Monthly Archives: April 2024

Market Polls To Help Handicap The Election

With election eve upon us, we thought it would be helpful to share market based presidential election polls along with Greg Valliere’s final thoughts.

The graph on the top left shows the price of Trump Media & Technology Group (DJT), which runs Truth Social Media. Truth will be a clear beneficiary if Trump wins and will likely struggle if he loses. The graph shows that the stock was relatively dull until earlier this year when it started to price in the benefits of a potential Trump victory.

Below the DJT graph is the Goldman Sachs basket of stocks likely to benefit from who wins the election. This market poll currently has a clear bet on a Trump victory and a Republican sweep of Congress.

Lastly, on the right are the Polymarket betting odds. As shown, Trump has 62.9% odds of winning, having gained some ground over the last month.

While the market polls seem to have Trump as the winner, Greg Valliere thinks Kamala Harris “will win the presidency by a fraction.” We have been sharing a few of this long-time Washington insider’s views over the last few months. Accordingly, here are his final election thoughts.

THIS ELECTION IS SO CLOSE that it could be Christmas before there’s a final result. It’s virtually certain that we won’t know the winner on the morning of Nov. 6, the day after the election.  A winner has to be declared by noon on Jan. 20.

IT’S POSSIBLE THAT HARRIS WINS COMFORTABLY — she even may make a last-minute push in Florida — and it’s possible that Trump may win Pennsylvania, and thus the election.

BUT THE MOST LIKELY OUTCOME IS A PHOTO FINISH — Harris by a fraction in a race that may not be settled until there’s a resolution of at least 8 or 9 recounts.  The big winners will be the lawyers.  

market polls

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Last week, we discussed the break of the rising wedge pattern.

“Unsurprisingly, the market stumbled a bit this past week, breaking the “rising wedge” pattern to the downside. However, the market continues to find buyers at the 20-DMA as portfolio managers are unwilling to be “out of the market” currently.”

Such remained the case this week until it didn’t. On Thursday, the market cracked the 20-DMA and swiftly fell to retest the 50-DMA. There is an important lesson in this week’s action. Over the last several weeks, we have warned about the weakening of momentum and relative strength and the triggering of the MACD “sell signal.” However, many followers commented that the market kept rising despite my warnings and “this time was different.” The lesson is that while technical analysis is NOT perfect, the signals derived from the analysis are often a good process to follow. As always, “timing” is the most difficult challenge. The indicators told us that the market would likely “derisk” before the election, which is now evident.

Market Trading Update

As we have repeated, while the market was set up for a short-term correction, the backdrop remains bullish. Thus, we expect momentum to carry into year-end. However, here is an interesting data point from Goldman Sachs trader Brian Garrett, which was pointed out this past week.

“Between the lows of October 2023 and the highs of October 2024, the SPX rallied over 40%.What is almost unprecedented about this rally is that it was achieved on a realized volatility of ~12, yielding a “Dirty Sharpe” ratio above 3. Such has only happened previously in ’95, ’97, and pre “vol-mageddon” in 2018.

Risk Adjusted 12-month returns

To put that into layman’s terms, the last 12 months have been one of the greatest risk-adjusted yearly returns in market history.

What should be noted is that such low-volatility, exuberance-driven rallies eventually end. They lack the appropriate catalyst. As we concluded last week:

“There is currently little risk of a bigger near-term correction. However, some things could cause one, like a highly contested presidential election. In the current political environment, such is not a low-probability event. As such, while we remain allocated to the markets, we are closely monitoring the amount of risk we take.”

In other words, don’t forget to manage risk.

The Week Ahead & The BLS Employment Report

The closely followed BLS employment report was well below economists’ expectations, but the market reaction was remarkably muted. The twin hurricanes likely played a significant role in the shortfall of new jobs. The graphic below shares the disclaimer issued by the BLS. The BLS reported that the economy added 12k jobs versus expectations of 115k and last month’s revised 223k. Moreover, August’s gain of 159k was revised lower to 78k. The unemployment rate was flat at 4.1%.

The election will be the most critical market driver of the week. However, if it is contested and a winner isn’t declared immediately, it could have a lasting impact for weeks. If Trump wins, as the market polls believe, we will likely see some of the Trump beneficiaries continue to do well. However, a Trump trade reversal could occur if Harris wins, as Greg thinks is possible. As we said a few days ago, buckle up!

As if the election weren’t enough news to digest, the Fed will meet on Wednesday and likely reduce rates by 25bps. They will also signal whether another 25bps in December is possible. The bond market will have to absorb a 10-year auction on Tuesday before the election and the Fed, followed by a 30-year auction on Wednesday. Both auctions will likely create some bond market unease as Wall Street will be asked to buy bonds with the Fed and election results unknown.

bls employment disclaimer

Corporate Buybacks: A Wolf In Sheep’s Clothing

Corporate buybacks have become a hot topic, drawing criticism from regulators and policymakers. In recent years, Washington, D.C., has considered proposals to tax or limit them. Historically, buybacks were banned as a form of market manipulation, but in 1982, the SEC legalized open-market repurchases through Rule 10b-18. Although intended to offer companies flexibility in managing capital, buybacks have evolved into tools often serving executive interests over broader shareholder value.

This article explores the mechanics of buybacks, how they impact markets, and whether they truly return capital to shareholders—or merely enrich insiders.

READ MORE…

stock buybacks

Tweet of the Day

euphoriameter

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Corporate Buybacks: A Wolf In Sheep’s Clothing

Corporate buybacks have become a hot topic, drawing criticism from regulators and policymakers. In recent years, Washington, D.C., has considered proposals to tax or limit them. Historically, buybacks were banned as a form of market manipulation, but in 1982, the SEC legalized open-market repurchases through Rule 10b-18. Although intended to offer companies flexibility in managing capital, buybacks have evolved into tools often serving executive interests over broader shareholder value.

This article explores the mechanics of buybacks, how they impact markets, and whether they truly return capital to shareholders—or merely enrich insiders.

The Rise of Corporate Buybacks: By the Numbers

Since 2003, U.S. corporations have spent over $11 trillion on share repurchases. Corporate buyback activity has surged in recent years, even in volatile markets:

  • 2021: $881 billion
  • 2023: $795 billion
  • 2024 (Projected): Expected to exceed $988 billion

Introducing a 1% excise tax on corporate buybacks in 2023 has barely slowed the trend. Companies prioritize repurchases over reinvesting in business growth, raising wages, or developing new technologies. Apple and Meta, among others, regularly allocate billions toward buybacks, supporting their stock prices and meeting shareholder expectations.

Schedule an appointment

How Buybacks Affect Markets

The impact of buybacks extends beyond individual companies. Since 2000, net corporate buybacks have accounted for 100% of the equity market’s net asset purchases—a reflection of the diminished participation from pensions, mutual funds, and individual investors:

  • Pensions & Mutual Funds: –$2.7 trillion
  • Households & Foreign Investors: +$2.4 trillion
  • Corporations (Buybacks): +$5.5 trillion
  • Net Flow: +$5.2 trillion
Equity flows since 2000

There are often statements made that corporate buybacks have only a limited impact on stock prices. However, the evidence is pretty overwhelming to the contrary since 2012, when corporations became very aggressive about buybacks.

Cumulative Corporate Buybacks vs the market

This trend raises important concerns. While buybacks temporarily support share prices, they can crowd out investments in innovation, capital expenditures, and employee compensation, contributing to long-term economic stagnation and inequality.

Who Benefits Most from Stock Buybacks?

Many analysts argue that buybacks return excess capital to shareholders. However, the reality is more complicated. Buybacks primarily benefit insiders through carefully timed stock sales, inflated earnings metrics, and compensation triggers:

  1. Timing Insider Sales with Buybacks
    • Insiders, aware of buyback schedules, can sell shares during repurchase periods when prices are temporarily elevated.
    • This practice boosts insider profits without triggering price declines or regulatory scrutiny.
  2. Boosting Earnings Per Share (EPS) to Unlock Bonuses
    • Buybacks reduce the number of outstanding shares, artificially inflating EPS.
    • Since many executive compensation packages tie bonuses to EPS growth, buybacks help executives meet targets and secure stock awards.
  3. Offsetting Dilution from Stock Options and RSUs
    • Buybacks reabsorb shares issued through stock options and restricted stock units (RSUs), preventing dilution and keeping share prices elevated for insiders.

Despite these benefits to executives, the average shareholder sees little return unless they sell their shares during buyback periods. This creates an uneven distribution of profits, favoring insiders and short-term traders over long-term investors.

