a.m. ET: FHFA House Price Index, month-over-month, September (1.2% expected, 1.0% in August)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite Index, month-over-month, September (1.20% expected, 1.17% in August)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite Index, September (19.30% expected, 19.66% during prior month)
  • 9:45 a.m. ET: MNI Chicago PMI, November (67.0 expected, 68.4 in October)
  • 10:00 a.m. ET: Conference Board Consumer Confidence Index, November (110.0 expected, 113.8 in October)

Earnings

  • 4:05 p.m. ET: Salesforce.com (CRM) to report adjusted earnings of 92 cents on revenue of $6.80 billion

Technical Backdrop Still Questionable

Yesterday’s “Cyber Monday” rally was not surprising given the depth of the decline on “Black Friday.” However, while the rally was strong enough to put the market back above broken support, it failed resistance at the 20-dma. Also, with major “sell signals” still intact, we could see some volatility in the days ahead.

This morning fears are resurfacing over the omicron variant and futures are sliding lower once again. But that is just the excuse to explain the sell-off we have been discussing for the last two weeks.

However, with the market getting decently oversold on a short-term basis, such should set investors up for the seasonal “year-end” rally. Therefore, it is a good idea to start “making your list, and checking it twice,” and using opportunistic entry points to add equity exposure heading into 2022.

S&P 500 Technical Chart

A Historic Cluster Of Warnings

“Single warning signs, like we saw in March, are less of a worry. It’s a more significant issue when we see multiple days of warnings and on more than a single exchange.

This is a problem now because they’ve been firing consistently lately, ahead of Friday’s carnage. In just 5 days, a combined 12 warning signs have triggered between the NYSE Hindenburg Omen, Nasdaq Hindenburg Omen, NYSE Titanic Syndrome, and Nasdaq Titanic Syndrome.” – Sentiment Trader

Titanic Hindeburg Warnings

“It’s been rare to see such a big cluster of warnings across both exchanges over the past 25 years. The handful of times these clusters popped up, the S&P 500 had a tough time holding any upside momentum.”

Titanic and Hindeburg Warnings vs the stock market.

Powell Pivots Gets Excuse To Slow Taper

We have wondered how long it would be before Jerome Powell came up with some excuse to delay tapering of the balance sheet and hiking the Fed funds rate. We now know the answer according to Zerohedge:

But for one market participant in particular, it’s a great excuse (especially after his re-nomination) as Fed Chair Powell’s prepared remarks ahead of The Coronavirus and CARES Act hearing before the Committee on Banking, Housing, and Urban Affairs, offered some insight into his next actions (after a token shift to more hawkish positions by some Fed speakers).

Here is the key paragraph:

“The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation.

Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.

That uncertainty can mean only one thing when it comes from The Fed… backing away from the taper’s current trajectory (and any guesses at when takeoff may occur).

Of course, this is truly amusing because only 10% of Wall Street respondents to a flash DB poll thing Omicron will be a big issue at year end…

Twitter Rollercoaster

On “Cyber Monday,” Twitter’s stock jumped almost 10% at the market open on news that CEO Jack Dorsey will be stepping down. The gains were short-lived, as shown in the graph below. Twitter has become a large social media brand, but its stock price is flat since IPO’ing in 2013. After the initial rush of enthusiasm, it appears investors are concerned that promoting a long-time Twitter veteran (current CTO – Parag Agrawal) to replace Dorsey will not result in the types of changes investors are asking for.

Twitter stock

Omicron Variant Shakes Wall Street

Omnicron Variant cyber monday

What’s Wrong with Foreign Stocks?

The graph below compares two widely followed foreign stock ETFs and the S&P 500, from the beginning of the Covid outbreak through today. EEM holds emerging market stocks, and EFA developed market stocks. As shown, all three ETFs performed similarly during the decline in early 2020 and the recovery afterward. However, starting in the spring of 2021, the foreign market ETFs peaked while the S&P 500 continued to new highs. Over the last nine months emerging markets (EEM)s have given up about 25% of their post-Covid gains, while developed markets (EFA) have essentially flatlined. The following factors help account for some of the U.S. equity outperformance:

  • Since June 2021, the USD index is up about 8%.
  • The economic recovery in the U.S. has been stronger than in most nations.
  • The Fed is slightly more hawkish than other central banks.
  • China’s economic activity has slowed significantly, weighing heavily on many emerging markets.
emerging and developed stock markets

The Week Ahead

The week’s significant events will be the ADP employment report on Wednesday and the BLS report on Friday. Currently, the forecast is for a gain of 550k jobs in the November BLS jobs report. Investors are likely to focus on the labor participation rate as Fed Chairman Powell claims the lower rate is a sign of labor weakness. The current estimate is for the participation rate to uptick 0.1% to 61.7%.

Investors will also watch the ISM manufacturing and services surveys on Wednesday and Friday, respectively. Current indications are that both numbers will remain at their current levels. We will follow the price gauges in both surveys closely.

The next Fed meeting will be in two weeks on the 15th of December. Assuming the new covid variant does not become problematic for global economic activity, we might see some Fed members encouraging a faster tapering pace in speeches and comments this week. Voting Fed members go into their self-imposed media blackout period next week, so this week may be their last chance to speak up publically before the meeting.

Investors will be looking for retail results from Black Friday and Cyber Monday to help assess holiday sales.


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Market Correction Before The Santa Rally Has Started

Last week, we asked if there would be a market correction before “Santa visits Broad and Wall?”

Investors’ ‘wish lists’ are hung by the chimney with care, hopeful the ‘Santa Claus rally’ will soon be there. While they remain ‘snug in their beds, the historical data dances in the heads.’ The chart below from @themarketear shows the annual “seasonality” from 1985 through 2019.

It certainly seems there is little to worry about. However, notice that dip at the beginning of December.

Seasonality for santa claus rally.

We made the case that mutual fund distributions would provide additional selling pressure on a market already plagued by weak internals. To wit:

However, there is potentially a negative impact on the market. Such is particularly the case when volumes are weak, liquidity is low, and breadth is poor. As shown, during the entire advance from the September lows, the volume declined. Importantly, over the last week, breadth deteriorated.

All that was missing was a catalyst to create a market correction.

“Over the last couple of weeks, the market has been warning to the risk of a downturn, all that was needed was a catalyst to change sentiment.” – The Real Investment Report

Chart updated through Friday.

The Lack Of Liquidity

On Friday, news of a new “Covid” variant broke, and stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows.

“Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.”Real Investment Report

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

As you will note, the market correction was swift. Such is because of the “lack of liquidity” in the markets.

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

The chart from last week’s discussion showed there was a lack of volume a lower prices. As I wrote:

“Buyers appear to be ‘living’ closer to the 50-dma (orange dashed line.) As the Wall Street axiom goes: ‘Sellers live higher. Buyers live lower.'”

Sp500 technical chart volume at price

These “gaps” between buyers and sellers lead to sharp price reversions in markets.

Breadth Suggests There May Be More Work To Do

While the market correction last Friday was sharp and did push several of our short-term indicators into oversold territory, any bounce this week could lead to more selling pressure near term. While we previously noted our concerns about the “bad breadth” of the market, SentimenTrader also suggests such may lead to a pause in the rally. To wit:

“For only the 6th time since 1926, declining issues outnumbered advancing issues for 7 consecutive days when the S&P 500 closed 2% or less from its 252-day high. If I eliminate the distance below the high condition, the study returns 123 instances when screening out repeats. Almost half of those signals occurred when the S&P 500 was down 10% or more from its 252-day high.”

“This signal triggered 5 other times over the past 96 years. After the others, future returns and win rates were weak in the 2-to-8-week time frame. If I optimize a short signal, the test returns 27 days as the best time frame to hold a negative view of the market. And, the S&P 500 closed down in 5 out of 6 instances. The sample size is small.”

Notably, weak breadth, light volumes on rallies, and speculative behaviors make the market vulnerable to sharp reversals. Moreover, as noted last week, with mutual funds adding to the selling pressure over the next two weeks, there is a risk of further downside.

However, such will provide a trading opportunity for year-end “window dressing.”

Trading The Santa Rally

I agree with Doug Kass’ recent comment:

While I am not bullish, I am less bearish. On a (tactical) trading and investing basis, markets probably overreacted to the Omicron news on Friday, It is likely time to consider being a bit more greedy when others are fearful. Many stocks, away from “The Nifty Seven,” have fallen dramatically and may represent both shorter and longer-term value“

We agree. After previously taking profits in overbought and extended equities, we are now looking for discounted positions in technology, energy, consumer, and financial-related sectors.

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

One other comment is that the “Omicron variant” could provide “cover” for the Federal Reserve to slow their monetary tightening. The majority of the rally on Monday was likely bulls coming around to this idea. As such, it was no surprise to see Jerome Powell already pivoting towards a more dovish stance in prepared remarks for the CARES Act Hearing.

“The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation.

Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.” – Powell

Of course, this is the excuse Powell needs to slow tapering of the balance sheet and delay hiking interest rates.

For now, that keeps the bullish bias in stocks. But as we head into 2022, I would not be surprised to see a pick up in volatility as liquidity flows decline along with economic growth.

As an investor, always remember that making money in the market is only one-half of the job. Keeping it is the other.

“We can not direct the wind, but we can adjust the sail.” – Anonymous

Viking Analytics: Weekly Gamma Band Update 11/29/2021

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) fell sharply on Friday, closing on the lows and below the end-of-day gamma flip level near 4,620.  Our model cut SPX exposure to 30%.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,460), the model will reduce the SPX allocation to zero.

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

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. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma 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.


Could The Fed Trigger The Next “Financial Crisis”

Could the Fed trigger the next “financial crisis” as they begin to hike interest rates? Such is certainly a question worth asking as we look back at the Fed’s history of previous monetary actions. Such was a topic I discussed in “Investors Push Risk Bets.” To wit:

“With the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” is the most significant risk.

The ‘stability/instability paradox’ assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

The problem, as shown below, is that throughout history, when the Fed begins to hike interest rates someone inevitability pushes the “big red button.”

Fed funds rates crisis

The behavioral biases of individuals remain the most serious risk facing the Fed. While they may hope that individuals will act rationally as they hike rates and tighten monetary policy, investors tend not to act that way.

Importantly, each previous crisis in history was primarily a function of extreme excesses in one area of the market or economy.

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy

What about currently?

A Bubble In “Everything”

No matter what corner of the market or economy you look there are excesses.

  • Real estate,
  • FANG-NATM (Facebook, Apple, Netflix, Google, Nvidia, Amazon, Tesla and Microsoft)
  • EV’s – Tesla is a $1 Trillion dollar company.
  • Corporate debt,
  • Credit,
  • Private equity,
  • SPAC’s,
  • IPO’s,
  • “Meme” stocks; and,
  • Options speculation

The list could go on, but you get the idea.

There is a correlation between the Fed’s interventions and the surge in speculative risk-taking. As shown, household equity ownership is highly correlated to the Fed’s balance sheet.

Equity ownership to Feds balance sheet

Unfortunately, in order to invest in the financial markets, individuals must have disposable income with which to invest. However, while the massive interventions by the Fed inflated the most prominent financial bubble in history, it did little to boost economic growth or prosperity. As a result, the top 10% of income earners own roughly 90% of the financial market assets.

Breakdown of equity ownership

Not surprisingly, after more than a decade of ultra-accommodative monetary policies, risk appetites surged as participants came to believe the Fed eliminated all “risk.”

Of course, if there is “no risk of loss,” why not take on more risk? Such is exactly what everyone did.

A Bubble In Leverage

In Seth Klarman’s famous book, “A Margin Of Safety,” he discussed the 1980’s bond mania before it imploded. At that time, many companies issued bonds even though they could not afford to pay the interest expenses. Today, we call such companies “zombie companies,” as they must feed on cheap debt to stay alive. Currently, the market capitalization of these zombie firms is at a record.

Total EV of firms with EBIT less than interest expense on debt
Chart courtesy of Kailash Concepts

The obvious problem is what happens when they cannot refinance their debt. Unfortunately, as Kailash Concepts explains, debt itself is a significant risk.

Currently, the world is awash in financial alchemy. There is currently a record number of companies unable to cover their interest expense from profits.

Since 2007, a big part of America’s debt crisis has moved from the financial sector to non-financial stocks with too much debt. We believe the mix of record debt and record equity valuations is likely a side effect of real rates approaching lows last seen in 1973. Whether we are right or wrong on the causality, the facts are intimidating in our view.

Our research has documented that the world has never been less prepared or less equipped to deal with a possible outbreak of inflation or pull-back in Federal largesse.

Total Debt of Non-Financial Firms To GDP

However, it isn’t just a corporate leverage bubble. It is also a bubble in investor leverage as individuals take on debt to chase markets.

Margin Debt and Free Crash Balances

Of course, the critical thing about “margin debt” is that it fuels the bullish advance. But, unfortunately, it also accelerates the market’s eventual decline as leverage reverses. Such is always a brutal and mauling event, which is why Wall Street calls it a “bear market.”

The Risk Of A Policy Mistake Is Enormous

In “Rising Interest Rates Matter” we discussed how if interest rates rise, the Fed tightens monetary policy, or the economic recovery falters, a financial crisis is possible.

“In the short term, the economy and markets (due to current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, they act as a ‘brake’ on economic activity as rates NEGATIVELY impact a highly levered economy:”

  • Rates increases debt servicing requirements reducing future productive investment.
  • Housing slows. People buy payments, not houses.
  • Higher borrowing costs lead to lower profit margins.
  • The massive derivatives and credit markets get negatively impacted.
  • Variable rate interest payments on credit cards and home equity lines of credit increase.
  • Rising defaults on debt service will negatively impact banks.
  • Many corporate share buyback plans and dividend payments are done through the use of cheap debt.
  • Corporate capital expenditures are dependent on low borrowing costs.
  • The deficit/GDP ratio will soar as borrowing costs rise sharply.

Most importantly, over the last decade, the primary rationalization for overpaying for equity ownership is that low rates justify high valuations. Unfortunately, with inflation surging, which shrinks profit margins, and the Fed set to hike rates, valuations are likely a bigger issue than most suspect.

Equity ownership vs Valuations

As Mohammed El-Erian stated in a recent interview:

“Investors should keep an eye on the risk of an abrupt shift from a relative valuation market mindset to an absolute valuation one. If that happens, you should stop worrying about the return on your capital and start worrying about the return of your capital.” 

However, for now, there is no reason to worry about the next “financial crisis.”

Well, that is unless someone pushes the “big red button.”

Black Friday Sales Hit The Markets As Omicron Emerges

The typical uneventful post-Thanksgiving Friday trading session was anything but that. Black Friday market discounts are now in effect as the stock market, cryptos, and many commodities fell sharply. Black Friday investors fear a repeat of the lockdowns, and economic weakness may be upon us again. Crude oil is among the biggest loser, down over 12% and below $70 a barrel. Bond yields fell sharply as the bond markets are pricing in slower economic growth and more dovish policy.

The graphs below, a sneak peek of our soon-to-be-released new version of RIAPro, show the day’s biggest gainers and losers. Moderna and Pfizer lead the winners. The ten worst stocks are primarily airlines and cruise ship companies.

S&P 500 winners and losers
+

Not surprisingly, market futures are pointing higher this morning. The question will be whether they are sustainable.

Daily Market Commnetary

What To Watch Today

Economy

  • 10:00 a.m. ET: Pending home sales, month-over-month, October (0.8% expected, -2.3% in September)
  • 10:30 a.m. ET: Dallas Federal Reserve Manufacturing Activity Index, November (17.0 expected, 14.6 in October)

Earnings

  • No notable reports scheduled for release

Reflex Rally After “Black Friday” Plunge

As news of a new “Covid” variant broke, stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows. Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.

With mutual fund distributions running through the first two weeks of December, there is additional downside pressure on stocks near term. However, our “money flow sell” signal is firmly intact and confirmed by the MACD signal. Such suggests we continue to maintain slightly higher levels of cash.

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

Notably, the market is getting oversold near-term, with the money-flow signal depressed. Such suggests that any further weakness will provide a short-term trading opportunity. As discussed last week, the statistical odds are high that we will see a “Santa Rally” as most professional managers will position for year-end reporting.

We expect a short-term bounce, but there is more risk of selling over the next few days.

Green in a Sea of Red on Black Friday

The Finviz heat map below shows that many stocks are down 2-3% on the day, but a few stocks are bucking the trend. In most cases, the green on the map is in businesses that benefit from the lockdowns. In addition to the obvious winners in the healthcare industry are Verizon, NetFlix, and Clorox. Moderna and Pfizer are up significantly. The restaurant and travel business are faring the worst. Notice losses are approaching 10% for Marriot, Las Vegas Sands, and Booking.com in the upper right corner.

Stocks Down S&P 500 omicron

B.1.1.529 Variant is Roiling Markets

Stocks are declining worldwide due to a new variant of covid detected in South Africa. Per CNBC:

“South African scientist Tulio de Oliveira said in a media briefing held by the South Africa Department of Health on Thursday that the variant contains a “unique constellation” of more than 30 mutations to the spike protein, the component of the virus that binds to cells. This is significantly more than those of the delta variant.

Many of these mutations are linked to increased antibody resistance, which may affect how the virus behaves with regard to vaccines, treatments and transmissibility, health officials have said.”

The bond market is assuming the new strain will force the Fed into a more dovish policy stance. 2-year yields are down 12 bps this morning, essentially taking out half of a 25bps Fed rate hike over the next two years.

Many traders are out for the holiday, so liquidity will be poor and trading may likely be volatile.

Black Friday Disappointment

The good news: Black Friday retail traffic was up 47.5% over last year. The bad news: It was still 28.3% lower vs. 2019 levels, according to CNBC, citing preliminary data from Sensormatic Solutions.

The peak time for Black Friday shopping in stores was 1 p.m. to 3 p.m., similar to trends in past years, Sensormatic said. Black Friday is still predicted to be the busiest in-store shopping day of the season, according to Sensormatic.

On Thanksgiving day, visits to brick-and-mortar stores cratered 90.4% from 2019 levels, Sensormatic found. Retailers including TargetWalmart and Best Buy opted to keep their doors closed to customers on the holiday. Target has said it will be a permanent shift. -CNBC

Online spending fell from 2020 levels, meanwhile, with e-retailers ringing up $8.9 billion in Black Friday sales – down from $9 billion last year, according to Adobe Analytics, which noted that this is the first year that growth reversed from the prior year as long as records have been kept. The company analyzes over 100 million items in 18 product categories spanning 1 trillion visits to US retail sites.

Thanksgiving day online sales were flat from one year ago at $5.1billion, according to Adobe.

The numbers provide even greater evidence that the holiday season got stretched out as more Americans began their shopping as early as October. Retailers have been spreading out their promotional offers, too. According to a survey from the National Retail Federation, the retail industry’s leading trade group, 61% of consumers had already started purchasing holiday gifts before Thanksgiving. -CNBC

Courtesy of Zerohedge

The Dollar is on Fire

Other than Friday, the dollar has been strong. The impetus behind the dollar continues to be economic data that the market believes will push the Fed to become more hawkish. Many corporate and sovereign borrowers that borrow in dollars for use in their home country get exposed to currency risk. Essentially, a stronger dollar increases their net borrowing costs as they have to convert to dollars at a higher rate to pay interest and principal. As such, a strong dollar tightens liquidity for the rest of the world and will inhibit global economic growth if the dollar continues upwards. The graph below shows the dollar index is up over 7% year to date.

U.S. Dollar

Defining “Prolonged” and “Substantially Exceeds”

The Fed recently informally updated its price stability policy. Under the new inflation averaging regime, they will allow inflation to run higher than 2% for short periods to compensate for periods when it was below average. The graph below shows the three-year average inflation rate is now 2.7%. Further, the annual inflation rate is 6.2%. Fed members are increasingly getting nervous that inflation is running hot for a prolonged period and the current rate substantially exceeds the Fed’s target on both a short-term and longer-term averaging basis. We expect to see various Fed members discussing their thoughts on how to adjust monetary policy to manage inflation better.

cpi inflation

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“Black Friday” Plunge As Market Rattled By Covid Variant

In this 11-26-21 issue of “Black Friday” Plunge As Market Rattled By Covid Variant

  • “Black Friday” As Market Plunges
  • Time To Buy Oil
  • Yes, Interest Rates Will Matter
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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“Black Friday” As Market Plunges

Last week, we discussed the weakness of the underlying market as “FOMO” had returned to the market.

“The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.”

Chart updated through Friday.

S&P 500 technical update

Over the last couple of weeks, the market has been warning to the risk of a downturn, all that was needed was a catalyst to change sentiment.

That occurred as news of a new “Covid” variant broke, stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows. Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.

With mutual fund distributions running through the first two weeks of December, there is additional downside pressure on stocks near term. However, our “money flow sell” signal is firmly intact and confirmed by the MACD signal. Such suggests we continue to maintain slightly higher levels of cash.

S&P 500 money flow signal RIAPRO

Notably, the market is getting oversold near-term, with the money-flow signal depressed. Such suggests that any further weakness will provide a short-term trading opportunity. As discussed last week, the statistical odds are high that we will see a “Santa Rally” as most professional managers will position for year-end reporting.

Just remember, nothing is guaranteed. We can only make educated guesses.

Will The Fed Slow Their Roll

While “Black Friday” usually marks the beginning of the retail shopping season, the question is whether the new “variant,” which is flaring concerns of additional lock-downs, will reverse the current economic recovery. As Barron’s notes, it will be worth watching the Fed closely.

“Fixed-income markets are signaling that the Federal Reserve will have to increase interest rates sooner than expected, which could put a dent in the stock market.

The yield on the 2-year Treasury note has gone from 0.5% in early November to 0.64% as of Wednesday. The move suggests that investors expect the Fed to raise interest rates to combat inflation that remains higher than expected because of soaring consumer demand and supply chains that are struggling to match demand.

Indeed, minutes released Wednesday from the Fed’s meeting earlier this month show that members of the central bank are prepared to increase rates sooner than previously anticipated if inflation remains high.”

Of course, this was before “Black Friday” sent yields plunging 10% lower in a single day. Suddenly, the bond market is starting to question the sanity of hiking rates in the face of an ongoing pandemic.

Bonds technical update

While many pundits have suggested higher interest rates won’t matter to stocks, as we will discuss momentarily, they do matter and often matter a lot.

The surge in the new variant gives the Fed an excuse to hold off tightening monetary policy even though inflationary pressures continue to mount. But, what is most important to the Fed is the illusion of “market stability.”

What “Black Friday’s” plunge showed was that despite the Fed’s best efforts, “instability” is the most significant risk to the market and you.

More on this in a moment.


Daily Market Commnetary

Time To Buy Oil?

Once a quarter, I review the Commitment Of Traders report to see where speculators place their bets on bonds, the dollar, volatility, the Euro, and oil. In October’s update, I looked at oil prices that were then pushing higher as speculators were sharply increasing their net-long positioning on crude oil.

We suggested then that the current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

Oil Rates Dollar, Traders Are Pushing Oil, Rates & The Dollar. Are They Right?

The dollar rally was the most crucial key to a view of potentially weaker oil prices. Given that commodities are globally priced in U.S. dollars, the strengthening of the dollar would reduce oil demand. 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.” – June 2021

Portfolio, Rates, S&P 500, energy, yield

Since then, as expected, the dollar rally is beginning to weigh on commodity prices, and oil in particular.

oil dollar technical chart.

While the dollar could certainly rally further heading into year-end, oil prices are becoming much more attractive from a trading perspective. The recent correction did violate the 50-dma, which will act as short-term resistance. However, prices are beginning to reach more attractive oversold levels.

There are also reasons to believe higher oil prices are coming.



Higher Oil Prices Coming

The Biden administration released oil from the “Strategic Petroleum Reserve,” attempting to lower oil prices. He also tasked the DOJ to “investigate oil companies for potential price gouging.” These actions are thinly veiled attempts to regain favor with voters but will not lower oil prices.

Oil prices are NOT SET by producers. Instead, speculators and hedgers set oil prices on the NYMEX. Think about it this way:

  • If oil companies are setting prices to “reap profits,” why did oil prices go below ZERO in 2020?
  • Furthermore, would producers need to “hedge” current production against future delivery?

There are two drivers reflecting positioning by speculators and hedgers:

  1. The expected supply and demand for oil; and,
  2. The value of the dollar.

The more critical problem comes from the Administrations’ attack on production over “climate change” policies. As noted in Crude Investing: Energy Stocks & ESG (kailashconcepts.com):

This isn’t rocket science.  Look at the sharply lagging rig response to the rise in energy prices post the Covid crash. This is an anomaly. 

According to history, there should be ~1,300 rigs in operation today based on current oil prices. With only ~480 rigs running today, oil’s prospects may be bright over the long haul.”

Portfolio, Rates, S&P 500, energy, yield

With output at such low levels, OPEC+ refusing to increase production, and “inefficient clean energy” increasing demand on “dirty energy,” higher future prices are likely.

If the economy falls into a tailspin, oil prices will fall along with demand, so nothing is assured. However, the ongoing decline in CapEx in the industry suggests production will continue to contract, leaving it well short of future demand.

Portfolio, Rates, S&P 500, energy, yield
Chart courtesy of Kailash Concepts

That is the perfect environment for higher prices.


In Case You Missed It


Higher Interest Rates Will Lead To Market Volatility

Did “Black Friday’s” plunge send a warning about rates? Last week, we discussed that it isn’t a question of if, but only one of when.

I showed the correlation between interest rates and the markets. With the sharp drop in rates, it is worth reminding you of the analysis. It is all about “instability.”

The chart below is the monthly “real,” inflation-adjusted return of the S&P 500 index compared to interest rates. The data is from Dr. Robert Shiller, and I noted corresponding peaks and troughs in prices and rates.

interest rates vs S&P 500

To try and understand the relationship between stock and bond returns over time, I took the data from the chart and broke it down into 46 periods over the last 121-years. What jumps is the high degree of non-correlation between 1900 and 2000. As one would expect, in most instances, if rates fell, stock prices rose. However, the opposite also was true.

Interest rate changes vs S&P 500

Rates Matter

Notably, since 2000, rates and stocks rose and fell together. So bonds remain a “haven” against market volatility.

As such, In the short term, the markets (due to the current momentum) can DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy:

  • Rates increases debt servicing requirements reducing future productive investment.
  • Housing slows. People buy payments, not houses.
  • Higher borrowing costs lead to lower profit margins.
  • The massive derivatives and credit markets get negatively impacted.
  • Variable rate interest payments on credit cards and home equity lines of credit increase, reducing consumption.
  • Rising defaults on debt service will negatively impact banks which are still not as well capitalized as most believe.
  • Many corporate share buyback plans and dividend payments are done through the use of cheap debt.
  • Corporate capital expenditures are dependent on low borrowing costs.
  • The deficit/GDP ratio will soar as borrowing costs rise sharply.

Critically, for investors, one of the main drivers of assets prices over the last few years was the rationalization that “low rates justified high valuations.”

Either low-interest rates are bullish, or high rates are bullish. Unfortunately, they can’t be both.

What “Black Friday’s” plunge showed was the correlation between rates and equity prices remains. Such is due to market participants’ “risk-on” psychology. However, that correlation cuts both ways. When something changes investor sentiment, the “risk-off” trade (bonds) is where money flows.

The correlation between interest rates and equities suggests that bonds will remain a haven against risk if something breaks given exceptionally high market valuations. The market’s plunge on “Black Friday” was likely a “shot across the bow.”

It might just be worth evaluating your bond allocation heading into 2022.



Portfolio Update

We made no substantive changes to portfolio allocations this past week given due to the holidays. Generally, the week of Thanksgiving is a poor indicator of market sentiment given the “inmates are running the asylum.”

Therefore, despite the market swinging around a good bit this past week, we will re-evaluate our positioning and holdings when institutional traders return to their desks next week.

However, as a reminder:

“Over the last two weeks, we took profits in overbought and extended equities. We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.”

Portfolio allocation model.

Despite the sell-off on Friday, the bullish bias remains strong. We also remain in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

However, as discussed most of this week, mutual fund distributions will begin in earnest and continue through the second week of December. Such suggests we could see some additional volatility and potential weakness in the market as those distributions get made.

Critically, any correction will provide a decent entry point for the year-end “Santa Claus” rally and the first week of January, which tend to be strong. Therefore, we will try and take advantage of that.

While Friday’s plunge likely shocked you out of your “tryptophan-induced” coma, I hope you had a Happy Thanksgiving.

See you next week.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

SP500 Tear Sheet

Performance Analysis

Market Sector Relative Performance

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 65.83 out of a possible 100.

Technical gauge RIAPRO

Portfolio Positioning “Fear / Greed” Gauge

Our “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 80.55 out of a possible 100.

Fear Greed Gauge

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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.
Risk Range Report

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

Market index growth screen

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

dividend growth screen

Fundamental Growth Screen

fundamental growth screen

Aggressive Growth Strategy

aggressive growth screen

Portfolio / Client Update

This past week, we took no substantive actions in portfolios. Such is because Thanksgiving week usually trades on very light volume.

“Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities (F, NVDA, AMD). We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

Santa Claus Rally, Santa Claus Rally Is Coming, But Will Markets Correct First?

The best opportunity to increase equity would come from a correction in early December as mutual funds distribute their annual gains. Such would provide a better entry point for the year-end “Santa Claus Rally.”

As we move closer to the end of the year, I will review our annual performance in both primary models and discuss what we expect as we head into 2022. With the Fed on course to taper their balance sheet, and the market forecasting 3-rate hikes, next year will likely be an entirely different “ball game.”

Portfolio Changes

There were no changes this past week.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Jobless Claims Plunge To 52 Year Lows

As we show below, Initial Jobless Claims plunged to a level last seen in 1969. This indicator is yet another signal the jobs market is fully or near fully recovered. San Francisco Fed President Mary Daly took notice. She commented: “It would not surprise me if in the least there were one or two rate increases next year.” The bottom line is that plunging jobless claims add to the pressure on the Fed to speed up the taper process and begin the discussion to raise interest rates.

Jobless Claims

Despite, plunging jobless claims, futures are tumbling this morning.


S&P 500 futures (
ES=F): 4,623.25, -75.75 (-1.61%)

Dow futures (YM=F): 34,973.00, -776.00 (-2.17%)

Nasdaq futures (NQ=F): 16,224.50, -141.50 (-0.86%)

Daily Market Commnetary

What To Watch Today

There are no major economic releases scheduled for Friday. The stock market will close at 1 p.m. ET on Friday due to the holiday weekend. 

Economic Data Recap

Jobless Claims plunged to 199k in the latest week, marking a low going back to November 1969. Keep in mind that the population is 65% larger today than in 1969, so today’s number is off the charts on a population-adjusted basis. This is yet another piece of data that affirms the labor market is robust. Having an inflation problem and strong labor market is more evidence the Fed needs to speed up tapering QE and start contemplating rate hikes.

Durable Goods fell 0.5% versus expectations for a 0.3% gain and a prior month reading of -0.4%. Excluding transportation, the number was positive at 0.5%. Accounting for the difference is the auto sector, which struggles to produce cars due to the chip shortage.

Wholesale inventories rose 2.2% versus 1.4% last month. This is a positive sign that supply line problems and shortages are abating. However, Retail Inventories only increased by 0.1% versus falling 0.2% last month. Either many retailers are not fully stocking up on goods to help justify higher prices, or trucking problems are making it difficult to deliver goods. It is likely a combination of both factors.

The $1.25 Tree

“In 1986 the first five locations opened of a new retail outlet, which had a simple premise for what it would sell, and an even simpler name — “Only $1.00”. Although not the first of its kind, “Only $1.00” would grow into what today is Dollar Tree, which is a $33bn giant with more than 15,900 retail locations throughout the US, split between its two biggest brands Dollar Tree and Family Dollar.

This week Dollar Tree had some big news, announcing that most of its prices will rise from $1 to $1.25. That’s a change that the company has been putting off for some time, dropping some products over the years that it could no longer afford to stock for just $1.” – Chartr

Dollar Tree

When the company started $1 could get you a fair amount. Today it buys you much less. In fact, $1 in 1986 is more like $2.50 in today’s money once you account for inflation over those 35 years.

If you bought $1 worth of Dollar Tree shares in 1995, your $1 would be worth, ironically, roughly $125 today

Junk Bonds Sending A Signal

The graph below shows the strong correlation between JNK and the S&P 500. JNK is a popular junk bond ETF. The ETF just hit lows going back to July, while the S&P is nearly 10% above its July levels. JNK is also back to its 200dma, something the S&P hasn’t done since it broke through the 200dma in June 2020. Higher yields for junk bond issuers can lead to financial hardship and bankruptcy in some cases as they tend to be overleveraged. Are inflation and the possibility of the Fed raising rates finally concerning JNK investors? Maybe the better question is, is the recent price action of JNK foreshadowing problems for the equity markets?

jnk junk bonds S&P 500

More Details on the SPR Oil Release

Of the 50 million barrels being released from the Strategic Petroleum Reserve, 32 million will be under the exchange program.  Companies that receive oil under the program must pay it back and with interest, so to speak. The winning bidders take delivery starting December 16th from one of four sites. They will have to return the oil with a premium. Each site has a different premium and return date. For example, Bryan Mound will offer 10 million barrels. The oil has three return dates, with the first starting January 2023. If the oil is returned at that time, the winning bidder must return an additional 3.9% of oil. The premium increases to 5.3% and 8.6% if they choose the second or third delivery dates, respectively. In the short run, the release will add supply to the market but reduce it starting in July of 2022.

The graph below, courtesy of Bianco Research, provides context for the size of the SPR and recent withdrawals from the reserves.

oil reserves SPR

Tesla Is Traded More Than Any Other Stock On The Market

Tesla is truly the stock of the times. Having more than doubled in value in the last year, the company has become a magnet for the full range of investors from retail traders to hedge funds and institutions.

Data from Koyfin reveals that ~$40bn of Tesla shares changed hands yesterday — more than twice as much as the next most-traded stock, and way more than other mega-cap giants like Apple, Amazon and Microsoft. Put another way, the amount traded in Tesla yesterday was equivalent to the volume traded in 307 members of the S&P 500 Index (which is a group of 500 of the largest companies).