Companies often market corporate buybacks as a “return of capital to shareholders,” but this framing is somewhat misleading. Unlike dividends, which distribute cash to all shareholders equally, buybacks benefit those who sell their shares. As a result, buybacks:

  • Prioritize short-term stock price gains over long-term investments.
  • Signal a lack of business reinvestment opportunities—or a deliberate choice not to pursue them.
  • Concentrate benefits among insiders and executives, whose compensation is tied to stock performance.

A study from the Securities and Exchange Commission (SEC) found that executives often sell significant amounts of stock shortly after buybacks are announced, reinforcing the idea that buybacks serve insiders more than ordinary shareholders.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

Alternatives to Buybacks: Real Ways to Return Capital

To promote sustainable growth and equitable returns, companies could shift their focus from buybacks to more transparent and shareholder-friendly strategies.

  1. Tender Offers
    • Tender offers involve buying back shares at a pre-determined premium, ensuring all shareholders have a fair opportunity to participate.
    • This process reduces the risk of manipulation and aligns better with shareholder interests.
  2. Dividends
    • Dividends provide predictable income to all shareholders, promoting financial stability, especially for retirees and long-term investors.
    • Regular dividend payments encourage companies to focus on profitability rather than temporary stock price boosts.
  3. Long-Term Investment in Growth
    • Companies can create sustainable value over time by reinvesting profits into research, innovation, and employee compensation.
    • This approach aligns corporate management with broader economic growth rather than short-term financial engineering.

While corporate buybacks can support stock prices in the short term, they do little to enhance long-term business performance. Studies, including the Bank for International Settlements research, have shown that buybacks prioritize EPS manipulation over actual value creation. This emphasis on stock price gains discourages investment in productive assets and innovation, weakening companies’ ability to grow sustainably.

William Lazonick, in his seminal article Profits Without Prosperity,” highlighted how stock buybacks divert corporate resources away from economic growth and into executive compensation. Between 2003 and 2012, S&P 500 companies allocated 54% of their earnings to buybacks and another 37% to dividends (91% of total earnings), leaving little for business expansion, wages, or job creation investments.

Conclusion: A Shift Away from Buybacks Is Necessary

While corporate buybacks are marketed as a “return of capital,” they primarily benefit insiders and short-term traders. Their rise reflects a broader shift in corporate priorities—from investing in growth and innovation to maximizing executive compensation through financial engineering.

To promote long-term shareholder value and economic prosperity, companies should adopt more transparent capital return strategies, such as tender offers and dividends. These methods distribute profits more equitably and encourage sustainable growth. A shift in focus could rebuild trust between corporations and shareholders, aligning business strategies with broader economic health.


Call to Action:
Want to learn more about sustainable investment strategies and how they impact your portfolio? Visit RealInvestmentAdvice.com for the latest insights and actionable advice.

PCE Price Index Is Back Into The Pre-Pandemic Range

It’s too early for the Fed to claim the infamous “mission accomplished” for inflation. However, yesterday’s PCE price index is now within the Fed’s mission accomplished range. The PCE price gauge rose 0.2% monthly and 2.1% year over year. That yearly rate is down 0.2% from last month and 0.6% over the previous six months. It is the lowest since February 2021 and within spitting distance of the Fed’s 2% target. The graph outlines the average (dotted line) for the 2010-2019 period and the one standard deviation range for more historical context. It’s fair to say the PCE price index is now on the high side of the range and within a normal band of the pre-pandemic period.

While the inflation data continue to decline, we are unlikely to hear the Fed taking a victory lap. Simply, it is too early. If they were to claim inflation is now at target, the market would likely assume the Fed has a clear path to significant rate cuts. While the Fed may be breathing a sigh of relief, the last thing they want to do is create anxiety in the inflation expectations markets. Inflation expectations can have an inflationary effect. We suspect another six months of a flat to declining PCE price index and CPI will be needed for the Fed to be publically comfortable with inflation.

pce price index

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As noted yesterday, the market had been holding the 20-DMA as support. However, that ended yesterday, as earnings reports from Microsoft and Meta led to a selloff that took out that key support. Unsurprisingly, the support break triggered the algorithms to sell as pre-election derisking finally took hold. The good news is that the 50-DMA remains the next key support level but was tested yesterday. While the 100-DMA is just below, it is important for the markets to hold support at the 50-DMA. As we have been warned, the break of the previous rising wedge and the MACD “sell signal” suggested that risk was elevated for a corrective phase. While it can seem at times these signals are wrong, mostly, it is a function of timing.

With yesterday’s end-of-the-month trading and a slate of events over the next few days, from employment to the election and the next FOMC rate announcement, it is unsurprising that markets are “taking some chips off the table.” We suggest not overreacting to yesterday’s market move as the post-election factors still provide a bullish backdrop to the market into year-end.

Continue to manage exposures but remain allocated for now.

Market Trading Update

Boeing Offers Another Example Of Buybacks Gone Bad

From 1998 to 2019, Boeing bought back nearly half of their shares. Such a robust buy-back policy contributed to significant price growth of its stock, as shown below courtesy of Wolf Street. Since 2020, its share count has risen as investors have been diluted to help pay for losses and lawsuits related to its faulty aircraft. Earlier this week, Boeing announced an approximate $19 billion equity and convertible fundraising, which will dilute current shareholders by roughly 15%. The equity raise will help replenish its equity value, which has fallen to negative $23 billion. In other words, the value of its assets is $23 billion less than its liabilities.

We bring this up to discuss a drawback with buybacks. Had Boeing spent its earnings on its production facilities and invested more in technology, its recent problems may never have occurred. Furthermore, their growth trajectory and customer satisfaction would certainly be higher than they are. As the Wolf Street graph shows, Boeing stock is at 10-year lows. Most of the stock the company purchased was at higher prices than the price at which they just issued new shares. Simply, not only did they waste money on buybacks, but they set the company back significantly.

boeing buybacks and share price

Providing Perspective To Higher Yields Following Rate Cuts

Jim Bianco’s graph below shows the yield change in ten-year notes following the first rate cut of each rate-cutting cycle since 1989. As shown, it’s not uncommon for yields to rise after the first cut. However, the recent incident is greater than the six previous examples. What might that mean?

Jim argues that the market is concerned that the Fed is too aggressive and “will overstimulate and create a resurgence of inflation, especially if Trump wins and fiscal and inflationary stimulus comes with it.” The counter to his comment is twofold. First, bond yields were greatly oversold technically going into the Fed meeting. It is hard to draw an apples-to-apples comparison without providing information on the technical situations surrounding the other examples. Second, he presumes that fiscal stimulus is inflationary. While the massive pandemic-related fiscal actions were certainly inflationary, they were against a backdrop of broken supply lines. Over the last forty years, excluding the pandemic, there is scant evidence that fiscal spending is inflationary. The negative multiplier economic thesis contends that it’s deflationary.

ten year yields fed rate cuts

Tweet of the Day

returns sharpe ratio

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Will Halloween Fear Bring November Cheer For Bondholders?

The last two Halloweens capped off a few frightful months for bondholders. However, as we share below, 10-year bond yields reversed course on Halloween in 2022 and 2023. Will 2024’s harrowing October for bondholders end with Halloween’s ghosts and goblins? Accordingly, will November be better for bonds as it has been for the last two years?

Despite the eerie correlation highlighted below, Halloween is insignificant to the bond market. However, what does matter is a slew of negative narratives about bond market fundamentals that cause fear in some bond investors. Additionally, famed investors Paul Tudor Jones and Stanley Druckenmill boost the fear as they publically “talk their books.” To help you navigate this tricky market, we add context around the recent bond bearish arguments to better appreciate what is happening with bond yields.

To wit:

The economy is about $8 trillion, or 33%, larger than it was on the eve of the Pandemic. Therefore, it’s not surprising the amount of debt has grown commensurate with that amount.

Following Japan’s path seems awfully bullish strictly from a bond holder’s perspective.

READ MORE….

Halloween and bond trends

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As noted yesterday, the market remains “stuck in neutral” over the last two weeks ahead of several key events. Tomorrow is “employment day,” when we will see the October numbers. A strong employment report could worry markets about reduced rate cuts from the Federal Reserve. On Tuesday is the election, with no small risk of a potential contested outcome. Then, on Wednesday is the Federal Reserve FOMC meeting, where we will get the latest update from the Fed on its rate cut decision and outlook. With the potential market volatility those events could unleash on the markets, it is quite surprising to see recent market action remain so calm.