A great piece in the FT reveals that the story goes much deeper. We’ve charted just the vanilla equity trading volume, but the volume traded in financial derivative markets (options) is even more off the charts, with more than $240bn a day recently being bet on Tesla by its army of fans, or detractors (who presumably think the company is overvalued).” – Chartr

Tesla Stock Trading

Who knows, with jobless claims plunging to historically low levels, maybe more people can afford to buy a Tesla?

Snapchat – Investors Are Overly Optimistic

“Snapchat’s primary source of revenue is advertising based on the use of its camera platform capable of taking “snaps” or short videos and images.  SNAP shares have soared on the euphoria around rising levels of “daily active users.” With 83% of the 41 analysts covering SNAP being bullish, Wall Street’s financial advice is “BUY”.  For those interested, we have discussed how groupthink is a risk in prior missives.

Our team believes that Snapchat may have been an outsized beneficiary of herding.  In our view, many investors are creating narratives to justify a valuation we believe is simply untenable. The stalling of the stock in the last few months may point to an opportune time to sell.”Kailash Concepts

Snapchat Investos Stock

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Technical Value Scorecard Report – Week Ending 11-26-21

Relative Value Graphs

  • Most sectors and factors/indexes remain oversold versus the S&P 500. As we noted last week, the analysis continues to pick up on the market’s bad breadth. Of note, communications are grossly oversold and are due for a bounce on a relative basis versus the index.
  • Financials beat the S&P 500 by over 2.5% last week, bringing its score from moderately oversold to fair value. Powell’s renomination, and the likely continuation of bank-friendly monetary policy, seem to be driving the outperformance. Energy beat the S&P 500 by over 5%, but its score only modestly improved to fair value. Why did financials improve so much but not energy? The technical analysis in this study uses multiple periods. Accordingly, while the past week of price activity matters, the prior weeks also significantly influence, especially the periods that drop out of the underlying analysis comprise the score.
  • Discretionary and technology took it on the chin over the past few days, and their scores fell slightly, albeit they remain overbought.
  • Developed international markets are grossly oversold versus the S&P 500 and likely due for a relative bounce.
  • The third table below highlights the consistent poor relative performance of the communications sectors over the last six months and the solid relative outperformance for discretionary over the same period.

Absolute Value Graphs

  • While most sectors are oversold on a relative basis, they remain overbought on an absolute basis. Communications is the only sector in oversold territory. Discretionary and technology, with scores over 75% last week, both fell to more moderate overbought levels.
  • Real estate (XLRE) is now the most overbought sector, followed closely by many sectors with similar scores.
  • Emerging markets and developed international markets are the two most oversold sectors. Developed markets are only slightly oversold compared to its very oversold relative score.
  • The bond scores show mortgages (MBB), corporate junk (HYG), and investment-grade corporates (LQD) are all oversold. Credit has been underperforming, which is another type of bad market breadth. The fourth graph below shows the concerning divergence between junk and the S&P 500. Whether or not you are interested in bonds, credit spreads at times foreshadow equity weakness.
  • The S&P score in the bottom right graph is overbought, but in line with where it has been the majority of the last year.  

Users Guide

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 action if other research and models do not affirm it.

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 the 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 is the most bearish.

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)

The NASDAQ Is On A Losing Streak

The NASDAQ was lower by over one percent at lunchtime but cut its losses in half toward the end of Tuesday’s trading. Had it held on to its losses, mimicking Monday’s 1% decline, it would be only the third time such a losing streak occurred in 2021. The black vertical lines below show the two times the NASDAQ fell by more than 1% in two consecutive days. The technology bull market of 2021 is a force to be reckoned with.

The NASDAQ and technology stocks are putting pressure on the S&P 500, yet most other stocks kept the S&P 500 in the green. Sound familiar? Last week the S&P was higher with a large majority of stocks lower, except the technology sector.

NASDAQ
Daily Market Commnetary

What To Watch Today

Economy

  • 7:00. a.m. ET: MBA Mortgage Application, week ended Nov. 19 (-2.8% during prior week)
  • 8:30 a.m. ET: Initial jobless claimsweek ended Nov. 20 (260,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Nov. 13 (2.033 expected, 2.080 million during prior week)
  • 8:30 a.m. ET: Advance Goods Trade Balance, October (-$95 billion expected, -$96.3 billion during prior week)
  • 8:30 a.m. ET: Wholesale Inventories, month-over-month, October preliminary (1% expected, 1.4% expected)
  • 8:30 a.m. ET: GDP annualized, quarter-over-quarter, 3Q second estimate (2.2% expected, 2.0% in 2Q)
  • 8:30 a.m. ET: Personal consumption, 3Q second estimate (1.6% expected, 1.6% in 2Q)
  • 8:30 a.m. ET: Core PCE, quarter-over-quarter, 3Q second estimate (4.5% expected, 4.5% in 2Q)
  • 8:30 a.m. ET: Durable goods orders, October preliminary (0.2% expected, -0.3% in September)
  • 8:30 a.m. ET: Durable goods orders excluding transportation (0.5% expected, 0.5% in September)
  • 8:30 a.m. ET: Capital goods orders, non-defense excluding aircraft, October preliminary (0.5% expected, 0.8% in prior print)
  • 8:30 a.m. ET: Capital goods shipments, non-defense excluding aircraft, October preliminary (0.5% expected, 1.4% in prior print)
  • 8:30 a.m. ET: Personal income, October (0.2% expected, -1.0% in September)
  • 8:30 a.m. ET: Personal spending, October (1.0% expected, 0.6% in September)
  • 8:30 a.m. ET: PCE Deflator, month-over-month, October (0.7% expected, 0.3% in September)
  • 8:30 a.m. ET: PCE Deflator, year-over-year, October (5.1% expected, 4.4% in September)
  • 8:30 a.m. ET: PCE Core Deflator, month-over-month, October (0.4% expected, 0.2% in September)
  • 8:30 a.m. ET: PCE Core Deflator, year-over-year, October (4.1% expected, 3.6% in September)
  • 10:00 a.m. ET: University of Michigan Sentiment, November final (67 expected, 66.8 in October)
  • 10:00 a.m. ET: New home sales, October (800,000 expected, 800,000 in September)
  • 2:00 p.m. ET: FOMC meeting minutes, November meeting

Earnings

  • 6:45 a.m. ET: Deere & Co. (DE) to report adjusted earnings of $3.88 on revenue of $10.48 billion 

Is A Jerome Powell Second Term A Bad Thing For Markets?

Jerome Powell Fed

Nasdaq Correction In Progress

We discussed over the last week or so that while investors were exceedingly bullish on the potential for a year-end “Santa Claus” rally, a correction was likely first. That correction is likely starting in the Nasdaq. As shown, with Nasdaq volatility rising, there is a risk of a deeper correction in Technology stocks near term as mutual funds sell to distribute large gains for the year.

The War on Oil Prices

President Biden is ordering the Department of Energy to release 50 million barrels of oil from the Strategic Petroleum Reserve. The action is in unison with China, India, Japan, Korea, and the U.K. Per the announcement:

“The President stands ready to take additional action, if needed, and is prepared to use his full authorities working in coordination with the rest of the world to maintain adequate supply as we exit the pandemic.”

What’s Wrong With Gold?

A reader asked us why gold fell over $40 an ounce on Monday. While some media outlets ascribe it to Powell’s nomination, the real answer lies in the two charts below. The first chart, from our article The Fed’s Ever-Growing Footprint, shows the strong correlation between the price of gold and real interest rates (nominal interest rates less the implied inflation rate). Gold prices often rise when real rates fall and vice versa. The second graph, courtesy of Zero Hedge, shows real rates (green) have risen about 20bps (from -1.20% to -1.00%) from midday Friday through Monday. The sharp increase is due to the 10-year break-even inflation rate (red) falling and bond yields rising.

gold real yields
real yields inflation

Will Bond Bears Be Proven Wrong, Again?

Short interest in bond futures is currently at or near record highs. Given the inflation outlook and the Fed’s lethargic response to combatting inflation, shorting bonds may seem like a nice trade. It may be, but context is valuable in this case. The graph below from Jim Bianco shows professional forecasters have been consistently wrong in predicting the path of bond yields. Those short bond futures better hope this time is different.

Treasury interest rates

Reminiscent of 1999

We stumbled upon the table below highlighting market performance by sector in the months leading to the NASDAQ crash in 2000. It looks awfully familiar to the poor breadth of the last few days of trading.


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Did Jerome Powell Just Mark The Market Top?

President Biden renominated Fed Chairman Jerome Powell for another four years as the head of the Federal Reserve. Jerome Powell is proving to be one of the more dovish members of the Fed, so his leadership warrants investor optimism that the Fed will continue to run exceedingly easy monetary policy. Despite a red day in the markets, JP Morgan, Goldman Sachs, and Bank of America are all up around 2% on the news. The Fed’s actions under Powell have and will likely continue to be bank-friendly.

Just as a reminder, in case you forgot, there is a high correlation between the Fed’s easy money policies and the market. With Jerome Powell on course to taper the balance sheet and hike rates, will his renomination mark the peak?

Daily Market Commnetary

What To Watch Today


Economy

  • 9:45 a.m. ET: Markit U.S. Manufacturing PMI, November preliminary (59.1 expected, 58.4 in October)
  • 9:45 a.m. ET: Markit U.S. Services PMI, November preliminary (59.0 expected, 58.7 in October)
  • 10:45 a.m. ET: Richmond Fed Manufacturing Index, November (11 expected, 12 in October)

Earnings

Pre-market

  • 6:45 a.m. ET: Burlington Stores (BURLto report adjusted earnings of $1.30 on revenue of $2.23 billion
  • 7:00 a.m. ET: Best Buy (BBY) to report adjusted earnings of $1.96 on revenue of $11.69 billion
  • 7:30 a.m. ET: Dick’s Sporting Goods (DKSto report adjusted earnings of $2.00 on revenue of $2.51 billion
  • 7:30 a.m. ET: Dollar Tree (DLTR) to report adjusted earnings of 95 cents on revenue of $6.44 billion
  • 8:00 a.m. ET: American Eagle Outfitters (AEOto report adjusted earnings of 61 cents on revenue of $1.23 billion

Post-market

  • 4:05 p.m. ET: Nordstrom (JWNto report adjusted earnings of 55 cents on revenue of $3.48 billion
  • 4:05 p.m. ET: Autodesk (ADSKto report adjusted earnings of $1.26 on revenue. of $1.12 billion
  • 4:05 p.m. ET: HP Inc (HPQ) to report adjusted earnings of 88 cents on revenue of $15.43 billion
  • 4:15 p.m. ET: VMWare (VMW) to report adjusted earnings of $1.54 on revenue of $3.12 billion
  • 4:15 p.m. ET: The Gap (GPS) to report adjusted earnings of 50 cents on revenue of $4.42 billion
  • 4:25 p.m. ET: Dell Technologies (DELLto report adjusted earnings of $2.23 on revenue of $26.81 billion

Economic Surprises Are Improving Which Supports The “Santa Rally”

The Citi Economic Surprise index finally turned positive after a very long stretch of disappointment. Such should be supportive, near term, of a market advance. (Such does not rule out short-term corrections along the way.) However, the improvement could be short-lived as we get into 2022 and liquidity begins to slow globally.

Citi Economic Surprise Index vs SP500 6mo ROC

Jerome Powell’s “Consigliere” Tells The World The Dollar Is Going Up

Below is an excerpt from TS Lombard on the implications from Richard Clarida’s last speech. (Courtesy of @themarketear)

  • Readies world for tightening by reminding all the Fed is the US central bank
  • Only way for policy to slow inflation is through strong dollar first
  • Deflation from China stayed the Fed in 2015/16, we see a repeat in 2022

The only way for the Fed to counter this inflation, without damaging the recovery and, more importantly, the equity market, is to ramp up the dollar. Rhetoric about raising the Fed funds rate, supported by accelerating the taper, accomplishes this goal.” – @themarketear

US Dollar

“China matters a lot to the 2022 outcome, and the downside risk is greater than what markets are pricing. Last, but not least, while ramping the dollar is the only route for the Fed to counter current inflationary risks, a strong dollar policy is not aligned with Administration aims.” – Steve Blitz

By the way, remember that the previous rationalization for buying overvalued equities was the WEAKNESS of the dollar.

dollar vs stocks

Rivian Is Falling Out of Favor

Last week’s favorite EV automobile company, Rivian (RIVN), is taking it on the chin. Today shares are down more than 10% as its plans to develop cars jointly with Ford (F) have been canceled. The stock has lost a third of its value in the last few days, yet is still up 14% since its November 11th IPO. Ford is up over 5% today on the news. Also helping Ford’s shares are rumors they may split off their electric car division.

rivian rivn

Is There Any Upside Left?

S&P 500 bull market

Powell Renominated

U.S. Federal Reserve Chair Jerome Powell is being renominated by President Biden for a second four-year term. The runner-up for the seat, Lael Brainard, is the new Vice-Chair. The initial reaction from the stock futures market is bullish. The asset markets and betting markets had high odds for his renomination.

Gamma Band Update

stock options gamma

Leverage At The Largest Pension Fund

As we write below, the use of leverage by retail investors is up sharply. Similar behaviors are occurring by many institutional investors, including the more conservative types. The following comes from David Robertson and Almost Daily Grant’s

“Facing a high bar to generate necessary returns within the confines of public markets, the largest pension fund in the United States tweaks its own strategy in the opposite direction.  The California Public Employees Retirement System (Calpers) voted in a board meeting yesterday to upsize its allocation to private equity holdings to 13% from 8% and bump private credit holdings to 5% from less than 1%, while adding $25 billion in leverage (equivalent to just over 5% of assets) to help juice returns. Without those changes, Calpers estimates that its portfolio would generate a 20-year return of 6.2% annually, lagging the 6.8% annual bogey established this summer, which was itself lowered from 7%.”

David’s summation- “To sum up, the largest pension fund in the country is not only increasing allocations to the riskiest assets at the most expensive valuations in history, but it is also taking on debt to boost returns even more.”

Leverage Galore

The graph from Top Down Charts below shows that investors’ participation in leveraged long ETFs has tripled since the pandemic. Due to zero interest rates, the cost of leverage has never been cheaper for the ETF managers and ultimately the investors. However, if the Fed gets closer to raising interest rates the cost of leverage will rise in anticipation. This may be a fly in the bull market’s ointment, but likely a story for next year, not this year.

Leveraged ETFs

The Week Ahead

Despite the Thanksgiving holiday, it will be a busy week for economic data releases. Of note are Existing and New Home Sales, PMI Manufacturing Survey, Durable Goods, GDP Price Index, and Personal Income and Spending. The Fed will also release the minutes from its November meeting on Wednesday.

Economic calendar

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

Santa Claus Rally Is Coming, But Will Markets Correct First?

Investors have high hopes for the annual “Santa Claus” rally. But, could there be a correction before “Santa visits Broad and Wall?”

At the moment, investors are “making their list, and checking it twice.” Sure, prices remain near all-time highs, but the Fed is remaining accommodative (at least for now.) Earnings remain very “nice,” and the market largely views “pandemic” related risks largely priced in.

Yes, inflation is “naughty,” but the market seems convinced it will be transient. Furthermore, companies seem to be able to pass costs along to consumers, at least for now. Hopes are high that profit margins will continue to be strong, and eventually, earnings will catch up to valuations.

Investors’ “wish lists” are hung by the chimney with care, hopeful the “Santa Claus rally” will soon be there. While they remain “snug in their beds, the historical data dances in the heads.” The chart below from @themarketear shows the annual “seasonality” from 1985 through 2019.

Seasonality for santa claus rally.

It certainly seems there is little to worry about.

However, notice that dip at the beginning of December.

Mutual Fund Distributions Come First

Before “Santa Claus” comes to visit “Broad and Wall” mutual funds distribute their capital gain, dividends, and interest income for the year. These distributions start in late November, but a large number of distributions occur in the first two weeks of December.

Every year, I get large numbers of emails from individuals confused by the sharp decline in their funds. To wit:

“Lance, I don’t understand what happened to my fund. Yesterday, the fund was trading at $10.54 per share, and today it is at $9.78. There is no news to account for decline.

There is nothing wrong with the mutual fund. They made their annual distribution. In this case, it was capital gains and dividend income.

When the distribution occurs, the fund price is immediately impacted. However, in a day or so, you will receive either additional fund shares or a cash deposit. Such depends on how you have elected to take your distributions. Yes, on the date of distribution you will see your portfolio value decline by the amount of the distribution. But when that distribution is received and credited, your value will return to normal.

There is no need to panic.

However, there is potentially a negative impact on the market. Such is particularly the case when volumes are weak, liquidity is low, and breadth is poor. As shown, during the entire advance from the September lows, the volume declined. Importantly, over the last week, breadth deteriorated.

sp500 technical chart breadth

The problem is that “for every seller, there must be a buyer.” The chart below shows where volume exists at various price levels.

Sp500 technical chart volume at price

When mutual funds start making distributions, buyers appear to be “living” closer to the 50-dma (orange dashed line.)

As the Wall Street axiom goes: “Sellers live higher. Buyers live lower.”

Let The Market Tell You

There are more than just a few caveats to this analysis, both bullish and bearish.

  • From the bullish perspective, sentiment remains optimistic, momentum is strong, and speculation is rampant. Such can certainly keep stocks elevated in the near term.
  • From a bearish view, valuations, inflation, and the Fed remain challenges. However, while these broader factors tend to play out over longer periods, they provide the “fuel” for an exogenous catalyst. Such could be a spike in interest rates, a more hawkish Fed, or an expected battle over the “debt ceiling.”

However, picking one side over the other leaves you exposed to the unexpected. Therefore, the best approach is to let the market “tell you.”

Such is our approach. As noted in this past weekend’s newsletter:

“Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities (F, NVDA, AMD). We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

Portfolio allocation

The RIAPro Technical Chart, suggests caution. The market is well extended above its 50-dma, is overbought, and the MACD “sell signal” suggests the risk is elevated.

sp500 technical chart

If the market breaks above the current consolidation, a move higher is likely, suggesting an increase in equity exposure. However, from current levels, any advance would remain limited.

The best opportunity would come from a correction in early December providing a better entry point for the “Santa Claus Rally.”

There Are No Guarantees

Does any of this mean the market will correct with absolute certainty? Of course, not. The one thing the market does well is doing exactly the opposite of what you would expect.

However, there is a strong likelihood with the market trading weak already, any additional selling pressure from mutual fund distributions could pressure prices short-term. It is a risk at least worth considering if you are looking for a better entry point.

The good news is that if “Santa does visit Broad and Wall,” the January effect has a greater degree of potential success. Of course, there is no guarantee of that either, but historical odds are strong that momentum will carry through

However, beyond that in 2022, I don’t have a clue. Currently, Wall Street analysts are optimistic with Goldman Sachs predicting the S&P to hit 5100 next year. Anything is possible, but when looking at the market on a longer-term basis, with earnings and economic growth likely peaking, I am a bit more sanguine on outcomes.

A Stocking Stuffer

Since we have our “stockings hung by the chimney with care,” we can stuff them with a few essential investment guidelines to navigate as we head into year-end.

  • Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.
  • Emotions have no place in investing.You are generally better off doing the opposite of what you “feel” you should be doing.
  • The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.
  • Market valuations (except at extremes) are very poor market timing devices.
  • Fundamentals and Economics drive long-term investment decisions – “Greed and Fear” drive short-term trading. Knowing what type of investor you are determines the basis of your strategy.
  • “Market timing” is impossible– managing exposure to risk is both logical and possible.
  • Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.
  • There is no value in daily media commentary– turn off the television and save yourself the mental capital.
  • Investing is no different than gambling– both are “guesses” about future outcomes based on probabilities.  The winner is the one who knows when to “fold” and when to go “all in”.
  • No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

While we are certainly anxiously anticipating the arrival of the “Santa Claus Rally,” we are also must remember the lesson taught to us in 2018.

Nothing is guaranteed.

Viking Analytics: Weekly Gamma Band Update 11/22/2021

The S&P 500 (SPX) reached all-time highs again on Friday, and the gamma flip level at the end of the week rose to 4,650. As long as we remain above this level, this model will maintain a 100% allocation to SPX. Monthly option expiration days are shown below by the vertical dashed lines.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,460), the model will reduce the SPX allocation to zero.

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

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. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma 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.


The Euro Tumbles as Covid Cases Surge

The Euro continues to tumble versus the dollar as Covid cases in Europe are spiking. Austria declared they are going into lockdown and mandating vaccines. Other nations will likely follow. The euro was already struggling versus the dollar as their central bank seems much less willing than the Fed to reduce monetary stimulus. The resulting stronger dollar will help temper inflation, especially on imported commodities. Crude oil is lower by another $2 while bond yields fall, partially as a result of the stronger dollar.

Fed Vice Chair Richard Clarida echoed other Fed members calling for the Fed to discuss a “faster taper” at the December FOMC meeting. While he had a softer tone than some other Fed members, Clarida is clear the economy is robust and the Fed should consider speeding up the removal of monetary stimulus.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Chicago Federal Reserve National Activity Index, October (-0.13 in September)
  • 10:00 a.m. ET: Existing home sales, October (6.20 million expected, 6.29 million in September)

Earnings

  • 4:05 p.m. ET: Agilent Technologies (A) to report adjusted earnings of $1.18 on revenue of $1.66 billion
  • 4:05 p.m. ET: Zoom Video Communications (ZMto report adjusted earnings of $1.10 on revenue of $1.02 billion

Market Consolidates Gains Near Highs

The FOMO is back. Previously, we discussed the speculative nature of the market, from record call option activity to historical highs in equity allocations. However, such occurs when the Fed is tapering bond purchases, futures are predicting three rate hikes, and inflation is surging.

There seems to be nothing that can derail this “freight train.” Consequently, such is usually about the time something happens. For now, we are maintaining our equity exposure as the consolidation of October’s advance continues. As shown, our biggest concern has been the absolute lack of volume during the recent advance.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

Notably, downturns in breadth were previously often aligned with market corrections. It is the flood of money into FAANG stocks keeping the markets elevated. So, while the lack of breadth in the short-term may not seem problematic, in the longer term, it likely will be.

As Bob Farrell quipped:

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

More Bad Breadth

The graph below shows that despite the NASDAQ hitting new highs, the number of new lows is now the highest since March of 2020.

nasdaq bad breadth

Faster Taper

The more hawkish Fed members are finally expressing their views and it seems they want to speed up tapering. For instance, Fed President Chris Waller said:

“The rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022.”

A “more rapid removal of accommodation” implies raising interest rates. He also mentions the Fed should consider “contracting its balance sheet“, aka selling bonds. As noted in this past weekend’s newsletter:

“The “stability/instability paradox” assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

Unfortunately, such has never been the case.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

What’s Ailing Europe?

Covid infections are on the rise in Europe and we are now learning Austria is going on a full lockdown. We suspect other European nations may follow their lead. The Euro has traded poorly over the last week, in part due to the rising number of infections and their economic implications. As we show below, the Euro/USD is down about 4% since the start of the month. More importantly, it has fallen about 10% versus the dollar since early June. Europe’s economy is not rebounding as strongly as the U.S. which helps explain part of the underperformance. As a result, the ECB has been more dovish (if that’s possible) than the Fed.

This morning ECB President Christine Lagarde essentially ruled out rate hikes in 2022. Per her speech- “conditions to raise rates are very unlikely to be satisfied next year.” Currently, the Fed’s “dot plots” call for one rate hike next year. The markets see as many as three hikes.

Euro USD dollar

Technical Value Scorecard

S&P 500 sector analysis

Buybacks > Investments

The Bloomberg graph below shows that the stocks spending the most on buybacks (orange) are outperforming the S&P 500 (white). The chart also shows that companies investing the most in R&D and Capex are considerably lagging the market. Investors should be concerned that the companies investing the most into their future are essentially being punished. Slowing productivity growth is a big factor limiting future economic growth. This chart highlights the personal incentive for most executives with equity-based salaries to buy back stock instead of engaging in productive investments.

stock buybacks capex

Covid Infections are Spiking Again in Europe

The graph below from Longview Economics shows that Covid infections in many European countries are rising rapidly and in some cases at the highest levels since the pandemic began. The sharply increasing number of cases will likely result in lockdowns in Europe, which will stunt economic activity in Europe and to a much lesser degree worldwide. The big question for U.S. investors is will the high rate of infections spread across the Atlantic? Further, the euro versus the dollar has been declining rapidly. If the high rate of infections continues and European economic growth suffers, will the dollar continue to appreciate versus the euro?

Covid europe

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

Fed “Taper” Is Good News For The Bond Market

Investors are fretting over the prospect of a “Fed Taper,” but history shows such will likely be good news for the bond market. Currently, it doesn’t seem that way, with rates rising post-announcement. As noted by CNBC:

“While the Fed has gone into policy retreat before, it has never pulled back from such a dramatically accommodative position. For the past eighteen months, it bought at least $120 billion of bonds each month, Such provided unprecedented support to financial markets that it now will walk back.

The bond purchases have added more than $4 trillion to the Fed’s balance sheet which now stands at $8.5 trillion. Roughly, $7 trillion of which is the assets bought up through the Fed’s quantitative easing programs. The purchases helped keep interest rates low. Such provided support to markets that malfunctioned badly during the pandemic, and fueled a powerful run for the stock market.”

Previously, when the Fed began to taper their bond-buying programs, the market buckled as the “risk-on” trade reversed.

Fed taper balance sheet market

As was the case previously, Wall Street analysts quickly assumed that this time would be different despite the previous debacles.

“When Federal Reserve officials talked about pulling back on accommodative policies in 2013, anxious investors sent markets into a tizzy.

The opposite is happening now: The Fed signaled it started discussions of reducing bond-purchase programs. Investors, however, remain placid. The markets, in short, are taking everything in stride.” – WSJ

That is the case for now. Now let’s take a look at how the potential impact of the Fed’s announcement to taper may possibly be good news for the bond market.

Global Liquidity Is Slowing

While Wall Street is eternally optimistic, there are two problems with the view the Fed can cut liquidity without consequence.

To begin with, it isn’t just the Fed cutting liquidity. Liquidity globally, from both Central Banks and Governments, has started reversing heading into 2022.

The hope, of course, is the economy is now strong enough to “stand on its own” without ongoing support. But, as discussed in “Reversion To The Mean,” economic growth is already falling well below expectations.

Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.

GDP annual change

During each previous QE cycle, as soon as the liquidity flows slowed or stopped, undesired outcomes were close by.

Awaken The Bond Bull

The recent “pop” in rates, when the Fed announced they will taper bond purchases, was not surprising. Such is the expectation if one of the primary sources of bond-buying is getting removed.

“In theory, tapering should lead to higher interest rates. By tapering its bond purchases, the Fed is increasing the supply that must get absorbed by the market. Such signals that policy is becoming less accommodative.” – Schwab

However, over the last decade, a reversal in Fed policy has repeatedly provided bond-buying opportunities. In the past, rates rose during QE programs as money rotated out of the “safety of bonds” back into equities (risk-on.).

When those programs ended, rates fell as investors reversed their risk preferences.

Fed Taper QE and Interest Rates bond market

As the Fed begins tapers, investors’ risk preferences will change as liquidity wanes. There are three reasons such will be the case.

  1. All interest rates are relative. With trillions in global debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls, and promises of continued largesse, the budget deficit will swell beyond $4 Trillion in coming years. Such will require more government bond issuance to fund future expenditures.
  3. Central Banks will continue to be a buyer of bonds to maintain market stability, but will become more aggressive buyers during each recession.”

With the current Administration and the Treasury pushing the idea of more government spending, the budget deficit is already rising, with economic growth running well below expectations. Such will foster more, not less, demand for bonds in the future and this is potentially good news for the bond market. 

Bonds May Outperform

Here is the primary point. While market punditry continues to push a narrative that “stocks are the only game in town,” such will likely turn out to be poor advice. But that is the nature of a media-driven analysis with a lack of historical experience or perspective.

From many perspectives, the absolute risk of the heavy equity exposure in portfolios gets outweighed by the potential for further reward. The realization of “risk,” when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. Such is why we continue to acquire bonds on rallies in the markets to hedge against a future market dislocation.

Household equity ownership versus stock market and fed taper

In other words, we get paid to hedge risk, lower portfolio volatility, and protect capital. Bonds aren’t dead. In fact, they are likely going to be your best investment in the not too distant future.

In the short term, the market could surely rise further, especially if the Fed continues reinvesting the proceeds from their balance sheet. Such is a point I will not argue as investors are historically prone to chase returns until the very end. But over the intermediate to longer-term time frame, the consequences are entirely negative.

As my mom used to say:

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

FOMO Rises As Investors Push Risk For Gains

In this 11-19-21 issue of “FOMO Rises As Investors Push Risk For Gains.”

  • Market Consolidates Gains Near Highs
  • FOMO Is Evident As Investors Chase Returns
  • The Next Financial Crisis
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Consolidates Gains Near Highs

FOMO is back. Previously, we discussed the speculative nature of the market, from record call option activity to historical highs in equity allocations. However, such occurs when the Fed is tapering bond purchases, futures are predicting three rate hikes, and inflation is surging.

There seems to be nothing that can derail this “freight train.” Consequently, such is usually about the time something happens. For now, we are maintaining our equity exposure as the consolidation of October’s advance continues. As shown, our biggest concern has been the absolute lack of volume during the recent advance.

Short-term technical chart

Furthermore, the MACD “sell signal” remains; however, the money flow signal is nearing oversold. Such suggests the market will likely remain weak near-term. As noted in Friday’s Daily Market Commentary (click the banner below to subscribe):

“Seasonality is strong this year as stocks push higher. However, note the first two weeks of December tend to sport a correction as Mutual Funds distribute capital gains for the year. That pullback would set up for the traditional rally to close out the year.”

FOMO keeps prices in seasonal trends.

The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.

FOMO has bad breadth

Notably, downturns in breadth were previously often aligned with market corrections. It is the flood of money into FAANG stocks keeping the markets elevated. So, while the lack of breadth in the short-term may not seem problematic, in the longer term, it likely will be.

As Bob Farrell quipped:

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

But as stated, for now, it’s all about FOMO.


Daily Market Commnetary

FOMO Rises As Investors Chase Gains

Last week, we touched on some of the excesses building in the market as investors continue to pile into risk. To wit:

 The chart shows us that the S&P 500’s annualized return when the composite model was above 80% was a miserly -9.2%. When the model was above 85%, accounting for about 2% of all days since 1998, that return was a horrid -15.6%.”

Four major sentiment models show FOMO

With the market up 25% in 2021, investors have a more significant “Fear Of Missing Out,” or FOMO, than they do of losing money. Such speculative activity is apparent in the volume of inflows into leveraged ETFs to bolster market returns.

Levered ETF flows and FOMO investors.

During very late-stage bull markets, the speculative frenzy of investors to chase returns is not uncommon. At the peak of every bull market cycle in history, we witnessed the same. Furthermore, in recent decades, we can measure such exuberance by the magnitude of “leverage” individuals take on to chase markets.

margin debt versus free cash balances shows FOMO

Of course, the critical thing about “margin debt” is that it fuels the bullish advance. But, unfortunately, it also accelerates the market’s eventual decline as leverage reverses. Such is always a brutal and mauling event, which is why it is called a “bear market.”

The only question is what causes investor sentiment to switch from FOMO to GTFO (Get The $*^# Out!)



The Next Financial Crisis

While investors remain engulfed in FOMO, serious issues are brewing within the fundamental underpinnings of the market. In Seth Klarman’s famous book, “A Margin Of Safety,” he discussed the 1980’s bond mania before it imploded. That book today will cost you dearly.

Margin of safety Seth Klarman

At that time, many companies issued bonds even though they could not afford to pay the interest expenses. Today, such a company gets nicknamed a “zombie.” Such is when a company must feed on cheap debt to stay alive. Currently, the market capitalization of these zombie firms is at a record.

Total enterprise value with EBIT less than interest expense.
Chart courtesy of Kailash Concepts

The obvious problem is what happens if interest rates rise to a level where they cannot refinance their debt.

Unfortunately, as Kailash Concepts explains, debt itself is the problem.

“We don’t understand why others are not alarmed by an ‘anything goes’ attitude towards record levels of leverage where interest expense cannot be paid for by profits. Currently, the world is awash in financial alchemy.

Since 2007, a big part of America’s debt crisis has moved from the financial sector to non-financial stocks with too much debt. We believe the mix of record debt and record equity valuations is likely a side effect of real rates approaching lows last seen in 1973. Whether we are right or wrong on the causality, the facts are intimidating in our view.

Our research has documented that the world has never been less prepared or less equipped to deal with a possible outbreak of inflation or pull-back in Federal largess.

Debt crisis in American equities. A big shock to investors.

If interest rates rise, the Fed tightens monetary policy, or the economic recovery falters, the seeds for the next financial crisis have already gotten sown.


In Case You Missed It

Rising interest rates matter blog post

The Stability / Instability Paradox

Over the last decade, the Fed’s monetary policy trained investors to take on increasing levels of risk. Each crack in the “financial foundation” got met with monetary injections. Moreover, the “stability” provided by the Fed’s interventions bolstered investors’ FOMO.

Interestingly, the Fed is dependent on market participants believing in this idea. As noted above, with the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” is the most significant risk.

The “stability/instability paradox” assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

Unfortunately, such has never been the case.

Federal Reserve Funds Rate

The behavioral biases of individuals remain the most serious risk facing the Fed. Throughout history, the Fed’s actions have repeatedly led to adverse outcomes despite the best of intentions.

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy
  • Today, it’s real estate, FAANNGT, debt, credit, private equity, SPAC’s, IPO’s, “Meme” stocks…or rather…”everthing.”

After the Fed inflated the most prominent financial bubble in history, they now want to reduce liquidity and hike interest rates.

They are hoping no one pushes the “big red button.”

“Only those that risk going too far can possibly find out how far one can go.” – T.S. Eliot



Portfolio Update

Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities. We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

As noted last week,

“In the meantime, we remain a bit more bullishly biased than we like. However, sometimes, being ‘uncomfortable’ is just part of the investment process.”

Such remains the case this week. For now, the bullish bias is strong. We are also in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

Those forces are powerful, and trying to fight them has been a futile and costly exercise. Such was a point made this past week as Michael Burry closed out all of his bearish positions. Furthermore, Russell Clark of Russell Clark Investment Management tagged the world’s most bearish hedge fund, shut down entirely.