The 20-DMA remains key support, with buyers repeatedly stepping in at that level. On the other hand, the upside remains contained to the underside of the broken rising trend line from the October lows. Notably, the previous “buy signal” has reversed to a “sell signal,” which currently limits the bulls. However, money flows are declining, which suggests that buying power is waning. With historical volatility at decently low levels, such sets the stage for a potential bearish reversal if something “unexpected” occurs.

Market Trading Update

We remain underweight equities and overweight cash in the near term with our core Treasury bond holdings intact to hedge against a sharp increase in volatility. That positioning is unlikely to change much over the next two months, and we are willing to sacrifice some performance in exchange for control over risk.

While we have discussed these simplistic rules over the last several weeks, we continue to reiterate the need to rebalance risk if you have an allocation to equities.

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

Keep moves small for now. As the markets confirm their next direction, we can continue adjusting accordingly.

JOLTS and ADP

With the Fed seemingly more focused on the labor markets than inflation, the JOLTs and ADP reports help add context to whatever we will learn about the labor market from the BLS employment report on Friday. As shown below, the number of job openings in the JOLTs report fell sharply by 418k. Moreover, there were 165k layoffs and another 107k quits, more than offsetting the 123k hires. The data, which is delayed a month, contradicts last month’s solid BLS employment report.

While JOLTs portrayed weakness in the labor market, ADP was stronger than expected. ADP reports the workforce added 233k jobs last month, more than double expectations and 90k more than last month’s figure. We caution with JOLTs and ADP that seasonal factors can significantly affect labor market data this time of year and won’t be fully sorted out for at least a few months. Furthermore, the hurricanes also played a role that is hard to estimate. The current consensus estimate for Friday’s BLS report is 180k new jobs, with the unemployment rate increasing from 4.1% to 4.2%

jolts job openings

GDP Remains Robust

Third quarter GDP was a mixed bag of information. GDP fell 0.2%, slightly short of estimates at 2.8%. However, the PCE prices deflator was well below the consensus estimates at 1.5%. Wall Street economists thought it would come in around 2.5%. Therefore, GDP was 1% lower than estimated due solely to overforecasting inflation. The counter to the lower prices was higher than expected consumer spending. Consumer spending grew by 3.7%, above estimates of 3.0%. Generally, the data points to a strong consumer and a continued decline in inflation.

real gdp growth contributions

Tweet of the Day

gdp defense spending

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Can Paul Tudor Jones and Stanley Druckenmiller Be Wrong?

Can famed investors Paul Tudor Jones and Stan Druckenmiller, who recently proclaimed they are short bonds, thus betting on higher yields, be wrong? Instead of mindlessly assuming such legendary investors are correct, let’s do some homework.

First, though, let’s remind ourselves that Paul Tudor Jones and Stanley Druckenmiller are known for their aggressive trading styles. Therefore, we don’t know whether their bets are short term trades for a quick profit, or longer-term bets on significantly higher yields. Moreover, maybe their negative bond commentary is just “talking their books” to get traders and investors to follow them and boost their profits. Such a proven strategy by famous traders can be a recipe for losses by those who try to mimic their trades.

The recent 50-basis point increase in longer-term yields started the day after the Fed cut rates by 50 basis points. Some bond bears claim the Fed will rekindle inflation by cutting rates while the economy remains strong. Others fear that fiscal deficits are out of control, leading to inflation. An emerging group of bond bears, led by Paul Tudor Jones and Stanley Druckenmiller, worry that a Donald Trump Presidency and Republican control of Congress will ramp up deficits, resulting in high inflation.

Let’s address the market narratives and assess their credibility. Doing so will help us decide if following Paul Tudor Jones and Stanley Druckenmiller is a good idea.

ten year yields
Ad for financial planning services. Need a plan to protect your hard earned savings from the next bear market? Click to schedule your consultation today.

Is Another Round Of Higher Inflation Likely?

Below is a review of some possible causes of inflation bandied about by the inflationist crowd.

Will High Inflation Reemerge

At its core, inflation is a function of supply and demand. The 2022-2023 bout of high inflation occurred because demand was grossly elevated by pandemic-related stimulus and unusual consumer behaviors. At the same time, the supply of many goods was significantly curtailed by global lockdowns and crippled supply lines.

Both demand and supply have since normalized. If inflation rises, it will not be for the same causes as the last round of inflation.  

A Repeat Of the 1970s Is In the Cards

Some investors argue that consecutive rounds of the 1970s-like inflation are inevitable.

That era and this era are very different, as we recently wrote in a four-part series. Instead of requoting from those articles, we share the links (ONE, TWO, THREE, and FOUR).

 “The 2020s aren’t the 1970s by any stretch of the imagination!” – Part Four

Government Spending Will Boost Inflation

Paul Tudor Jones and many others warn that uncontrollable federal deficits will boost inflation. We will also address this topic in the Debunking Deficits section, but before doing so, it’s worth a quick lesson on an economic term called the negative multiplier. To do so, we share a section from our article Stimulus Today Costs Dearly Tomorrow:

As we note, debt increasing faster than economic growth proves that borrowing and spending are unproductive. Unproductive government debt or private sector debt also results in a negative economic multiplier. Essentially, the ultimate expense of the debt outstrips its benefits over the long run.

Economists define the multiplier effect as the change in income divided by the change in spending. Over an extended period, if the change in spending is more significant than the change in income, the effect of said spending is negative. Replace GDP for income and government debt for spending to compute the government’s spending multiplier.

Multiplier = Change Income / Change Spending

Government Multiplier = Change GDP / Change Debt Outstanding

Bottom line: government debt stimulates the economy. However, the debt detracts from growth over time, more than offsetting the initial benefits. If you think the government is suddenly spending productively, then inflation may have an upward bias. However, assuming the government continues to spend unproductively, higher deficits are deflationary and weigh on economic growth.

The U.S. Will Import Inflation

Some say we will import inflation. The first graph below shows that inflation in the Eurozone, China, and the U.K., three of our largest trading partners, is falling alongside that of the United States. China’s inflation is near zero. Japan, not shown, has seen meager inflation with bouts of deflation for the last 25 years.

We also ran a multiple regression to forecast U.S. inflation based on the inflation of China, the U.K., and the Eurozone. The second graph shows a significant correlation, with an r-squared of .86. Moreover, the model states that U.S. CPI needs to fall by 0.3% to align with the historical relationship.

Both charts lead to the question of who we will import inflation from.

us euro uk china cpi trends
us inflation regression uk euro china
Ad for The Bull/Bear Report by SimpleVisor. The most important things you need to know about the markets. Click to subscribe.

Debunking Deficits

Before we put context to the recent deficit spending, it’s important to caveat that we believe, and have written on many occasions, that the nation’s consistent deficit spending and accumulating debt are a considerable headwind to economic growth. We, in no way, condone the recent deficit spending or the excessive spending for most of the last forty years. We are also well aware that countries with debt-to-GDP ratios above 1.0 have not fared well. 

That said, considering bond returns for the next year or two, we must assess the situation for what it is today and not let the narratives and hyperbole surrounding the market sway our decision-making.

We now review a few popular arguments claiming that the trajectory of deficits has changed considerably, and the change is inflationary.   

Recent Spending Is Obscene

A common argument from the emerging bond bears is that recent deficits are obscene compared to past ones. Accordingly, bond bears think these increased deficits will be inflationary and require higher yields to satisfy Treasury investors.

While that may be true, the argument lacks context. They fail to mention that the economy has grown significantly over the last few years.

The economy is about $8 trillion, or 33%, larger than it was on the eve of the Pandemic. Therefore, it’s not surprising the amount of debt has grown commensurate with that amount.

The graph below shows the debt-to-GDP ratio and its trend line since 1980. After the ratio jumped higher on massive COVID-related spending, it settled down slightly above where it was before the Pandemic. Furthermore, it has been flat for the last two years.   

debt to gdp deficits

Now, let’s take the analysis one step further and theoretically calculate what the current debt growth would look like had the Pandemic never occurred. We admit that this is not a traditional way to assess debt, but it does provide unique context on the debt outstanding compared to GDP.

To do this, we reduce the debt by the estimated $5.6 trillion spent on COVID relief. Furthermore, we assume the interest expense of the Treasury debt would have stayed on the pre-inflation trend. For perspective, this cuts approximately $500 billion of added interest expense in the past year.