We remain focused on the risk of what can, and will, eventually destroy unimaginable amounts of capital. However, we will continue to participate in markets while they are rising.

Just be aware we are sitting very close to the exit of this particular theatre.

“May The FOMO Be With You.”

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

SP500 Tear Sheet 112119

Performance Analysis

Index Sector Relative Performance Sheet 111921

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 85.65 out of a possible 100.

Technical overbought sold composite FOMO

Portfolio Positioning “Fear / Greed” Gauge

Our “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 92.00 out of a possible 100.

FOMO Allocation Based Fear/Greed Index

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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.
Risk Reward Ranges 111921 Show FOMO

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

Screen Growth Stocks SP500

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

Value based dividend screen

Fundamental Growth Screen

Fundamental Growth Screen

Aggressive Growth Strategy

Aggressive growth screen

Portfolio / Client Update

FOMO is in the air. As noted last week:

“It has been a stellar few weeks in the market. The speculative frenzy quickly returned to the market, and the fear of a correction has “gone with the wind.” However, as noted, the market is now back into more extreme overbought levels. Therefore, we have started taking profits in egregiously overbought positions.”

That process continued this week as we continued to rebalance risk accordingly. As noted in the main body of this week’s missive:

“The bullish bias is strong. We are in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

Those forces are powerful and trying to fight them has been a futile and costly exercise. Such was a point made this past week as Michael Burry closed out all of his bearish positions. Furthermore, Russell Clark of Russell Clark Investment Management, tagged the world’s most bearish hedge fund, shut down entirely.

We remain focused on the risk of what can, and will, eventually destroy unimaginable amounts of capital. However, we will continue to participate in markets while they are rising.”

Over the next few weeks, there are a couple of risks worth watching. Furthermore, Thanksgiving is traditionally a light trading week, which increases market volatility. However, the first two weeks of December will see the bulk of mutual fund distributions and rebalancing. Such could put downward pressure on the market.

Therefore, any decline will set the market up for the traditional “Santa Claus” rally over the next couple of weeks. Accordingly, we will look to position portfolios while still focusing on our risk controls.

Next year will likely be an entirely different “ball game.”

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 previously put on a small volatility hedge in light of the record number of call options outstanding. At that time we said we would close out that hedge when those options expired. This more we sold the entire hedge of VXX at a small loss. Given that next week is Thanksgiving, and trading volumes will be exceptionally light, we are leaving the portfolios with a heavier weighting of cash to offset risk.” – 11/18/21

Equity & ETF Models

  • Sell 100% of the Volatility Index (VXX)

This morning news hit that Amazon (AMZN) would not be accepting Visa (V) credit cards issued in the U.K.  That news sent the stock immediately lower this morning violating all of our stop-loss levels. While we still have a small gain in the stock, we are selling the remaining shares in our portfolio. We are looking for a replacement in the space and are evaluating some candidates to add.” – 11/17/21

Equity Model

  • Sell 100% of Visa (V)

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Technical Value Scorecard Report – Week Ending 11-19-21

Relative Value Graphs

  • On Thursday, the S&P 500 was up .40%, yet every sector was lower except technology. Such was not just a one-day anomaly. The breadth of the market has been poor for a couple of weeks. The third graph below shows that over the last ten days, technology is the only sector to outperform the S&P 500.
  • The top graph shows most sectors have negative/oversold scores. Financials, communications, and healthcare are the most oversold sectors. Technology with a score nearing 75% is moving into strongly overbought territory. As discussed below, its absolute score of 80% argues it is due for consolidation at best and more likely a period of underperformance.
  • The inflationary sectors tended to give up ground. As a result, our inflation-deflation index is again favoring growth and deflationary beneficiaries. The deflationary sectors, defined in the footnotes below, have given up over 5% to the growth sectors. Surprisingly, this is occurring as inflation readings, and expectations hit new highs.
  • All but two factors and indexes are oversold. Technology (QQQ) has a strong score (51%), although it certainly has room to become more overbought versus the S&P. After a nice run, small caps have given back 2.7% versus the S&P pushing its score back to fair value.

Absolute Value Graphs

  • Technology and discretionary are extremely overbought from an absolute perspective. We are not surprised as the FAANG stocks have led the market higher with significant contributions to the S&P 500. Communications is the only oversold sector yet not far from fair value.
  • The S&P 500 has a score of around 50%, putting it in overbought territory but not yet offering a strong sell signal.
  • The momentum factor (MTUM) has been improving as of late. The ETF has a curious mix of holdings. Tesla contributes over 8% to the ETF. The stock, which is recently lower, was on a tear. Next up are three financials (JPM, BAC, and BRK/B). As we noted earlier, financials, along with communications, are the most relatively oversold sectors. Financials are at fair value on an absolute basis with the second-lowest absolute score. We suspect holdings in the FAANG stocks will increase as a percentage of the ETF in the days ahead. In such a market where sector and style preferences rotate so quickly, can MTUM truly capture momentum? Our concern is that the holdings do not change fast enough and tend to reflect yesterday’s high momentum stocks.  

Users Guide

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 action if other research and models do not affirm it.

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 the 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 is the most bearish.

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)

FAANG Stocks Keep The S&P 500 Afloat

Thanks to the FAANG stocks, the S&P 500 and NASDAQ were higher on the day. AMZN (+4.15%), AAPL (+2.85%), and GOOGL (+1.22%) led the charge for the FAANG stocks. Most other stocks were not so lucky. The Dow, equal-weighted S&P (RSP), and the Russell 2000 closed in the red. As we show below, the market’s breadth was poor. 10 of the 11 S&P sectors were lower, and five of them fell by about half a percent or more. Further, two-thirds of S&P 500 stocks are down on the day despite a .35% gain. Bad breadth in an upward trending market can signal weakness ahead, so stay tuned.

S&P sectors FAANG
Daily Market Commnetary

What To Watch Today

Economy

  • No notable reports scheduled for release

Earnings

  • No notable reports scheduled for release

Seasonality Is Strong But Watch The First Two Weeks Of December

Seasonality has certainly held strong this year as stocks continue to push higher. As shown in the chart below, such bodes well for an end-of-the-year “Santa Claus Rally.” However, before we get these, note that the first couple of weeks of December tend to sport a correction as Mutual Funds distribute their capital gains, interest, and dividends for the year. That pullback will set the market up for the traditional rally to close out the year on a strong note.

Stock market seasonality

APPLE (AAPL) Surges To New Highs

Apple surged to new highs yesterday on the news they would enter the Electric Vehicle market by 2025. Of course, given the recent performance chase of other EV automakers, the surge was of no surprise.

Apple stock chart

However, the following note from @TheMarketEar brings up an interesting point about what has been supporting Apple’s stock price in recent years. Of course, this holds true for all of the FAANG stocks in particular.

Apple buyback commentary

In other words, Apple would not be trading at current levels, without the benefit of its massive stock buyback programs. Of course, given that 40% of the S&P 500’s advance since 2011 is from buybacks along, such should not be a surprise.

NVIDIA (NVDA) Earnings

NVDA GAAP EPS of $0.97 easily tops the consensus estimate of $0.86, thanks to strong demand and favorable product mix. Gross margins increased +2.6% YoY to reach 65.2% in the third quarter. Revenue of $7.1B (+50.1% YoY) modestly beat expectations of $6.8B. Revenue is driven by record sales in the Gaming (+42% YoY) and Data Center (+55% YoY) segments.

Management set guidance for Q4 revenue at $7.4B plus or minus 2%, above expectations of $6.9B. In addition, they guide for gross margin to remain steady at 65.3% plus or minus 50 bps. Investors love the report as the stock is trading +10%. We hold a 1.75% position in the Equity Model and have taken profits in it twice in the last month. NVDA is not a FAANG stock but certainly acted like one!

Charts courtesy of RIAPRO.NET

Nvidia NVDA technical study.
Nvidia NVDA analyst analysis

Higher Prices in Philly

The Philadelphia Fed Economic Survey, showing current economic conditions in the mid-Atlantic, points to robust activity. The index rose to 39, its highest level since April. Prices also continue to rise with the prices paid index rising to 80, just a hair below 80.7 in June, a 42 year high. A score of 80 means that 80% of those surveyed witnessed higher prices in November than October. Price received rose as well to its highest reading since 1974. The bottom line is that companies are paying more for input goods but can pass the higher costs to consumers.

The most important part of this survey is this month’s special question. Per the Fed:  In this month’s special questions, the firms were asked to forecast the changes in the prices of their own products and for U.S. consumers over the next four quarters. Firms are bracing for more inflation in the prices of goods they sell and higher wage expenses. More telling, their longer-term inflation forecast rose by half a percent to 3.5%.

Philadelphia Fed Philly

Are We Due For A Santa Claus Rally?

santa claus rally

Stocks are Expensive

The chart below from the Leuthold Group shows that stocks are extremely expensive by all measures except those that compare valuations to interest rates. The Fed model and the two equity risk premium valuations are relatively cheap because interest rates are so low. The problem we have with those models is that interest rates are so low in part because future economic growth and therefore earnings growth are also trending lower.

stocks are expensive

Infrastructure Spending Forecasts

The graph below from Moody’s shows net spending from the recently passed infrastructure bill and the current proposal for the social infrastructure bill. Currently, nominal GDP is over $23 trillion. If we assume the social bill passes, as it is currently written, additional government spending from both bills will peak in 2025 at about $150 billion. That amount would add approximately .60% to GDP. While somewhat meaningful, we must also consider net government spending from the two bills in aggregate decline in the years 2028 and beyond.

infrastructure spending bill

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Rising Interest Rates Matter To The Stock Market

Do rising interest rates matter to the stock market? Many in the financial media and advisory community are scrambling to locate periods where rates rose along with stocks. Has it happened? Absolutely. However, it was only a function of timing until it mattered.

Let’s start with the narrative.

Hedge fund manager Bill Ackman is worried about the impact of rising interest rates on his portfolio:

Bill Ackman on higher rates

History shows Ackman’s worries about his long-only portfolio could be misplaced though. Earlier this year I looked at the relationship between rising interest rates and stock market performance:

Ben Carlson
Interest rates vs Stock returns

The table shows periods where interest rates were rising and the relative return of stocks during those periods. As Ben notes:

There have only been two instances where stocks fell during a rising rate environment. In fact, the annualized returns in each of these periods where rates rose 1% or more was 10.5%, which is right around the average long-term return for the U.S. stock market.

While he is correct, the problem with the analysis is that it doesn’t go far enough to tell you what happened next.

The Long-Term View Of Rates & Stocks

The chart below is the monthly “real,” inflation-adjusted return of the S&P 500 index compared to interest rates. The data is from Dr. Robert Shiller, and I noted corresponding peaks and troughs in prices and rates.

Stocks vs. Rates long-term chart.

The data is a bit cluttered when looking at it in this manner. However, even an untrained eye can pick up that spikes in interest rates led to unfavorable outcomes for stocks.

To try and understand the relationship between stock and bond returns over time, I took the data from the chart and created the table below of 46 periods over the last 121-years.

Stocks vs Rates long-term table.

What jumps is the high degree of non-correlation between 1900 and 2000. As one would expect, in most instances, if rates fell, stock prices rose. However, the opposite also was true. The chart below shows each of the 46-periods graphically.

Stocks vs Rates long term graph

The historical non-correlation changed in 2000, and rate movements and stock prices became correlated. The only change that explains this immediate switch from non-correlation to correlation is the Federal Reserve.

The Fed Changed The Correlation

While many focus on the Federal Reserve’s interventions beginning in 2008, the Fed was becoming more active in stabilizing financial markets under the guidance of Alan Greenspan. From bailing out Long-Term Capital Management to sharply dropping interest rates during the “Dot.com” crash, the early experiments of monetary policy formed. Importantly, for investors, “don’t fight the Fed” became a mantra.

Then in 2008, with the invention of “Quantitative Easing.” the evolution of monetary policy became complete and cemented the stock/bond relationship. As investors became trained that monetary policy would push asset prices higher, investors sold bonds (risk-off) to buy stocks (risk-on.)

While Ben’s table above is correct, what it lacks is what came next. In EVERY period where rates and stocks both rose, most of those gains got forfeited as interest rates slowed economic growth, reduced earnings, or created some crisis.

10-year interest rate less Fed Fund rate.

In the short term, the economy and the markets (due to the current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy:

  • Rates increases debt servicing requirements reducing future productive investment.
  • Housing slows. People buy payments, not houses.
  • Higher borrowing costs lead to lower profit margins.
  • The massive derivatives and credit markets get negatively impacted.
  • Variable rate interest payments on credit cards and home equity lines of credit increase, reducing consumption.
  • Rising defaults on debt service will negatively impact banks which are still not as well capitalized as most believe.
  • Many corporate share buyback plans and dividend payments are done through the use of cheap debt.
  • Corporate capital expenditures are dependent on low borrowing costs.
  • The deficit/GDP ratio will soar as borrowing costs rise sharply.

I could go on, but you get the idea.

The Valuation Problem

Most notably is the valuation problem.

The primary bullish argument for owning stocks over the last decade is that low-interest rates support high valuations.

Such gets based on the assumption the present value of future cash flows from equities rises, and subsequently, so should their valuation. While true, assuming all else is equal, a falling discount rate does suggest a higher valuation. However, as Cliff Asness noted previously, that argument has little validity.

“Instead of regarding stocks as a fixed-rate bond with known nominal coupons, one must think of stocks as a floating-rate bond whose coupons will float with nominal earnings growth. In this analogy, the stock market’s P/E is like the price of a floating-rate bond. In most cases, despite moves in interest rates, the price of a floating-rate bond changes little, and likewise the rational P/E for the stock market moves little.” – Cliff Asness

Here is the primary problem of the current argument that higher rates won’t impact stock prices:

“You can’t have it both ways.”

Either low-interest rates are bullish, or high rates are bullish. Unfortunately, they can’t be both.

As noted, rising interest rates correlate to rising equity prices due to market participants’ “risk-on” psychology. However, that correlation cuts both ways. When rising rates reduce earnings, economic growth, and investor sentiment, the “risk-off” trade (bonds) is where money will flow.

With exceptionally high market valuations, the market may remain correlated to rising interest rates for a while longer. However, at some point, rates will matter, and they often matter more than most think.

The Next Big Shock

Fed’s Williams says “we must think about how to shore up the Treasury Market so it can better endure the next big shock.”

That “big shock” headline and similar comments from Fed President Loretta Mester make us wonder. Does the Fed foresee a big shock on the horizon that could destabilize the Treasury markets? The only apparent events we can think of are a quickened pace of tapering or the coming debt ceiling debate in Congress.

The bond market is also worrying about something. The graph below charts the MOVE index. The index measuring bond implied future volatility is similar to the VIX index measuring equity volatility. Currently, it is on the rise and near the peaks of the last five years, excluding the spike in March 2020.

bond move index
Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Initial jobless claims, week ended Nov. 13 (260,000 expected, 267,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Nov. 6 (2.160 million during prior week)
  • 8:30 a.m. ET: Philadelphia Fed Business Outlook, Nov. (24.0 expected, 23.8 in Sept.)
  • 10:00 a.m. ET: Leading Index, Oct. (0.8% expected, 0.2% in Sept.)
  • 11:00 a.m. ET: Kansas City Fed Manufacturing Activity Index, Nov. (28 expected, 31 in Oct.)

Earnings

Pre-market

  • 6:55 a.m. ET: Macy’s (M) to report adjusted earnings of 32 cents per share of $5.19 billion
  • 7:00 a.m. ET: Kohl’s (KSS) to report adjusted earnings of 69 cents on revenue of $4.28 billion

Post-market

  • 4:00 p.m. ET: Applied Materials (AMAT) to report adjusted earnings of $1.96 per share of $6.35 billion 
  • 4:00 p.m. ET: Intuit (INTU) to report adjusted earnings of 97 cents on revenue of $1.82 billion
  • 4:00 p.m. ET: Workday (WDAYto report adjusted earnings of 87 cents on revenue of $1.31 billion
  • 4:05 p.m. ET: Palo Alto Networks (PANW) to report adjusted earnings of $1.57 on revenue of $1.21 billion
  • 4:15 p.m. ET: Williams-Sonoma (WSM) to report adjusted earnings of $3.10 on revenue of $1.98 billion 

What does The Fed Know?

  • Fed’s Mester Says Improving Treasury-Market Resilience Is Top Priority
  • Fed’s Williams says: “We Must Think About How To Shore Up The Treasury Market So It Can Better Endure The Next Big Shock

The Next Financial Crisis – Problem With Expensive Stocks & High Leverage

A recent analysis from Kailash Concepts explains the problem of overvalued stocks and high leverage.

“We don’t understand why others are not alarmed by an ‘anything goes’ attitude towards record levels of leverage where interest expense cannot be paid for by profits. As documented in our brief post, Stocks vs. Bonds, the world is awash in financial alchemy.

Since 2007, a big part of America’s debt crisis has moved from the financial sector to non-financial stocks with too much debt. KCR’s research team believes that the mix of record debt and record equity valuations is likely a side effect of real rates approaching the record lows last seen in 1973. Whether we are right or wrong on the causality, the facts are intimidating in our view.

Our research has documented that the world has never been less prepared or less equipped to deal with a possible outbreak of inflation or pull-back in Federal largess.

Figure 1 below shows the growth in total debt of non-financial firms as a percent of GDP.   Financial repression and low rates have led to an explosion in borrowed money.  Corporate America has never owed this much.”

Debt crisis in American equities. A big shock to investors.

Powell or Brainard?

President Biden says he will choose the next Fed Chair in the coming days. The market is betting that Powell gets renominated, but some believe Lael Brainard has a chance. “Who Will Be The Next Fed Chair? a Baron’s article, compares and contrasts the two candidates. While they certainly have differences, Brainard is likely to be equally as dovish as Powell if she gets the nomination. However, the markets may be uncomfortable with Brainard. To wit, Danielle DiMartino Booth is quoted in the article as follows:

“Moreover, a shift away from the continuity at the Fed that Powell represents would like roil the markets, which is the last thing Biden needs now, she adds in an interview.”

Stocks or Bonds?

stocks or bonds

Deflation Remains A Bigger Threat

Most Central Banks are increasingly convinced high inflation rates might not be so transient after all. Which is why the tightening cycle has now begun. It’s worth reminding oneself that secular demographics are set to reach maximum deflationary pressure in the decade ahead. This is in stark contrast to the 1970s when demographic trends underpinned the then inflationary surge.

But amid the current inflation panic, Eric Basmajian of @EPBResearch reminds us that the demographic headwinds facing the major economies are intensifying (especially with people dropping out of the workforce). His great charts show deflation pressures are intense. – link.

In the long-term, demographics will be a big shock to Central Banks hopes of higher inflation rates.

7% Risk-free Yields

Mark Hulbert from MarketWatch shares a little-known secret about earning 7% yields in U.S. Treasury securities. In his article, Hidden In Plain Sight Is A U.S. Treasury Yielding More Than 7%, Mark walks through Treasury I bonds and the benefits of owning them in a higher inflation environment such as today. With the 6.2% inflation, the new coupon rate on I-bonds is 7.12% for the next six months.

Because I-bonds reflect the current inflation rate, they are a viable alternative to TIPs. As a comparison, the real yield (nominal yield less expected inflation rates) on the 5-year Treasury note is -1.66%. The graph below compares nominal yields for I-bonds versus the Treasury curve.

I bonds

Job Quitters Are Driving Up Wages

The Job Quit rate is up to 3%, the highest level since they started tracking it twenty years ago. People typically “quit” or voluntarily leave jobs in search of higher-paying jobs. The graph below confirms a strong correlation between the quit rate and wages for those switching jobs. Given the record number of job quitters, we suspect wages will continue higher, putting further pressure on corporate profit margins and, more importantly, increasing the risk of a wage-price inflation spiral.

employment job quits

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Crypto’s Crash and Stocks Head Higher

“Crypto’s Crash,” says some financial news headlines. The reality is Bitcoin, Ethereum and others are down about 10-15% in the last few days. The word “crash” may seem appropriate to describe the sharp decline, except 10%+ moves in a matter of days is the norm, not the exception for crypto.

Ignoring the crypto crash, the S&P 500 went higher. The index is up over 25% this year. Despite such an outsized gain, the table below from LPL Research argues we should be optimistic for 2022. Of course, it’s worth noting some of these outsized returns were coming off of major bear market lows such as 1975, 2003, and 2009.

S&P record high
Daily Market Commnetary

What To Watch Today

Economy

  • 7:00 a.m. ET: MBA mortgage applications, week ended Nov. 12 (5.5% during prior week)
  • 8:30 a.m. ET: Building permits, month-over-month, Oct. (2.8% expected, -7.8% in Sept.)
  • 8:30 a.m. ET: Housing starts, month-over-month Oct. (1.5% expected, -1.6% in Sept.)

Earnings

Pre-market

  • 6:00 a.m. ET: Lowe’s (LOWto report adjusted earnings of $2.35 on revenue of $22.12 billion 
  • 6:20 a.m. ET: Target (TGTto report adjusted earnings of $2.84 on revenue of $24.27 billion 
  • 7:30 a.m. ET: TJX Cos. (TJX) to report adjusted earnings of 81 cents on revenue of $12.28 billion 

Post-market

  • 4:05 p.m. ET: Sonos (SONOto report adjusted earnings of 10 cents on revenue of $360.00 million
  • 4:05 p.m. ET: Cisco (CSCOto report adjusted earnings of 81 cents per revenue of $12.99 billion
  • 4:20 p.m. ET: Nvidia (NVDA) to report adjusted earnings of $1.11 per revenue of $6.81 billion
  • 4:15 p.m. ET: Victoria’s Secret (VSCO) to report adjusted earnings of 70 cents on revenue of $1.47 billion

Stronger Than Expected Retail Sales

Despite weakening confidence, consumers spent a lot of money last month. Retail Sales rose 1.7%, up from 0.7% last month and well above the 1.0% consensus. While the number was great, there are a couple of factors that may be overstating it.

Retail Sales are nominal, meaning it doesn’t capture inflation. As such, consumers may be buying a similar number of goods but paying more for them. Second, we believe many people are ordering Christmas gifts early due to concerns about supply lines and shortages. If this is the case, sales for November and especially December may end up being weaker than expectations. One last point, Hanukah starts on the Sunday after Thanksgiving this year, which is also driving earlier than normal demand.

Retail sales and inflation

Trading The Bull

bull market

Bitcoin Correction or Just an Average Move?

As the first graph shows Bitcoin is down about 11% over the last few days. While a double-digit percentage move is quite often significant for most assets, it is fairly commonplace for Bitcoin. In fact, the five-day average price range using the high and the low for each five-day period since 2014, is 11.65%. The second graph circles the recent five-day range, highlighting just how average it is.

Bitcoin
Bitcoin

Lofty Earnings Expectations

“The attractive P/E to LTG ratio, or ‘PEG ratio’, of the S&P 500 is due to lofty growth expectations, not low valuations… LTG rates are better contrary than positive indicators… today’s level would suggest losses of -20% over the next 12 months” – BofA

Bottom line- implied long-term earnings growth of nearly 20% is well above any level witnessed since 1986, including 1999. It’s also more than double any actual growth rate over the period.  Now consider, profit margins will be under pressure due to rising prices and wages, the Fed is removing accommodations, and economic growth will normalize. Given these headwinds, the implied growth forecast seems like pie in the sky. An adjustment of growth expectations is likely to make investing much more difficult in 2022 than this year.

S&p 500 Earnings Growth

Diversification Ain’t What it Used to Be

The graph below, courtesy of Jim Bianco, shows the diversification benefits of a passive portfolio are rapidly fading as the five largest stocks now garner nearly 25% of the contribution to the S&P 500. While many investors may think they are diversified because they indirectly own 500+ stocks, such is not mathematically accurate. Yes, they own a piece of 500+ stocks, but the returns are heavily based on five stocks.

S&P 500 FANG Stocks

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How Durable Is The Potemkin Economy?

“Increased borrowing must be matched by increased ability to repay. Otherwise, we aren’t expanding the economy – we’re merely puffing it up.” – Henry Alexander of Morgan Guaranty Trust

The original Potemkin Village dates to the late 1700s. At that time, Russian Governor Grigory Aleksandrovich Potemkin constructed facades to hide the poor condition of his town from Empress Catherine II.

Since then, Potemkin Village represents a false construct, physical or narrative, created to hide the actual situation.

As the pandemic ravaged the economy, the Federal Reserve, White House, and Congress went to work and built a Potemkin economy around the ailing economy.

As a result, the curb appeal of today’s economic recovery is beautiful. However, when our clients’ wealth is at stake, we understand looks can be deceiving. As such, we prefer to open the front door and explore the real economy. In the long run, it is sustainable economic growth that supports asset prices. In the short run, however, investors may continue to be mesmerized by the Potemkin economy. At some point, any differences between the Potemkin economy and the actual economy will become problematic for investors.

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Selling A Narrative

Narratives of a booming economic recovery can only mislead the public and investors for so long. Toss in robust economic data, and the façade seems awfully real.  

Consider the following:

Nominal GDP is now 4.5% above the high-water mark set pre-pandemic. Historically, economic recoveries do not get more “V-shaped!”

GDP Potemkin economy

Retail Sales are running about 12% above its trend of the last ten years. The premium represents nearly five years of growth at the prior trend.  

Retail Sales

CPI and Core CPI (excluding food and energy) are nearly triple their respective growth rates of the last five years.

The ISM Purchasers Managers Index, measuring manufacturers sentiment, was recently at its highest level in over 30 years. The ISM Services Index is at the highest level in over 25 years.

Many other measures of economic activity are fully recovered or will be shortly. The only major economic data point under some pressure is employment. Even that, however, is improving sharply from the Pandemic lows. In What A Rate Hike Might Mean For “Stonks,” we quantify that it too is fully recovered. Supporting our belief is the fact there are more job openings than unemployed people.

Job Openings

The Real Economy

There is no doubting economic data is incredibly strong. However, what’s essential to understand is whether the economic activity is durable and sustainable or just a flimsy façade propped up by weak timbers that will erode in short order. To examine the recovery properly and its staying power, we must examine the impetus behind it. 

The pandemic recession was atypical. The global economy shut down in an unprecedented manner. To offset lost activity, the fiscal response from the government was massive.

As shown below, Federal Debt outstanding rose by over $5 trillion in a little more than a year. As a comparison, debt increased by a little over $2 trillion during the 2008/09 financial crisis.  Debt has grown at about six times the rate of the economy since the pandemic began.

Treasury Debt Outstanding

As a percentage of GDP, the current deficit is more significant than during the Civil War, WWI, Great Depression, and the Financial Crisis. Only the deficit funding WWII surpassed current levels.  

Backstopping the Treasury

Before the pandemic, the level of government debt was already at record highs and climbing faster than economic growth. The only way to keep such a scheme going is to continually lower interest rates to manage the federal interest expense. Since interest rates are already at record lows, the Fed also buys a considerable amount of bonds, effectively reducing the amount of debt outstanding.

Over the last year, the Fed bought more than half of the Federal debt issued. The graph below shows the Fed now holds 25% of all public Treasury debt outstanding. After the financial crisis, the percentage was less than 10%.

The Fed is Buying Treasury Debt

The following graph puts the growth of the Fed’s balance sheet into context. The resulting rise in annual M2 money supply growth is the largest since at least the Civil War.

M2 or money supply growth is enormous
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Illustrating The Facade

The graph below shows how government spending greatly boosted GDP The orange line shows GDP has fully recovered from the pandemic. The dotted-orange line, subtracting government spending from GDP, shows the organic economy is still 5% below pre-pandemic levels. That is in stark contrast to GDP, which is running almost 5% above pre-pandemic levels.

The potemkin economy and real economy

Will the Façade blow over?

If something can’t go on forever, it will eventually stop.

This article is not about whether the government should have supported the economy, and if so, to what degree. We leave politics at the door.

What we care about is understanding how long the economic recovery façade can last. To do so, we need to study the foundation of the façade.

The timbers and beams forming the façade are massive federal spending. The foundation supporting government spending is the Federal Reserve. Specifically, purchasing Treasury securities and keeping interest rates at zero allows the Treasury to borrow at will with minimal impact on the bond markets or the government’s interest expense.

Despite recent reductions, the Fed is still buying bonds at a $105 billion monthly pace and pledging to keep interest rates at zero. The internal and external pressure on the Fed to fight inflation is increasing. However, the Fed seems intent not even to discuss raising interest rates.  

Headwinds to QE and Ultimately our Facade

Politicians, economists, and even some Fed Presidents are increasingly concerned inflation may be persistent. “Transitory,” a term to describe a short bit of higher inflation, seems to be overstaying its welcome. To wit, Senator Rick Scott recently penned a letter to Powell. In it he says he will not support his renomination unless the Fed focuses on inflation and starts winding down excessive monetary policy.

“I cannot stand idly by as the Federal Reserve continues its current path of foolishly ignoring rising inflation that is hurting American families. Further, I am gravely concerned by the Federal Reserve’s inaction in winding down its unprecedented market intervention and increased purchase of federal government debt as well as the increased politicization of the Federal Reserve itself that has occurred under your watch.”

Persistent, not transitory, inflation poses significant problems for the Fed. To combat inflation, the Fed needs to raise rates and stop QE. If that doesn’t work, they would likely sell assets on their balance sheet. If the Fed tightens policy via the steps above, the Treasury’s job becomes much more complex and costly.

Sustained inflation will weaken the foundation of the facade and blow our Potemkin economic recovery over. 

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Summary

As long as the foundation for the Potemkin economy can withstand economic and market pressures, our façade can last. However, there are limits to what the Fed can do. Inflation is one such limiter. If the Fed can thread the needle and taper QE but still adequately support post-crisis Treasury deficits, the façade may last longer than we think.

If, however, inflation, political pressures, or other factors cause the Fed to slam on the brakes, our foundation will crack, and the Potemkin economy will fall, revealing a much worse state of the economy than most investors understand.

The economy is not robust. As Alexander says, “we are puffing it up” with fiscal and monetary gimmickry.  

Stock Options Expiration Looms

Stock options expiration has been a source of volatility over the last year. Despite a record number of stock options expiring this Thursday, stocks drifted with little concern. As noted yesterday, over the past year, monthly stock options expirations have tended to usher in brief market declines.

S&P 500 options

Will it happen this week? We do not know, but we do know that the volume of November options is at record levels and that general liquidity is low. The recipe for volatility is in place, so trade with caution and keep an eye on your key risk levels.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Retail sales advance, month-over-month, Oct. (1.5% expected, 0.7% in Sept.)
  • 8:30 a.m. ET: Retail sales excluding auto and gas, month-over-month, Oct. (0.7% expected, 0.7% in Sept.)
  • 8:30 a.m. ET: Import price index, month-over-month, Oct. (1.0% expected, 0.4% in Sept.)
  • 8:30 a.m. ET: Export price index, month-over-month, Oct. (1.0% expected, 0.1% in Sept.)
  • 9:15 a.m. ET: Industrial Production, month-over-month, Oct. (0.9% expected, -1.3% in Sept.)
  • 9:15 a.m. ET: Capacity Utilization, Oct. (75.9% expected, 75.2% in Sept.)
  • 10:00 a.m. ET: NAHB Housing Market Index, Nov. (80 expected, 80 in Oct.)

Earnings

  • 6:00 a.m. ET: Home Depot (HD) to report adjusted earnings of $3.39 on revenue of $34.91 billion
  • 7:00 a.m. ET: Walmart (WMTto report adjusted earnings of $1.40 on revenue of $135.69 billion

A Sea Of Liquidity

One of the main supports for the “bull market” over the last couple of years has been the surge in global liquidity. As shown by this chart courtesy of @isabelnet, while equity inflows are strong, bond inflows dwarf everything.

Lofty Expectations for Interest Rate Hikes

The graph below shows the implied Fed Funds rate based on Fed Funds futures pricing. The blue bars represent the expected dates at which a 100% chance of a rate increase will occur. For example, the market assigns a 100% chance of a rate increase by August 2022 and a 100% chance of a second increase by November 2022. As we show, the market expects the Fed to increase rates five times to 1.25% by the end of 2023.

interest rates hikes are coming

Options Expire

Options

A Shortage of Turkeys – RIA Pro PSA

There is definitely not a shortage of turkeys on Wall Street, but if you plan to serve turkey for Thanksgiving, you may want to buy one soon. As the graph shows, the volume of birds in storage is running at half the average rate.

Turkey prices

Slumping Confidence and Political Ramifications

Last week we reported the University of Michigan Consumer Sentiment Survey fell more than expected and now sits at 10-year lows.

consumer sentiment, Consumer Sentiment At 10-year Lows Spurs Stocks Higher

After digging deeper into the report, we discovered something interesting that will likely gain importance as we near next year’s mid-term elections. For starters, the divide in sentiment between Democrats and Republicans is massive at 90.8 and 53.1, respectively. Further, confidence among those considering themselves independents fell sharply to 69.2.

It is likely independents, along with moderate Democrats and Republicans, will decide the balance of power in the House and Senate. If independents’ confidence continues to fall, the Democrats are more likely to lose the House, Senate, or possibly both.

The Week Ahead

The economic calendar starts in earnest on Tuesday with Retail Sales and Industrial Production. Given the recent drop in consumer confidence, we would expect retail consumption to slump. However, retail sales do not account for inflation which will likely push the number higher. On Wednesday, we will see inflation which will likely print higher than estimates. After that, the rest of the week is relatively quiet.

Economic Calendar

We expect to see numerous Fed speakers this week. With the recent barrage of employment and inflation data, a few speakers may call on the Fed to increase the pace of tapering and move up the timeline for interest rate increases.

This week is also starting the winddown of earnings season as well, with only a few notable companies reporting.

Earnings calendar

Options expiration is on Thursday. As David Robertson points out below, options market volume has been extreme. Such high volumes, open interest, and generally low stock volume can lead to significant price swings.

Retail is extremely active, and they love punting options. Below are a few stunning facts via Goldman’s Scott Rubner:

  • 1. single stock option notional (140%) now exceeds single stock shares notional
  • 2. over 70% of options traded have an expiry of two weeks or less (more in the 2,3,4 day range)
  • 3. $904bn (Thursday stock option notional). This is largest single stock option notional traded of all time.