The graph below shows the revised debt to GDP in orange. Might it be fair to say that without the Pandemic, current debt issuance would be on par with pre-pandemic debt to GDP levels given the economy’s size? Furthermore, despite the pandemic, spending, debt, and GDP growth have primarily been aligned for the last two years.

debt to gdp excluding covid

Deficit Spending Increases The Money Supply

Money is lent into existence. Such is a fact; therefore, larger deficits (borrowing) increase the money supply. However, as the graph below shows, the money supply (M2) is on the pre-COVID trend. More importantly, M2 as a ratio of GDP, a better measure of money supply, is decently below the pre-COVID trend.

money supply

Also, for consideration, the supply of money is only part of the inflation equation. The other significant half is the velocity of money, or how often it is spent. Currently, the velocity of M2 is at the same level as at the start of 2020.

The supply and velocity of money have erased the pandemic-related anomalies and are similar to where they stood in late 2019. At that time, inflation was consistently running at 2%. The current supply and velocity of money should not lead one to believe that inflation is set to increase. If anything, the figures argue that inflation will return to the Fed’s 2% target.

We Are Following Japan’s Path

Paul Tudor Jones mentions a similarity between our fiscal situation and Japan’s. He refers to Japan’s excessive government debt and its central bank, which keeps interest rates extraordinarily low to help service the debt.

Japan has a debt-to-GDP ratio of 263%, more than twice that of the U.S. Its central bank has set interest rates at or below zero and relied on massive amounts of Q.E. for the last 20 years. The result is longer-term bond yields, as shown below, of 2% or less and sub-1 % inflation with prolonged periods of deflation. 

japan ten year yields

Following Japan’s path seems awfully bullish strictly from a bond holder’s perspective.

Ad for SimpleVisor. Get the latest trades, analysis, and insights from the RIA SimpleVisor team. Click to sign up now.

More From Jones

Paul Tudor Jones also believes that inflating away the debt is the only way to resolve the issue without taking strict fiscal steps. Maybe he knows something we don’t, but Japan proves that is not necessarily the case, at least not yet.

Jones also comments that we need to “get to the point where we stabilize debt to GDP to where it is right now.” As we showed earlier, the debt to GDP is stable and not rising.

Donald Trump and a Republican Sweep

Paul Tudor Jones and Stanley Druckenmiller voice concern over inflation and bond yields if Donald Trump becomes the President and the Republicans sweep Congress.

Let’s take their assumption a bold step further and assume Donald Trump immediately attempts to cut taxes, spend like crazy, and rack up massive deficits. Even so, he must contend with Democrats, who will still have nearly 50% of the votes in Congress, and the Republican Freedom Caucus, which wants to curtail government spending and balance budgets. The Caucus and Democrats could be strange bedfellows in that circumstance.

Summary

The bearish arguments we discuss in this article have merit. However, when taken in proper context, we believe some of them are not as worrying as the headlines may seem. Further, as we see in Japan, there is quite likely more monetary policy runway before problems escalate.

We believe the slowing economic growth and lower inflation trends that persisted before the Pandemic are reasserting themselves. It may sound ridiculous today, but we wouldn’t be shocked if investors and the Fed were again worried about deflation in the coming years.

Market Turbulence Ahead: Buckle Up

Many events could roil the markets over the next two weeks and/or send them surging. Accordingly, it’s worth summarizing the political, monetary, and economic schedule to prepare for market turbulence.

The intense schedule kicked off yesterday with the JOLTs report and Google earnings.

Today is the ADP jobs report and Microsoft and Meta earnings. Thursday features Apple and Amazon earnings and the critical PCE inflation report. Furthermore, the Bank of Japan, whose actions have recently caused volatility in global markets, will set interest rates. As seen in early August, hawkish signals from the BOJ could revive the market turbulence. The PCE and Friday’s BLS employment report will go a long way to setting market expectations for next week’s Fed meeting. Current expectations point to a high likelihood they cut by 25bps.

Market turbulence continues next week, with elections on Tuesday and the Fed meeting on Wednesday. If the election results are unknown and likely contested, the Fed will have a tough decision to make. As if the election and Fed weren’t enough for the bond market to digest, the Treasury Department will conduct ten- and thirty-year auctions. Consequently, with decent odds of increased market turbulence over the next two weeks, buckle up and manage risk, as it will be an exhausting two weeks.  

Fed rate probabilities

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As noted yesterday, the market continues to grind sideways below the broken rising trend line. However, the action remains bullish as investors anticipate good earnings from Microsoft, Meta, Ely Lilly, and Abbvie today. We hold long positions in all those stocks, so today’s announcements after the bell will greatly impact portfolios tomorrow.

Market Trading Update

This earnings season has heavily rewarded companies that beat earnings estimates, but overall revenue beats have been roughly average. Such suggests the economy is slowing down, and earnings may become more challenging next year. However, that is a story we will discuss with you later.

The market continues to trend higher, holding support at key levels, namely the 20-DMA (not shown in the chart above). However, this is all positioning for earnings this week. Once those reports are finished on Thursday, we could see some derisking headed into Tuesday’s election, given that no one is certain of the outcome. As such, continue to manage risk for now, and after next week’s election and Fed meeting, we should have a better picture of how to position for the remainder of the year.

DHI Warns Of Weakening Housing Market

DR Horton (DHI) opened over 10% lower, dragging the rest of the homebuilder sector lower. DHI’s earnings and revenue fell short of expectations. More importantly, its number of completed but unsold homes rose 17% over the quarter to 10,300. This is especially concerning as it is going into a seasonally slow selling period, and mortgage rates are up by over 0.50% over the last month. Further, making matters worse for shareholders, DHI reduced its revenue guidance from $39.4 billion to $36-37.5 billion.

Further weighing on DHI and other homebuilders are homebuyers with lower mortgage rate expectations. Per its CEO:

“While mortgage rates have decreased from their highs earlier this year, many potential homebuyers expect rates to be lower in 2025. We believe that rate volatility and uncertainty are causing some buyers to stay on the sidelines in the near term.”

Lastly, the Case-Shiller housing index fell by 0.13% last month, with the year-over-year change running at 4.2%. For context, the 2022 peak was +5.5%. Moreover, flat to declining home prices support DHI’s weaker earnings and forward-looking revenue shortfall.

dr horton DHI

Key Market Indicators For November 2024

The November outlook marks a critical period with macroeconomic and election uncertainties still in play. The Fed’s dovish tone remains encouraging for equity markets, but geopolitical risks and U.S. election developments could inject volatility. As we approach the year-end, investors must remain agile and ready to respond to sudden market shifts.

READ MORE…

best six months for the market November 2024

Tweet of the Day

earnings reports this week

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Key Market Indicators for November 2024

Key market indicators for November 2024 present a complex but opportunity-filled environment for traders and investors. Following the first phase of Federal Reserve rate cuts and growing global uncertainties, the technical landscape suggests several notable shifts. Let’s explore the key market indicators to watch.

Note: If you are unfamiliar with basic technical analysis, this video is a short tutorial.

YouTube video

Seasonality and Breakout Patterns

As discussed recently, Seasonality is a crucial key market trend in November. Historically, the stock market transitions from the weaker summer months into a stronger end-of-year rally, often dubbed the “Santa Claus Rally,” beginning mid-December. On a rolling 6-month basis, November to April has both the highest percentage returns and the highest hit rate at 77%.

Best Six Months Market Returns

The seasonal trend is reinforced by the weekly MACD (Moving Average Convergence Divergence) signal crossing into bullish territory, hinting at upward momentum through the year-end. The previous two seasonal “buy signals” have worked well for investors. However, that signal does not preclude a short-term correction to moving average support levels.

Stock market  technical analysis

As noted in that previous article, the return of corporate share buybacks will be an important support to the market, adding nearly $6 billion daily to large-cap purchases.

Buybacks authorizations
Schedule an appointment

Sectors to Watch: Tech and Industrials Lead

With interest rates declining, cyclical sectors—like industrials and technology—are gaining strength. Large-cap tech companies, particularly the “Magnificent 7,” are all holding above critical moving averages. Despite more bearish investors suggesting the “AI” trade is done, the price action continues to suggest strong institutional participation, which could drive the Nasdaq higher into year-end. Such is particularly the case given that hedge funds remain significantly underweight U.S. equities versus the benchmark. On a risk-adjusted return basis, we are already seeing them increase exposure to “catch up” on performance into year-end.

Positioning by hedge funds

Notably, these stocks generate all estimated earnings growth for the S&P 500 index.

Earnings growth expectations

Meanwhile, the industrial and materials sectors, which were consolidating from March to August, are beginning to trend higher. Such is due to expectations of a Presidential election outcome that would lead to stronger economic growth, oil and gas investments, tax cuts, and reshoring of U.S. manufacturing.

Basic materials and industrials

Those policies would also generate stronger domestic employment, higher wage growth, larger investments in technology, and increased loan demand from the financial sector. This is likely why we have also seen improvement in those sectors lately.