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Trade “The Off-The-Charts Bull Market”

“How do you trade this off-the-charts bull market?”

That was an email question I got last week that deserves a deeper explanation.

However, let me start with an excellent note from Global Macro Monitor, ironically entitled “The Off-The-Charts Bull Market.”

“Bezos, Musk, and Branson (BMB) are not the only ones recently touching the earth’s thermosphere for a brief and shining moment. Take a look at today’s stock market valuation. Note the structural shift, which took place around 1995. Before the mid-1990s, valuations traded in a nonvolatile range of around 50 percent of GDP.   

Lots happened in the 1990s,  the internet, the return of the emerging markets post debt crisis, the rise of China (probably the most important factor), the end of the Cold War, and some massive sovereign bailouts. 

We get the trade, as we do in Crypto, but we do dare ask if valuations can continue to defy gravity. Or, will they get forced back to earth?”

stock market valuation market cap to gdp chart

The belief, currently, is that the massive reservoir of liquidity from both Governments and Central Banks can keep valuations inflated.

The unknown question, of course, is for “how long.”

So, back to our email question, how do we trade this “off-the-charts” bull market?

The Problem With Valuations

In the short term, all that matters is price. As we have discussed in “Pet Rocks & Other Signs:”

Valuations are a terrible market timing indicator. However, in the short term valuations tell you everything about market psychology. In the long term, they tell you everything about expected returns.

Currently, every measure of valuation suggests investors have thrown all “caution to the wind.”

As noted, valuations are a reflection of investor psychology. Currently, at 40x earnings (Shiller’s CAPE ratio), there is little argument that investors are just about as bullish as they can get.

stock market valuation chart

Looking at the chart, it indeed suggests that investors should be selling everything immediately. However, given this is monthly data, these turns can take much longer than expected.

It is this “lag” that leads investors in the short-term to believe that “valuations” no longer matter. Such is a dangerous assumption and one that investors paid dearly for in the past. Valuations do matter, and they matter a lot.

Navigating WIth Technical Analysis

When it comes to technical analysis, there are millions of different ways to approach it. In addition, there are millions of combinations of technical indicators that investors use to try and decipher market movements.

I am only going to discuss with you how we do it.

Notably, technical analysis does NOT predict the future. It is the study of historical price action, which is the purest representation of the psychology of market participants. From that study, we can make statistical observations about the behavior of market participants in the past. Those assumptions can help form a “guess,” assuming similar variables, about how they may act in the near term.

We keep our analysis very simplistic for our portfolio management needs. We use one indicator to signify if prices are overbought or sold, two moving averages to determine the trend of prices, and Bollinger bands to warn of significant deviations from those moving averages. I show the technical setup in the sample chart below from RIAPRO.NET.

Stock market technical chart short-term

We are looking for either “warning signs” that stocks could be due for a short to intermediate-term corrective period. Or, indications they are oversold and ready to advance. Currently, we are dealing with the former.

Historically, when prices move into the “red zone,” or 3-standard deviations above the 50-day moving average (dma), the Williams %R is overbought, and the MACD is crossing lower from a high level, stock prices usually correct to some degree.

Such is the environment we are dealing with currently. It is also why we suggested raising cash and reducing risk over the last couple of weeks.

Let The Market Tell You

Commandment #1: “Thou Shall Not Trade Against the Trend.”James P. Arthur Huprich

Let me be very clear, we are discussing risk management. It is vitally important you understand the overall trend of the market, and when it is changing.

Currently, we are in a “bull market” advance. As such, we want to maintain our exposure to equity risk. However, such does not mean we should simply ignore what the market is telling us and let the ebbs and flows wash over us. Eventually, an “ebb” will become a flood of selling when the levy breaks.

When that trend changes from positive to negative, we will need to be solely defensive.

“In a bull market, you can be either long or neutral. In a bear market, you can only be neutral or short.” – Dennis Gartman

While the market could certainly pull back to the lower of those “bands,” so far, corrections remain confined to the 50-dma. As such the bullish trend remains constant.

Therefore, with the overbought condition and sell signals in place, we are holding a bit more cash. However, when the current correction process ends, and those signals reverse, we will increase our exposure accordingly. Such is when the odds of investment success significantly improve.

Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.” – Gerald Loeb

This “Off-The-Charts” Bull Market Is Not New

The following chart, like valuations, is monthly data, so it is very slow to move. Such makes it less valuable for short-term risk management but tells you much about the long-term. The upper band is the Relative Strength Index (RSI). Whenever the monthly RSI was above 70, such was near more critical peaks of the market.

However, it was a substantially more critical signal when that extreme overbought gets combined with a market significantly deviated from its long-term moving average (arrows). The MACD in the lower panel also tells us the same.

stock market technical chart long-term.

Does this mean this “off-the-charts” bull market is about to crash? Maybe. But markets can remain irrational much longer than you think. Such is why were are trading this “bull market” carefully and applying our risk-management rules regularly.

While many believe “this time is different,” there is a lot of history from a “technical perspective” that suggests it is not.

As a portfolio manager, I don’t have the luxury to “guess” at an outcome. Instead, I must navigate the waters in which we currently sail and avoid the rocks ahead.

Surviving The “Off-The Charts” Bull Market

Regardless of whether you believe fundamentals will ever matter again is irrelevant. What is essential is that periods of excess speculation always end the same way.

If you are one of our younger readers, who have never lived through a “bear market,” I wouldn’t believe what I am telling you either.

However, after watching the Crash of ’87, managing money through 2000 and 2008, and navigating the “Great Crash of 2020,” I can tell you the signs are all there.

A real bear market will happen. When? I don’t have a clue. 

But it will be an unexpected, exogenous event that triggers the selling. 

It always appears easiest at the top. But, at the bottom, retail investors want to “get out” at any price.

Historically, the environment we are living in currently has not worked out well for investors. However, in the short term, the “irrationality” will last long enough to convince you “this time is different.” As Warren Buffett once quipped:

“The market is a lot like sex, it feels best at the end.”

We continue to trade the “off-the-charts” bull market much the same way you pick up a porcupine; very carefully.

For us, that means putting a spin on Warren’s quote:

“If you engage in the market in an unprotected fashion, you may not want the unexpected surprise.”

Viking Analytics: Weekly Gamma Band Update 11/15/2021

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) consolidated before a Friday recovery last week, and the gamma flip level at the end of the week rose to 4,620. As long as we remain above this level, this model will maintain a 100% allocation to SPX. With option expiration pending for this coming Friday, we point out that there has been a sell-off immediately preceding or following monthly option expiration the last several months. Monthly option expiration days are shown below by the vertical dashed lines.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,455), the model will reduce the SPX allocation to zero.

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

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. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma 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.


Consumer Sentiment At 10-year Lows Spurs Stocks Higher

The latest University of Michigan Consumer Sentiment Survey fell sharply to a new 10-year low. Despite dour consumer sentiment, investor sentiment is optimistic. Stocks rallied on Friday despite little news and light volume. Given the recent spate of weak volume, it doesn’t take much to move markets. Likely some of the impetus is coming from the options markets which seem to be increasingly the marginal driver of stock prices. With options expiration occurring on Thursday, we should prepare for the possibility of significant swings this week.

Michigan Consumer Sentiment
Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Empire Manufacturing, November (22 expected, 19.8 in prior print)

Earnings

Pre-market

  • 7:00 a.m. ET: Oatly (OTLY) to report adjusted losses of 10 cents on revenue of $185.69 million
  • WeWork (WEto report quarterly results before market open

Post-market

  • 4:10 p.m. ET: Endeavor Group Holdings (EDRto report adjusted earnings of 15 cents on revenue of $1.32 billion 
  • After market close: Lucid Group (LCID) to report adjusted losses of 18 cents on revenue of $1.25 billion

Market Stalls Ahead Of Options Expiration

Unlike recent weeks, this past week saw the market begin to consolidate recent gains ahead of options expiration next Friday. However, as we discussed previously, pullbacks have occurred with regularity. Interestingly, as noted by the vertical lines in the chart below, these pullbacks occur near option expirations.

Given the options expire next week, is there more volatility coming? Maybe. As noted in the chart above, the MACD signal is very close to triggering a short-term “sell” signal from an elevated level, and the market remains very overbought.

Furthermore, as noted last week, our “money flow sell signal” triggered a “sell signal.” The combination of the sell signals, very light volume, and weak breadth certainly warrants some caution heading into next week.

investor sentiment is tied to options expiration

Does this mean the market will experience a significant contraction? A pullback to the short-term moving averages would not be surprising and would encompass about a 3-4% drawdown.

What would cause such a correction? I don’t know. However, we are entering the mutual fund distribution season where fund managers need to distribution capital gains, dividends, and interest. Given that most funds are carrying very low cash levels, they will likely have to sell holdings to make those distributions.

However, the good news is that a pullback would set the market up for the traditional end-of-year “Santa Claus” rally.

It’s Transitory They Say

Inflation is surging

Consumer Sentiment and JOLTs

The University of Michigan Consumer Sentiment Survey fell more than expected to 62.8. The one-year inflation expectation ticked up from 4.8% to 4.9%. The report states: “Consumer sentiment fell in early November to its lowest level in a decade due to an escalating inflation rate and the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.”

The BLS reports there are now 10.438 million job openings, slightly better than forecasts of 10.30 million. The two graphs below show the extreme imbalance between the number of job openings and the unemployment rate. The ratio of the two in the bottom graph is at 20-year highs. The “quits” rate rose from 2.9% to 3%, another sign of a robust labor market. Our latest article, What a Rate Hike in 2022 Might Mean for “Stonks“, discusses how the labor market is much healthier than the Fed believes.

job openings and unemplyoment

Rivian vs Ford and Gm

Rivian (RIVN) is the latest company to benefit from the electric vehicle stock craze. Its stock went public on Wednesday and now has a market cap of over $100 billion. We thought it would be helpful to compare RIVN to Ford and GM for proper context. Keep in mind, both Ford and GM, have numerous electric vehicles for sale and more models in the pipeline.

  • Ford has a market cap of approximately $80 billion and GM is at $90 billion.
  • Rivian’s revenue will range between zero and $1 million this quarter. Ford and GM have revenue of approximately $135 billion each.
  • Ford has EBITDA of over $12 billion for the last 12 months and GM is nearly double Ford at $23.8 billion. RIVN lost over $1.5 billion.

Speculative investors are putting the cart well ahead of the horse. They seem enamored with new entrants without contemplating established automakers with extensive financial and manufacturing means competitive electric vehicles for sale.

JNJ is Splitting Into Two

Johnson and Johnson (J&J) will split into two companies, separating consumer health goods from its medical devices and prescription drug businesses. The split will occur within the next two years. Shares of JNJ are up on the news. We currently hold a 1.5% of JNJ in the Equity Model. (Rumor is the two new companies will just be called Johnson)

Buybacks Gone Bad

The chart below, courtesy of Charlie Bilello, compares IBM’s market cap to its buybacks and declining shares outstanding. Over the last 20 years, IBM has repurchased $132 billion worth of its shares. Its current market cap is now only $113 billion. Simply, they threw away a lot of money. Imagine what its market cap would be had they invested the $132 billion into other companies or projects that would boost earnings?

IBM and stock buybacks

Yield Curves Are Starting to Invert

An inversion in the 2-year/10-year U.S. Treasury yield curve is frequently a precursor for a recession and accordingly well followed by investors. Other parts of the yield curve can give us hints about the future shape of the 2-year/10-year curve. For instance, the graph below shows the 20-year/30-year yield curve. It is currently inverted by about five basis points, having flattened by nearly 30bps in the last year. While not a precursor for a recession necessarily, it does warn the entire curve is flattening.  The last time the 20-year/30-year curve was inverted was in the period leading up to and during the financial crisis.

Bond yield curve inverts

Fed Issues Stock Market Warning As Valuations Surge

In the semi-annual Financial Stability Report, the Fed issued a stock market warning as elevated valuations are causing markets to be “vulnerable to significant declines”. To wit:

Prices of risky assets generally increased since the previous report, and, in some markets, prices are high compared with expected cash flows. House prices have increased rapidly since May, continuing to outstrip increases in rent. Nevertheless, despite rising housing valuations, little evidence exists of deteriorating credit standards or highly leveraged investment activity in the housing market. Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall.

Is the Fed’s stock market warning justified?

The Fed is stating that valuations, as the prices of “risky” assets keep rising, make the stock market continually more vulnerable to a crash. It is the “stability/instability” paradox.

What could cause asset prices to crash? The Fed notes specifically:

  • Another surge, or variant, of the COVID virus,
  • A stalling of the economic recovery, or;
  • Investor “risk-sentiment” deteriorates

Given that Fed interventions boosted the stock market and “investor sentiment,” the withdrawal of that support could be problematic. As I discussed in “Bob Farrell’s Rules For A QE Market:”


The high correlation between the financial markets and the Federal Reserve interventions is all you need to know to navigate the market.

Fed balance sheet stock market correlation

Those direct or psychological interventions are the basis for justifying all the speculative “risk” investors can muster.

Fed Balance Sheet Stock Market

Fed Driven “Irrational Exuberance”

There is little doubt that “risky” assets are surging higher, driven by speculative investor confidence. That speculation appears throughout the market, from record call options to “meme” stocks surging in price.

Stock market put call options
Chart courtesy of TheMarketEar via Zerohedge

But it’s not just the retail investor piling into stocks, but even professional managers are now “all in” the equity risk pool.

NAAIM Stock Market Allocation

Of course, such speculative appetite is no surprise as the Fed’s monetary policy created the “Pavlovian” response to “risk-taking.” Or, more commonly known as:

“Don’t fight the Fed.”

And “fight the Fed” retail investors did not. As shown below, household equity ownership is rocketing higher, towards $30 trillion.

Household ownership of stock market equities
Chart courtesy of TheMarketEar via Zerohedge

Before you marvel at the feat of household equity ownership, you need to remember two crucial factors.

  1. The top 10% of income earners own 90% of those assets, and;
  2. It took $43.5 trillion dollars of liquidity to create that “wealth.”
Government Fed interventions vs Economic growth

Given the amount of “liquidity” thrown at the stock market, the Fed should take responsibility for investors’ “irrational exuberance.”

Valuations Are Extreme By Virtually Every Measure

“Across most asset classes, valuation measures are high relative to historical norms. Since the May 2021 Financial Stability Report, equity prices rose further.”Federal Reserve

The description of valuations by the Fed is somewhat misleading. When saying something is high relative to historical norms, its meaning gets lost without some context. In this case, the context best comes from historical charts of various valuation measures.

The most obvious is the Shiller CAPE ratio which takes current prices dividend by 10-years of earnings. This method smoothes out the volatility of earnings that can occur on an annual basis. At 40x trailing earnings, current valuations are higher at the peak of the market in 1999.

Stock market valuations vs real price

A look at market capitalization to the economy also gives you some sense of the “excess” in markets. Given that earnings and revenue come from economic activity, the market can not “outgrow” the economy long term.

Stock market vs. Market Cap to GDP valuation

Lastly, price-to-sales (what happens at the top line of the income statement) is also exceedingly stretched.

Price to sales valuation vs stock market

While stock prices can advance, earnings are ultimately a function of economic growth and sales. Therefore, when excesses occur, an eventual reversion must, and will, occur.

The only question is the timing and the catalyst.

Hoping For A “Soft Landing”

In the Fed notes, valuations are elevated; in the stock market warning report, they identify several risks to the stock market.

The Fed report, highlighting the most salient risks that could undermine the financial system, flagged many previously stated concerns. Those included “structural vulnerabilities” in money market funds. “stable coins,” which the central bank now uses as a generic warning about risks associated with cryptocurrency adoption, inflation, and fading fiscal support.

But, as always, the Fed hopes they can orchestrate a “soft-landing” for the stock market.

Unfortunately, the Fed has a miserable track record of such outcomes.

Richard Thaler, the famous University of Chicago professor who won the Nobel Prize in economics, stated:

We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. I admit to not understanding it.

I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked. Nothing seems to spook the market.”

Such is always the case, just before something does.

History Always Rhymes

While the Fed notes valuations are elevated, the crucial message to investors gets obfuscated. From current valuation levels, the expected rate of return for investors over the next decade will be low.

There is a large community of individuals who suggest differently. They rationalize a case this “bull market” can continue for years longer. But, unfortunately, any measure of valuation does not support that claim.

Such does not mean that markets will produce single-digit rates of return each year for the next decade. The reality is there will be some great years to get invested. Unfortunately, there will likely also be a couple of tough years in between.

That is the nature of investing. It is just part of the full-market cycle.

The economic cycle, demographics, debt, and deficit also suggest optimistic views are unlikely. 

“History doesn’t repeat itself, but it often rhymes.”Mark Twain

Unfortunately, despite the Fed’s stock market warning, the market will ultimately deal with “irrational exuberance,” just as it has done every time previously.

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Inflation In Irrational Exuberance

In this 11-12-21 issue of “Inflation In Irrational Exuberance.”

  • Market Stalls Ahead Of Options Expiration
  • Sentiment Is Showing Irrational Exuberance
  • Inflation Is Surging
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Stalls Ahead Of Options Expiration

Unlike recent weeks, this past week saw the market begin to consolidate recent gains ahead of options expiration next Friday. However, as we discussed previously, pullbacks have occurred with regularity. Interestingly, as noted by the vertical lines in the chart below, these pullbacks occur near option expirations.

S&P 500 Index technical measures

Given the options expire next week, is there more volatility coming? Maybe. As noted in the chart above, the MACD signal is very close to triggering a short-term “sell” signal from an elevated level, and the market remains very overbought.

Furthermore, as noted last week, our “money flow sell signal” triggered a “sell signal.” The combination of the sell signals, very light volume, and weak breadth certainly warrants some caution heading into next week.

S&P 500 stock market technical measures money flow signal

Does this mean the market will experience a significant contraction? A pullback to the short-term moving averages would not be surprising and would encompass about a 3-4% drawdown.

What would cause such a correction? I don’t know. However, we are entering the mutual fund distribution season where fund managers need to distribution capital gains, dividends, and interest. Given that most funds are carrying very low cash levels, they will likely have to sell holdings to make those distributions.

However, the good news is that a pullback would set the market up for the traditional end-of-year “Santa Claus” rally.

But at the moment, a correction is the furthest thing from investors’ minds. So while price inflation may be a problem, there is inflation in “irrational exuberance” as of late.


Daily Market Commnetary

Inflation In Irrational Exuberance

In our recent Daily Commentary (click the banner above for FREE pre-market email delivery), we touched on signs of inflation in “irrational exuberance.” To wit:

“The S&P 500 “buying” stampede continues, pushing stock market valuations to extremes. As of Friday, the Shiller PE valuation rose above 40. Current valuations now dwarf that seen in 1929 and only bettered by the latter months of 1999.

S&P 500 index versus valuations

Of course, “valuations are a terrible market timing device,” but they tell you much about investor psychology and future returns. However, there are other measures also supporting inflation in irrational exuberance.

For example, the chart from TheMarketEar shows the price of Bitcoin to Tesla shares. In recent weeks, the surge in both is a good proxy of the inflation of irrational exuberance and a disregard for risk.

Bitcoin versus Tesla shares

Furthermore, as retail investors pile into equity risk, Sentiment Trader also put out two gauges on Wednesday showing similar measures of inflation in irrational exuberance reaching problematic levels.

The Panic/Euphoria Model, constructed using a methodology described by Citigroup in public posts, has rebounded and is once again above its ‘euphoria’ threshold.

Panic  Euphoria Model Technical Measures

“And the Bear Market Probability Model, described in interviews by Goldman Sachs, has soared to one of the highest levels in 50 years.

bear market probability model technical measures

As they conclude, and with which we agree:

“Choppiness among stocks within indexes pushed the composite model below 50% in late September. Now, enthusiasm is back, and the model is above 90%, challenging the highest readings in 23 years. The chart shows us that the S&P 500’s annualized return when the composite model was above 80% was a miserly -9.2%. When the model was above 85%, accounting for about 2% of all days since 1998, that return was a horrid -15.6%.”

Combined sentiment models technical measures

Such is why being a bit more defensive near-term may be well advised.


What Driving & Portfolio Management Have In Common

Our newer readers require a bit of a chronology.

In mid-August, we discussed a similar situation where markets got very elevated, and we needed to reduce risk in our portfolios.

Then, in late September, following a 5% decline in the market that reduced the momentum chase, we added exposure. To wit:

“With the markets now deeply oversold on a short-term basis, we deployed some of our cash throughout the week to rebalance the portfolio toward normal allocation levels. We don’t expect a tremendous amount of upside, given the ongoing weakness of market internals, but a retest of previous highs is not out of the question.”

Stock market technical setup for 11/13/21

Importantly, notice that we state “decrease” and “increase.” Such does not mean being “all-in” or “all-out.”

Portfolio and risk management is a process of making small moves and adjusting for changes in the market as they come. It is much like driving a car. Therefore, when the vehicle is moving, you are constantly making minor adjustments to keep the vehicle in the proper lane, accelerating or decelerating as needed, and paying attention to the constant flow of signals from all around you.

Most of this we do subconsciously, but the actions all ensure two things:

  1. A reduction of risk
  2. Getting to our destination safely.

Investing is much the same. Paying attention to the warning signs, adjusting the “speed” of the portfolio, and keeping the allocation in the “proper lane can ensure safe arrival at your destination.

Not doing so can have very damaging consequences.

We are driving a little slower, having our foot over the brake, and adding a bit of “liability insurance” to our portfolio as warnings rise.

One of those warnings is the Fed’s choice to ignore inflation.


In Case You Missed It


Inflation Is Surging

On Wednesday, the latest print of the consumer price index came in much hotter than expected. The chart below shows 3-measures of inflation:

  1. CPI
  2. Core-CPI (Less food and energy,) and
  3. Variable-CPI (Less healthcare and rent.)
3-measures of inflation

The surge in inflationary pressures is evident, with “Core CPI” surging to 6.2% on an annualized basis. However, for most Americans, their food and energy consumption is something they deal with every week. Therefore, the impact on discretionary incomes is far more insidious when those get included.

As my colleague Doug Kass noted:

“My eyeballs tell me inflation is running a fair bit hotter than what is being reported now. I think the average person would also think that based on their buying experiences today.”

Furthermore, most individuals have their rent or mortgage payments under a contractual agreement for a certain period. The same goes for healthcare costs as premiums stay stable under a contractual term. The “Variable CPI” shows what inflation looks like from a consumer’s point of view. At 8.5%, it is not surprising consumers are getting upset.

annual change in inflation and wages

Consequently, the surge in variable CPI is even more problematic when wages fail to keep up with inflationary pressures. Therefore, despite headlines of rising wage pressures, real wages are currently 2% below the annual pace of inflation. So, again, the implications on economic growth, and the market, are not tremendous.



The Fed Has To Be Sweating

As discussed in “Did The Fed Set The Market Up For A Crash,” the choice of ignoring inflation in hopes of getting back to historically low unemployment rates may be problematic.

Ignoring the inflation risk is likely unwise. Previous spikes in the inflation spread aligned with weaker economic growth, stock market contractions, or crashes.

When it comes to ‘full” employment, Michael Lebowitz ran some analysis suggesting the Fed may be overly confident in its abilities to support economic growth.

“The U6 Unemployment Rate is not as well followed as the U3 shown above. U6 includes those unemployed in the U3 number but also those underemployed and discouraged from seeking jobs. Jerome Powell thinks the U6 figure is a more credible indicator given the pandemic-related dislocations. As shown below, the U6 rate is 0.4% below the average of the five years leading to the pandemic.”

rate hike in 2022, What A Rate Hike In 2022 Might Mean For “Stonks”

As Michael concludes, the Fed has already met its mandate of full employment. However, they are ignoring inflation to support asset valuations that the Fed recently admitted were excessive.

“Prices of risky assets keep rising, making them more susceptible to perilous crashes if the economy takes a turn for the worse. Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stalls.” – Bloomberg

Ignoring the surging rates of inflation to support asset prices may result in a “policy mistake” that leads to the one outcome the Fed is trying to avoid – a stock market crash.

Of course, such would not be the first time the Fed’s hubris exceeded their grasp and led to unwanted outcomes.

It is likely to be no different this time.

However, I am sure the Fed is starting to sweat.



Portfolio Update

Given the inflation in “irrational exuberance” in the short term, we have been taking profits and rebalancing portfolio risk over the last two weeks. As we noted previously:

We took profits; we did not sell the entirety of our position. Therefore, our portfolio allocations are near fully invested. However, our cash position is growing as the market becomes more aggressively extended.”

Portfolio model allocation

Significantly, not only did we reduce our exposure in some of the more grossly extended holdings such as NVDA, AMD, and F, but also TLT (bonds).

Over recent weeks, after increasing the duration of our fixed-income allocation, TLT also became overbought and triggered a short-term money flow sell signal. The current inflation print pushed bond prices lower, yields higher, for now. I suspect that we will get an opportunity to increase our TLT holdings at lower prices within the next few weeks.

With slightly increased cash levels, we are watching the current “sell signals” develop as we head into options expiration” next week. Since March, retests of the 20- and 50-day moving averages were triggered by the rollover of options. Considering there is a record number of call options, we could see a volatility spike during expiration. As such, we did add a small volatility hedge to our portfolio should such an event occur.

In the meantime, we remain a bit more bullishly biased than we like. However, sometimes, being “uncomfortable” is just part of the investment process.

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

S&P 500 statistics and analysis

Performance Analysis

S&P 500 market and sectors relative 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 84.78 out of a possible 100.

Stock market technical gauge composite RIAPRO.NET

Portfolio Positioning “Fear / Greed” Gauge

Our “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 94.37 out of a possible 100.

Stock market Greed Fear Index (allocation based)

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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.
S&P 500 stock market risk range analysis

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

Portfolio S&P 500 Screen RIAPRO.NET

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

Portfolio dividend growth screen RIAPRO.NET

Fundamental Growth Screen

Portfolio fundamental growth screen RIAPRO.NET

Aggressive Growth Strategy

Portfolio aggressive growth screen RIAPRO.NET

Portfolio / Client Update

There is inflation in “irrational exuberance” as late. Let me repeat what I wrote previously.

“It has been a stellar few weeks in the market. The speculative frenzy quickly returned to the market, and the fear of a correction has “gone with the wind.” However, as noted, the market is now back into more extreme overbought levels. Therefore, we have started taking profits in egregiously overbought positions.”

That process continued this week again. We took profits in some of the same positions again after they ran up further.

Furthermore, over the last few weeks, we stated that we continue to watch interest rates closely. As a result, we took profits after the recent runup in bond prices and reduced the duration of our fixed-income holdings. Such mainly was based on the technically overbought condition of the assets. However, from a fundamental perspective, we still think yields will move lower next year, so we are looking for an opportunity to add back to our bond holdings opportunistically.

Over the next few weeks, there are several risks we are watching closely. First, options expiration is next Friday which has previously led to market declines over the past 8-months. Second, Thanksgiving is a traditionally very light trading week, which could lead to a rise in market volatility. Lastly, the first two weeks of December will see the bulk of mutual fund distributions which could put downward pressure on the market.

However, any decline over the next few weeks will set the market up for the traditional “Santa Claus” rally as managers position for the end of year reporting. None of this is guaranteed. Of course, it is just our best guess based on historical tendencies. Regardless, our job remains to protect your capital first and foremost, and we continue to make that our priority.

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 ***

“Over the last week, we have discussed reducing equity risk slightly by raising cash and adding hedges. As we head into options expiration week, the Thanksgiving holiday, and mutual fund distribution season, we are looking to become a little more defensive by raising cash levels.

Currently, our bonds have gotten extremely overbought short term, so we are trimming our duration back a bit by reducing TLT. We are still fully in the camp that rates will fall next year as the economy slows, so we will use a pullback in bond prices to increase our exposure.

On the equity side of the allocation, we are just reducing our position sizes in some stocks or sectors that are more extremely overbought and triggering short-term sell signals.” – 11/10/21

Equity Model

  • Trim TLT from 8% to 6%
  • Reduce PFF from 10% to 7.5%
  • Reduce MSFT from 2.5% to 2% of the portfolio.
  • Taking profits in AMD from 2.5% to 1.75%
  • Trimming ABBV from 4% to 3.5%
  • Reducing ABT from 2% to 1.5%
  • For a second time, we are reducing NVDA from 2% to 1.75%
  • Trim ADBE from 2.5% to 2%

ETF Model

  • Trim TLT from 8% to 6%
  • Reduce PFF from 10% to 7.5%
  • Take profits in XLY from 5% to 4%
  • Reduce XLK from 13.5% to 12%

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Rivian Surpasses GM As Electric Exuberance Reigns Supreme

Shares of Rivian (RIVN), the newest entrant into the electric vehicle market, are soaring. Rivian closed Thursday with a market cap of $100 billion. Not bad, considering GM is at $89 billion and Ford is $78 billion. Despite lagging in market cap, Ford benefits as it owns 12% of Rivian. Amazon has a 20% stake in the company and expects to own at least 10,000 Rivian trucks for deliveries next year.

Rivian Market Cap
Daily Market Commnetary

What To Watch Today

Economy

  • 10:00 a.m. ET: JOLTS Job Openings, September (10.300 million expected, 10.439 million in August)
  • 10:00 a.m. ET: University of Michigan Sentiment, November preliminary (72.5 expected, 71.7 in October)

Earnings

  • Before market open: Warby Parker (WRBY) to report adjusted losses of 57 cents on revenue of $537.43 million

Are Semiconductor Sales Peaking?

Semiconductor stocks have been on a tear lately as chip demand is robust. Further helping the cause, semiconductor manufacturers can’t produce enough chips, which gives them significant pricing power. The graph below warns, investors may be overexuberant. As shown, courtesy of Stouff Capital, semiconductor sales strongly correlate with credit growth in China. Given China produces a large number of goods using chips, the relationship makes sense. Recently, China has clamped down on credit creation resulting in negative credit growth and, not surprisingly, weak economic growth. If the semi-credit relationship holds up, the graph portends semiconductor sales may appreciably underperform sales estimates for 2022. However, the shortage of chips and demand for products using chips, such as cars, provides a decent base of demand for future sales.

Semiconductor Chips

Inflation, Inflation, and More Inflation!

inflation

The Dollar and Commodities Are Not Behaving Like Normal

The first graph below charts the dollar in orange and the CRB commodities index in blue. Typically a strong dollar results in weak commodity prices and vice versa. Throughout 2021, commodity prices and the dollar have a positive correlation, as circled. The second graph highlights the abnormal correlation a little better. In the Bloomberg graph, the dollar index (white) is plotted on an inverse scale to the left and Bloomberg’s commodity index to the right. The positive correlation is likely because commodity prices are increasing due to supply line factors and not traditional economic factors.

commodities
dollar

A Stronger Dollar Reflecting Bets The Fed Will Move Faster

“Traders are becoming more certain that inflation, which topped 6% in headline terms last month, will prompt the Fed to accelerate its timetable for liftoff from zero interest rates. Whether the central bank does or doesn’t is an open question, but America’s soaring inflation means the Fed is far more likely to tighten before Japan or the Eurozone.

Marc Chandler at Bannockburn Global Forex, told the Morning Brief in an email that consumer prices above 6% ‘is a shock. I suspect [price inflation] is poised to accelerate in coming months, and the Fed will accelerate tapering to allow it to be prepared for all probabilities, including having to hike rates sooner.’” – Yahoo Finance

Importantly, a stronger dollar will have eventually lead to a “deflationary” impact on the economy as shown. While not always an immediate impact, a stronger dollar leads to lower commodity prices, and other inflationary trends, as foreign demand for U.S. products weaken, and ultimately, the demand for commodities contract (think recession).

More CPI Worries

The graph below foreshadows that inflation may continue rising. The chart, measuring median CPI, assesses the breadth of inflation. As discussed in recent articles and commentary, the headline CPI figure everyone follows can be swayed by a few items. For instance, “shelter” represents nearly 30% of CPI. The median figure helps assess how the prices of many goods are behaving. As the graph shows, median CPI is now at highs last seen in 2008. More problematic, the 3-month change is running at levels more significant than any seen since at least 1984.

cpi

Technical Value Scorecard Report – Week Ending 11-12-21

Relative Value Graphs

  • The consumer discretionary sector lost 2.9% versus the S&P 500 after beating it by a similar amount in the prior week. As a result, its relative score fell quickly from grossly overbought to near fair value.
  • Communications and utilities remain the most relatively oversold sectors, but their respective scores improved this week. After underperforming other inflationary stocks for a month or even longer, materials had a good week, beating the S&P 500 by nearly 3%.
  • In a trend reversal from the prior few weeks, the S&P underperformed almost all sectors.
  • Emerging markets and value (versus growth) had a good week, following very oversold readings. Interestingly emerging markets beat the S&P by 2.86%, yet developed foreign markets lost 0.07% to the S&P 500.
  • The three sets of “spaghetti” graphs below show each sector’s path over the last eight weeks. The charts compare each sector’s absolute momentum to their relative score versus the S&P 500. We look for sectors moving into the top-right quadrant. Materials (XLB), for instance, just moved into the quadrant, potentially offering more upside. Discretionary (XLY) remains in the top-right quadrant but well off its extreme levels of last week.

Absolute Value Graphs

  • Technology is the most overbought factor/index, followed by small and mid-cap.
  • As we thought might happen, the glaring overbought and oversold signals from last week moderated as the market corrected.
  • Transports, Discretionary, and Technology, which were all considerably overbought, corrected this past week. They remain overbought but not to the same extreme. Communications is the only oversold sector. Discretionary and transports are 2.5 standard deviations above their 200dma.
  • The factor/index graphs moderated strong overbought conditions as well. Small-cap, mid-cap, and the NASDAQ saw their respective scores fall to 50% or below. All factor/index scores are now above fair value.
  • The S&P 500 corrected as well, bringing its absolute score to only moderately overbought from the highest we have seen this year. Our proprietary cash flow model and other technical indicators turned bearish early in the week, and the market followed. While the market is not as overbought as it was, our technical indicators warn the decline may not be over quite yet. Next week’s options expiration and coming mutual fund distributions may pressure stocks. That said, seasonality argues for a good end of the year.

Users Guide

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 action if other research and models do not affirm it.

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 the 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 is the most bearish.

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)