Technology and Financials

Back to seasonality, it is also notable that many of the stocks that drive the Technology and Financial sectors are also some of the largest purchasers of their shares. As that window opens into year-end, additional price support should be provided.

Volatility Rising

Of course, while the market may be betting on a certain election outcome, over the last month, the rise in the Volatility Index (VIX) signals potential unease beneath the surface. Typically, VIX declines as equities rise, reflecting lower risk sentiment. However, the current divergence suggests investors continue to hedge against an unanticipated or contested election outcome. The chart shows the $VIX index inverted against the S&P 500 index. Normally, there is a high correlation between the inverted volatility index and the market. However, the non-correlation is currently extremely elevated, suggesting professionals are hedging their portfolios against downside risk.

Stock market versus the volatility index

While not an immediate red flag, this disconnect warrants caution. Investors should monitor for potential market reversals or volatility spikes, as rising VIX amid bullish markets can indicate heightened sensitivity to external shocks. However, if the election passes as anticipated, the reversal of volatility hedges could also provide an additional tailwind for equities into year-end.

The key point for investors is to be aware of short-term risks in the market despite a stronger bullish view into year-end. Therefore, continue to adjust strategies to incorporate volatility-based stops or other hedges to manage risks effectively.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

Momentum Indicators: Negative Divergences

The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) indicator offer mixed signals on the broad market. While the broad market remains bullish, holding above key moving averages, relative strength and momentum show a negative divergence.

Market vs RSI and MACD negative divergence

These negative divergences have often preceded short to intermediate-term corrective market actions. At this point, investors tend to make two mistakes. The first is overreacting to these technical signals, thinking a more severe correction is coming. The second is taking action too soon.

Yes, these signals often precede corrections, but there are also periods of consolidation when the market trades sideways. Secondly, reversals of overbought conditions tend to be shallow in a momentum-driven bullish market. These corrections often find support at the 20 and 50-day moving averages (DMA), but the 100 and 200-DMAs are not outside regular corrective periods.

Navigating Market Uncertainty and Upcoming Catalysts

The November outlook marks a critical period with macroeconomic and election uncertainties still in play. The Fed’s dovish tone remains encouraging for equity markets, but geopolitical risks and U.S. election developments could inject volatility. As we approach the year-end, investors must remain agile and ready to respond to sudden market shifts. Therefore, investors may want to consider several strategies:

  1. Increase Equity Exposure: Large-cap stocks historically perform well during this period. You could consider increasing exposure to diversified index funds or sector ETFs that align with historical trends. If you are a stock picker, focus on large-cap, highly liquid names that generate the strongest earnings growth.
  2. Review Portfolio Risk: While the MACD buy signal is a positive indicator, you should assess your portfolio’s risk tolerance and ensure it aligns with your long-term goals.
  3. Rebalance Allocations: Now may be a good time to rebalance by reducing positions in riskier assets or diversifying across asset classes.
  4. Use Stop-Loss Orders: To manage downside risk, consider using stop-loss orders.

While the markets remain very bullish currently, rebalancing risk may lead to short-term underperformance while the “sun is shining.” However, a steady practice of risk controls ensures you won’t be caught without an umbrella which it “begins to rain.”

The trick to navigating markets is not trying to “time” the market to sell exactly at the top. That is impossible. Successful long-term management is understanding when “enough is enough” and being willing to take profits and protect your gains. For many stocks currently, that is the situation we are in.”TheBullBearReport

As we head into the Mega-cap earnings reports, that advice remains relevant this week. The trick will be to navigate the outcome without making emotionally driven decisions.

Continue to follow the rules and stick to your discipline. (Read our article on “What Is RIsk” for a complete list of rules)

Continuing Jobless Claims Diverge From Initial Claims

Along with this week’s BLS, JOLTs, and ADP labor market reports are the weekly initial and continuing jobless claims data from the BLS. While the market doesn’t seem to focus on the continuing and initial jobless claims data as much as the monthly data, it is constructive. It helps us affirm the divergences we see in the monthly data. Furthermore, it is much closer to real-time, so it quickly alerts us to potential changes.

Initial and continuing claims affirm the stale jobs market, whereas few employers are hiring and few are firing. The graph below from ZeroHedge shows continuing claims (red) are at a 3-year high and have been trending higher over the last couple of months after being rangebound for 2023 and early 2024. Furthermore, excluding the pandemic-related period of 2020 and 2021, continuing claims are above 2018 and 2019 levels. The divergence between initial and continued claims portends that the pace of layoffs is not increasing, but those laid off are finding it hard to find a new job. This data jibes with the JOLTs data, showing the hires rate is at the lowest level in 10 years.

This week, we might get further confirmation between JOLTs and the continuing claims data. Such a signal can be a leading indicator of broad-based labor market weakness in the pipeline. However, take the data with a grain of salt as it may be employer consternation leading into the election.

continuing jobless claims

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As discussed yesterday, the market has taken a breather over the last several trading days after a long and uninterrupted six-week advance. Notably, volatility remains somewhat elevated but subdued within a tight trading range. That compression, as noted previously concerning the stock market, indicates that a fairly substantial move in volatility is likely when it breaks out of that range.

We guess that the market is not hedged enough for an election outcome that favors Kamala Harris, which could send volatility sharper higher for a day or two as Wall Street repositions from their recent “Trump trade” bets. If Donald Trump wins the election, we could see volatility break to the downside into year-end as professional managers chase stock returns for year-end reporting.

To us, the volatility index suggests some short-term risk to the market. Unfortunately, we have no idea what that means. As we saw in 2016, it was assumed that if Donald Trump won, the market would crash. It did on election night, but by the time the markets opened the next day it was flat and ended up 500 points by the end of the day. That kind of overnight swing is impossible to hedge for and any potential thing you do has an opportunity to turn out wrong.

Market Trading Update

As such, we will likely stay the course for now—wait for the election and then adjust for the outcome. Furthermore, a lot of critical economic data this week, from PCE to Employment, will weigh on the Federal Reserve and their meeting next week. We also have earnings from MSFT, GOOG, AMZN, AAPL, and LLY, which will move markets.

As you can see, there are many moving pieces this week. Remain nimble and be prepared to adjust if necessary.

Hedge Funds Own The Largest Stocks

With earnings releases from some of the largest companies this week, we know hedge funds will be paying close attention. The chart below shows that the five most popular hedge fund holdings will present earnings this week. Given hedge funds’ general trading and positioning aggressiveness, the earnings reports will generate significant volatility if they over-or underperform expectations or present guidance different from market expectations. Nvidia will report its earnings in a month, but any commentary on AI from the technology companies shown below will likely influence Nvidia’s shares.

hedge fund holdings

The Healthcare Sector Lags On Election Jitters

The coming election is taking a toll on healthcare stocks. The first SimpleVisor screenshot shows that the healthcare sector is grossly oversold relative to the broader market and other sectors. Moreover, the graph on the right shows that healthcare appears to be the only sector trading poorly going into the election. While the sector is ripe to outperform the market, we caution that it could be rough until the election is over and the market processes the results.

For more detail, the second graphic zooms into the top ten underlying healthcare stocks. ISRG is the lone outperformer. That was almost solely the function of an excellent earnings report on October 18th. Thermo Fisher, Danaher, and Merck are trading the poorest of the group.

absolute and relative analysis
healthcare relative analysis

Tweet of the Day

earnings expecatations

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Compounding With Passive And Active Strategies

The Tweet on the left below from Charlie Bilello makes a strong case for a passive, buy-and-hold investment strategy. Supporting his graphical evidence is a quote from investment legend Charlie Munger, alluding that investors should buy and hold and let compounding work its magic. Consequently, investors who panicked at the market low in 2020, sold everything, and did not buy back in would have surrendered significant gains. Compounding and the fortitude to stick with a passive strategy proved to be a winning combination over the last few years. Albert Einstein once said, “Compound interest is the world’s eighth wonder.” It’s daunting to challenge Munger and Einstein, but here we go.

Bilello’s graph assumes the extreme worst-case scenario: an investor sells everything at the low and doesn’t reenter the market. Let’s take the opposite case with a perfect active strategy. What if an investor sold the market peak in January 2020 and repurchased it at the bottom in March? The green line on the graph to the right adds this scenario to Bilello’s other two scenarios.

The point of this exercise is not to claim that calling market tops or bottoms is achievable but that active management, when done well, allows investors to outperform a passive strategy. Moreover, the benefits of compounding are greatly accentuated when active investing outperforms a passive approach. Furthermore, even if an active investor doesn’t perfectly time significant peaks and troughs, active management can still help you achieve better results than the market. However, we caution that poor active management decisions can result in underperformance versus the market.

compounding

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

st week, we discussed the triggering of the weekly seasonal MACD buy signal. To wit:

“The WEEKLY S&P 500 chart, with three different signals, confirms the start of the seasonal period. With Friday’s close in the green, keeping the week broadly positive, all three seasonal buy signals have been triggered. However, just because the seasonally strong period of the year has technically started, it doesn’t mean that the markets won’t have corrections along the way. Notably, we have already had 6-straight weeks of gains, which is a long stretch without a pullback. Secondly, while the market is on a weekly “buy signal,” the market is both deviated and overbought short-term. When the market breadth is very elevated, combined with overbought and deviated markets from the 50 and 200-DMA, corrections and consolidations tend to be more prevalent.”

Unsurprisingly, the market stumbled a bit this past week, breaking the “rising wedge” pattern to the downside. While the correction has been mild, with the election looming, some further consolidation or reversal as portfolio managers “derisk” for election risk should be expected. However, the market continues to find buyers at the 20-DMA as portfolio managers are unwilling to be “out of the market” currently.

Notably, the market rallied to the underside of the rising trend line but failed at that resistance level. While the moving averages will provide some short-term support, we must remember that the negative divergence in relative strength and momentum remains.

Market Trading Update

As noted, there is currently little risk of a bigger near-term correction. However, some things could cause one, like a highly contested election. In the current political environment, such is not a low-probability event. As such, while we remain allocated to the markets, we are closely monitoring the amount of risk we take.

The Week Ahead

This week, earnings, inflation, employment, and election polling will make the headlines.

The BLS JOLTs and Employment Report will be released on Tuesday and Friday. ADP will shine additional light on the labor market on Wednesday. Economists expect to see a gain of 170k jobs, down from 254k last month. A downward revision to the previous month’s figure would not be surprising. Headline and Core PCE, the Fed’s preferred inflation gauge, are expected to increase by 0.1%. That data will be released on Thursday.

The markets have been pricing in a Trump victory with an increasing chance the Republicans take both houses of Congress. The daily onslaught of polls will either affirm the market or cause some consternation among investors.

As we share below, courtesy of TradingView, many earnings reports from some of the largest companies are due this week.

week earnings announcements

Low Forward Returns Are A High Probability Event

As stated at the outset, valuations are a terrible market timing metric. However, they tell us much about asset bubbles, investor psychology, and future returns.

No matter how many valuation measures we use, the message remains the same: From current valuation levels, investors’ expected rate of return over the next decade will likely be lower.

There is a large community of individuals who suggest differently and make a case for why this “bull market” can continue for years longer. Unfortunately, no valuation measure supports that claim.

But let me be clear: I am not suggesting the next “financial crisis” is upon us either. I am suggesting that based on various measures, forward returns will be relatively low compared to what we witnessed over the last eight years. Such is particularly the case as the Fed and central banks globally begin to extract themselves from the cycle of interventions. 

READ MORE…

forward return expectations

Tweet of the Day

retail single stock trades

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Robo-Taxi: Tesla Or Uber?

What a difference two weeks make. Despite a 15% gain on Thursday, Tesla shares are back to where they were two weeks ago. The stock fell roughly 15% when its Cybercab robo-taxi presentation was a dud. As further attestation to the problems besetting Tesla’s robo-taxi program, shares of Uber and Lyft rose 10%. Today, shares of Uber and Lyft trade lower as hope for Tesla’s robo-taxi program is revived. Despite numerous setbacks to its robo-taxi production, Elon Musk believes robo-taxis are potentially a $5 to $7 trillion opportunity. On the earnings conference call, Musk provided an optimistic outlook.

I do feel confident of Cybercab reaching volume production in ’26, just starting production, reaching volume production in ’26. And that should be substantial, but we’re aiming for at least 2 million units a year of Cybercab– Elon Musk

As investors, we can bet on robo taxi success with Tesla shares or against its progress via Uber. To put a shorter-term technical context to the decision, we share the analysis from SimpleVisor below. The top blue line charts the price ratio of Tesla versus Uber. Over the last year, as demonstrated by the lower ratio, Uber has outperformed Tesla. The second graph from the top is a proprietary trading signal we created. Like the MACD and stochastic graphs below it, our model signals that Tesla is set to outperform Uber. Accordingly, given the immense profits from robo-taxis, this analysis argues that Tesla is likely to gain support from shareholders for its robo-taxi program.

uber and tesla analysis

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As noted yesterday, the market broke out of the “rising wedge pattern” to the downside. This likely begins the correction/consolidation process heading into the election. With traders largely offside, having chased stocks over the last week, reversing some of those trades seems logical heading into the election in two weeks.

Yesterday, the market held the 20-DMA, which continues to act as support with the MACD “sell signal” triggered. We suspect the market may attempt a rally to the bottom of the rising trendline and then turn lower into the election as portfolio managers “derisk” portfolios for the possibility of a contested outcome. Such would likely coincide with a test of the 50-DMA, which would get markets decently oversold short-term. The 100-DMA slightly below that is certainly possible. However, such a correction would be ideal for a year-end rally as portfolio managers try to make up performance for the year and buybacks return at a robust $6 billion/day clip.

Market trading update

The bullish momentum remains, although it is diminishing a bit, which suggests remaining long-biased equity exposure for now. However, such does NOT mean that you should not continue a process of risk management along the way.

Stock And Bond Volatility

One reason for the recent increase in bond yields is that the odds of Trump winning and a Republican sweep of Congress are growing. Presumably, according to the media, such a scenario would foster tax cuts and increased deficit spending. It’s not just yields that highlight this concern, but volatility. The Bloomberg graphs below show the implied volatility for the stock and bond markets. Bond market volatility (MOVE) is the highest it’s been this year. Yet, despite the concerns, stock market volatility has risen but remains well off prior levels.

The election and, more importantly, future fiscal policies are unknown. Therefore, we need to ask why the bond market is so concerned about the election and, ultimately, changes in fiscal policies while the stock market is sanguine.

stock and bond volatility

Election Handicapping Is Fraught with Risks

As we previously noted, the bond market narrative driving yields higher is that a Trump victory and Republican sweep of Congress will result in higher government spending. While that is highly debatable, we instead focus on the polls that point to a Trump victory. The table below from Real Clear Politics is simply an average of national polls. Harris has a slight lead, with the underlying individual polls mixed and incredibly close. More importantly, focus on the yellow highlighted section “This day in history.”

On this day in 2020, President Biden had a big lead over Trump. On this day in 2016, Hillary Clinton had a decent lead over Trump. Biden went on to win by a slim margin in 2020, and Clinton, despite being the odds-on favorite, lost. Bottom line: polls can be misleading. Thus, making investments based on said polls is fraught with risk. Furthermore, market assumptions on what a president may or may not do are often proven false. For gamblers and speculators, the environment is ripe for trading. Investors should sit back, wait to see who wins, and give the new president and Congress time to see what they will and won’t enact.

election polls

Tweet of the Day

tesla stock gain

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Lower Forward Returns Are A High Probability Event

I was emailed several times about a recent Morningstar article about J.P. Morgan’s warning of lower forward returns over the next decade. That was followed up by numerous emails about Goldman Sachs’ recent warnings of 3% annualized returns over the next decade.

Goldman Sachs 10-year Return Forecast

While we have previously covered many of these article’s points, a comprehensive analysis is needed. Let’s start with the overall conclusion from JP Morgan’s article:

“The investment bank’s models show the average calendar-year return for the S&P 500 could shrink to 5.7%, roughly half the level since World War II. Millennials and Generation Z might not enjoy the robust returns from U.S. stocks that helped swell the retirement accounts of their parents and grandparents.”

While such a statement may seem obvious to long-time students of markets, the outsized returns over the last decade have many questioning whether “this time is different.” As we discussed in “Portfolio Return Expectations Are Too High.” To wit:

The chart shows the average annual inflation-adjusted total returns (dividends included) since 1928. I used the total return data from Aswath Damodaran, a Stern School of Business professor at New York University. The chart shows that from 1928 to 2023, the market returned 8.45% after inflation. However, after the financial crisis in 2008, returns jumped by nearly four percentage points for the various periods. After over a decade, many investors have become complacent in expecting elevated portfolio returns from the financial markets. However, can those expectations continue to be met in the future?”

Bar Chart of "Arithmetic Average S&P 500 Annual Total Real Return Over Different Periods" with data from 1928 to 2023.

After over a decade, many investors have become complacent and now think that these elevated rates of return are “normal.” However, the reality may be quite different.

The stock market is a complex ecosystem with various factors influencing outcomes. Those factors include valuations, inflation, monetary policy, and political regulations. Investors should consider the impact on future stock market returns as we enter a period of potentially higher average inflation (compared to the last decade), less monetary accommodation from central banks, and growing political uncertainty.

Stock Market Valuations: Are We in Bubble Territory?

Valuations are one of the most critical factors in determining future stock market returns. However, valuations are a terrible market timing tool. Valuations only measure when prices are moving faster or slower than earnings. In the short term, valuations are a measure of psychology and the manifestation of the “greater fool theory. As shown, there is a high correlation between our composite consumer confidence index and trailing 1-year S&P 500 valuations.

Consumer confidence vs valuations

However, where valuations matter is in the long term. Historically, over a decade or more, future returns tend to be lower when stock prices are high relative to earnings. Metrics like the price-to-earnings ratio or P/E ratio often measure such. Conversely, when valuations are low, future returns tend to be higher. The scatterplot chart below compares valuations and returns over a rolling 10-year period.

Forward 10-Year Returns based on Valuations

There is little argument that U.S. stock market valuations are elevated compared to historical averages. The S&P 500’s cyclically adjusted price-to-earnings (CAPE) ratio remains well above its long-term exponential growth trend. High valuations reflect optimism but can also signal caution. If the market is pricing in perfection, any disappointment can lead to significant corrections

Cape Valuations Deviation From Trend.

However, here is the crucial point. High valuations do NOT mean that every year going forward over the next decade will experience a low return. It means the “average” return over the next decade will be low. The chart below shows hypothetical annual market returns with a 10-year average of just 3%. Notice that while 70% of the years provided a return of 10% or more, the 30% of the years with negative returns dragged the average substantially lower. This is the problem of market declines and time.

Annual Vs Average Returns

Inflation also presents another challenge to future returns.

Less Monetary Accommodation: The End of Easy Money?

The Federal Reserve and other central banks worldwide have spent the last decade engaging in highly accommodative monetary policies. Near-zero interest rates and massive asset purchases (known as quantitative easing) provided tailwinds for stock market returns by reducing the cost of borrowing and encouraging risk-taking. However, if inflation settles in at or above the Fed’s 2% target rate, central banks may be forced to pull back on these policies. While the Federal Reserve has been reducing its balance sheet, Government spending (The Inflation Reduction and CHIPs Act) has continued supporting economic growth and earnings.

Government Interventions and the stock market

While the Federal Reserve has started cutting interest rates, it has stated that it does not foresee the Fed Funds rate returning to zero. Therefore, if central banks maintain a higher interest rate environment and continue reducing their balance sheets, reversing “easy-money” conditions may weigh on future returns.

Political and Regulatory Changes

Political uncertainty is another factor that could impact stock market returns. As we look ahead, several potential regulatory changes could influence markets. For instance, increased taxation, stricter environmental regulations, and changes to labor laws could all create headwinds for corporate profits.

One key area of concern is the potential for higher corporate taxes. While the current administration in the U.S. has discussed raising taxes on corporations and high-net-worth individuals, it remains unclear whether such measures will pass through Congress. If corporate tax rates increase, companies may see their after-tax earnings decline, which could put downward pressure on stock prices.

Another area to watch is the regulation of the tech sector. Major technology companies have been under increasing scrutiny by regulators worldwide for issues ranging from privacy concerns to monopolistic practices. Any new regulations aimed at curbing the power of big tech could have significant implications for stock market performance, given the outsized role that technology companies play in today’s market.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

This Time Isn’t Likely Different

As stated at the outset, valuations are a terrible market timing metric. However, they tell us much about asset bubbles, investor psychology, and future returns.

No matter how many valuation measures we use, the message remains the same: From current valuation levels, investors’ expected rate of return over the next decade will likely be lower.

There is a large community of individuals who suggest differently and make a case for why this “bull market” can continue for years longer. Unfortunately, no valuation measure supports that claim.

But let me be clear: I am not suggesting the next “financial crisis” is upon us either. I am suggesting that based on various measures, forward returns will be relatively low compared to what we witnessed over the last eight years. Such is particularly the case as the Fed and central banks globally begin to extract themselves from the cycle of interventions. 

That statement does not mean that markets will produce single-digit rates of return each year for the next decade. There will be some great years to invest during that period. Unfortunately, most of those years will be spent making up for the losses from the coming recession and market correction.

Conclusion

That is the nature of investing in the markets. There will be fantastic bull market runs, as we have witnessed over the last decade, but to experience the ups, you will have to deal with the eventual downs. This is part of the full market cycles that make up every economic and business cycle.

Despite the hopes of many, no one can repeal the cycles of the market and the economy. While artificial interventions can delay and extend the cycles, the reversion will eventually come.

No. “This time is not different,” and in the end, many investors will once again be reminded of this simple fact:

 “The price you pay today for any investment determines the value you will receive tomorrow.” 

Unfortunately, those reminders tend to come in the most brutal of manners.  


If you want to learn more about how to position your portfolio for the future or seek personalized investment advice, contact our team at RIA Advisors. Schedule a free consultation, and let’s discuss how we can help you meet your financial goals, even in this changing market environment.

The Bougie Broke Cut Back On Starbucks

In March, we wrote an article on the Bougie Broke. This consumer group spends above their means while sharing their purchases on social media. Importantly, these consumers shed some light on consumer confidence. Simply, it’s easier to be Bougie Broke and flaunt your purchases when you are more confident in your wages and job than when you are less confident. We think Starbucks provides a good window into the confidence of Bougie Broke and consumers in general.

In early May, after Starbucks released its first-quarter earnings report, we wrote the following on cheap luxury items:

Starbucks latest earnings report sends the message that consumers may finally be retrenching after a few years of spending above their means. Cheap luxury items are low in price by definition and include items that we do not necessarily need but are nice to have. When consumers have confidence in the economy and their jobs, they tend to reward themselves by consuming more cheap luxury items. Conversely, concerns about their job status or doubts about whether they will get a raise lead many consumers to tighten their wallets. For many consumers, cheap luxury items are the easiest items to cut back on when their confidence wanes.

On Wednesday, Starbucks released its third-quarter earnings results. The news was not good. In fact, they pulled forward guidance for 2025 after the third consecutive decline in sales. Furthermore, it reported a 7% decline in same-store sales and a 10% decline in the U.S.

With sales of cheap luxury items falling and many labor market measures weakening, might the Bougie Broke and other consumers’ confidence be waning?

Starbucks bougie broke

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Yesterday, we discussed why I took a trading position in Treasury bonds. The decision was based entirely on the short-term bond market’s “technical” backdrop. Speaking of technicals, we spent yesterday morning reviewing the basics of Technical Analysis on the Real Investment Show.

This brings us to today’s market update. We have recently noted the market’s “rising wedge,” which can pose a rising risk. As shown, as the market rose, that advance became more narrow. That compression of price is ultimately resolved with a break out of that compression. If it breaks to the upside, it tends to lead to further gains. A break to the downside usually denotes the start of a correction or consolidation process. Yesterday’s market sell-off took the index below the rising trend line from the August lows. Such suggests that we may see more corrective action heading into the election. Furthermore, we also triggered a short-term MACD sell signal, which confirms a more negative market bias.

Market Trading Update

With the election rapidly approaching, we are not surprised to see the market take a break after its torrid advance over the last six weeks. Furthermore, we also previously suggested that a correction was possible even as the seasonally strong period of the year had started. Continue to manage risk for now; however, look for any correctional process to be contained in the 20 and 50-DMA.

A Historic Winning Streak

The chart below from Sentimentrader helps explain why investors appear overly confident despite the coming elections and the possibility of a contested outcome. The graph shows the number of days in a row where the market hasn’t posted two consecutive down days. Per Sentimentrader:

It has rarely gone this long without at least small consecutive losses. The current streak ranks among the best since 1928. It’s even better on the Nasdaq, and similar streaks preceded one-year gains 100% of the time.

sentimentrader  winning streak

Memory Inflation Warps Bond Yields

The Mayo Clinic defines Post Traumatic Stress Disorder, or PTSD, as “a mental health condition that’s caused by an extremely stressful or terrifying event — either being part of it or witnessing it.” Within the field of PTSD research is a concept called “memory inflation.” Memory inflation occurs when memories of traumatic events become more intense over time.   

Memory inflation of past events amplifies one’s emotions and behaviors. Accordingly, distress from recent price inflation is causing many investors to overly fear that a similar situation will reoccur.

Given the tight relationship between inflation and bond yields, memory inflation negatively affects bond prices. Additionally, memory inflation may prevent some investors from seeing an opportunity to profit from the distorted market views.

READ MORE…

inflation and fed funds

Tweet of the Day

s&P 500 call put skew

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Donald Trump Or Fundamentals? Whats Irking The Bond Market

Bloomberg states: “The presidential race is still a coin-toss with two weeks to go, but Republican Donald Trump has the advantage over Democrat Kamala Harris in betting markets. His support for higher tariffs and looser fiscal policy has been seen as unfriendly to bonds because it means faster inflation and more debt.” Furthermore, the graph on the left supports their statement. It highlights that yields and the betting odds of Donald Trump winning have recently been well correlated. While one can make a narrative that Trump’s plans may result in larger deficits, inflation, and ultimately higher yields, we caution that correlation is not causation. In other words, the relationship between yields and Donald Trump’s reelection odds may not be as robust as some assume.

Two of our recent Commentaries (HERE & HERE) showed the correlation between bond yields versus oil prices and the Citi Economic Surprise Index surprise index. In both cases, the relationships are often strong regardless of the President and political composition of Congress. The Goldman Sachs graph on the right supports our opinion that economic and inflation fundamentals are primarily responsible for higher bond yields. Their graph attributes five basis points of the 35 basis points increase in ten-year yields to the shift in election odds favoring Donald Trump. We, Wall Street nor the betting markets, know who will win the election. Moreover, knowing which campaign promises will ultimately be enacted and which are vote-getting fodder is extremely challenging. Accordingly, focus on oil prices and economic data to assess the future direction of bond yields.

donald trump and bond yields

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

In yesterday’s update, we discussed the onset of seasonality and the market. The full blog post is linked below for your review. Yesterday, in my personal trading account (not our client accounts) I took a speculative long position in the iShares 20+ Year Treasury Bond ETF (TLT). I also bought December call options at the money for a trade.

My reasoning is purely technical. As shown in the chart below, TLT is pushing well into 3-standard deviations below the 50-DMA, with a deeply oversold MACD and RSI. Historically, it has been a decent setup for a reflexive trade higher, particularly after a 50% retracement of the rally from the previous lows. I am maintaining a short-term price target of $96-$98/share and will close out my call options early. However, the long position of TLT may well be maintained longer if evidence of economic weakness becomes more apparent, which I suspect will be the case.

Market Trading Update

So, why did we not do this for client accounts? Great question.

  1. In our client portfolios, we work to buy longer-term positions for capital appreciation and create tax efficiencies over time.
  2. This is my personal account. If I am wrong and lose money, I can live with that. However, I don’t speculate with our clients’ money, which they are dependent on for their financial goals.
  3. Furthermore, our client portfolios already have significant bond holdings. Taking on additional bond risk for a speculative trade will not create a return sufficient to warrant the increased portfolio risk and volatility.

However, I wanted to be transparent about my personal actions. We discussed previously why the recent bond correction was likely. I believe we have completed the correction between now and the end of the year..

We will see if I am right.

Bank Of Canada And The ECB Mull Faster Rate Cuts

While the Fed and U.S. investors are backing off of rate cuts, other countries are moving to ramp up rate cuts. ECB member Mario Centeno sees the risks skewed toward undershooting its inflation target rather than higher-than-target inflation. With ECB inflation running at 1.7%, below its 2% target, Centeno will find support to cut rates more quickly from other voting members. The first graph below shows Euro inflation is back to normal.

The Bank of Canada is expected to cut rates by 50bps to 3.75% at today’s meeting. The action is being taken against the backdrop of lower inflation. The latest core CPI for Canada was 1.6%, as shown in the second graph. Per Bloomberg:

“Arguably the Bank of Canada is well behind the curve,” Jason Daw, head of North American rates strategy at Royal Bank of Canada, said by email. “They had to wait due to inflation uncertainties, but with price growth normalizing quickly, the economy no longer needs the current degree of restrictiveness.”

Global inflation is slowing and quickly returning to pre-pandemic levels. Quite frequently, inflation in most developed Western nations tracks each other. While U.S. inflation is still running above target, its trend and that of other countries, as we note, will likely keep the Fed cutting rates, even if economic activity remains firm.

euro cpi ecb
canada cpi

Seasonality: Buy Signal And Investing Outcomes

For investors, this seasonality signal could be an opportunity to increase exposure to equities, particularly in large-cap stocks that tend to drive the broader market. However, it’s essential to recognize that while the MACD signal aligns with historical trends, it does not guarantee future performance.

Despite the historical reliability of seasonality and the MACD buy signal, investors must still be aware of risks.

  • Monetary Policy: Inflation, interest rates, and global economic uncertainty could weigh on stock performance, even during a seasonally strong period. Given the recent bout of strong data, if the Federal Reserve slows the pace of rate cuts, this could disappoint markets. A good example is 2018, where the Federal Reserve’s more hawkish stance preceded a 20% correction in November and December.
  • Geopolitical Risks: Ongoing geopolitical tensions, whether in Eastern Europe, the Middle East, or relations between major economic powers, can quickly disrupt financial markets. Unexpected events, such as escalating conflicts or trade wars, could derail the seasonal trends.
  • Market Volatility: Volatility can spike unexpectedly, leading to sharp market corrections. Even during strong periods like the “Best Six Months,” short-term market corrections are always possible. Investors should be prepared for heightened volatility, especially if other risk factors, like earnings surprises or economic data, create uncertainty.
  • Historical Trends Are Not Guarantees: Past performance, while instructive, does not guarantee future results. Although the MACD buy signal has been a reliable indicator in the past, external factors could reduce its predictive power. Investors must be cautious and not rely solely on seasonality and technical signals.

Most crucially, the technical backdrop also poses near-term risks. The market has been up six weeks in a row, which historically is a very long stretch without a correction.

READ MORE…

S&P 500 weekly consecutive gains

Tweet of the Day

buybacks

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Memory Inflation Warps Bond Yields

The Mayo Clinic defines Post Traumatic Stress Disorder, or PTSD, as “a mental health condition that’s caused by an extremely stressful or terrifying event — either being part of it or witnessing it.” Within the field of PTSD research is a concept called “memory inflation.” Memory inflation occurs when memories of traumatic events become more intense over time.   

Memory inflation of past events amplifies one’s emotions and behaviors. As we will discuss, distress from recent price inflation is causing many investors to overly fear that a similar situation will reoccur.

Given the tight relationship between inflation and bond yields, memory inflation negatively affects bond prices. Additionally, memory inflation may prevent some investors from seeing an opportunity to profit from the distorted market views.

Apollo Management’s Chart Crime Amplifies Memory Inflation

The following graph from Apollo Management has been circulating in social media for nearly a year. We believe it keeps yesterday’s high inflation fresh in people’s minds and stokes memory inflation, which warps investors’ current view of inflation.

apollo management inflaiton comparison

The graph insinuates that inflation is perfectly tracking the 1970s and 1980s. The graph prompted us to write a four-part article (ONE, TWO, THREE, and FOUR) explaining why the current environment vastly differs from the 1970s and 1980s. The series made a strong case that another round of inflation is not likely, barring an unpredictable black swan event.

Within the article, we created a more accurate graphical comparison, as shown below, between the two periods and explained why the graph is deeply flawed. To wit:

First, the two vertical y-axis scales on Apollo’s graph are different. This makes it appear that the inflation rates of the 1970s and today are nearly identical.

Second, the horizontal axis doesn’t compare apples to apples. From 1960 to 1965 (not graphed), inflation fluctuated below 2% a year. In 1966, inflation started to increase consistently. In the modern time frame, the year 2020 is when the wheels for inflation were set into motion.

Therefore, the recent data for comparison should start in 2020, not six years prior, when there was little inflationary impulse. The graph below adjusts both axes and provides a better comparison.

Our graph below has been updated since it was initially published.

inflation vs 1970s
Ad for financial planning services. Need a plan to protect your hard earned savings from the next bear market? Click to schedule your consultation today.

Inflation Rates Versus Price Levels

When most people discuss inflation, they talk about how the prices of many goods and services are much higher today than only a few years ago. For instance, “Dinner for my wife and I now runs close to $100; it used to be $50 or $60”, or “Can you believe a gallon of milk is now $6.” Those statements reflect the price differences between today and the past but do not reflect the recent rate of change. The difference may sound trivial, but it is substantial.

When discussing inflation, economists will note the annual or monthly rate of change and not the absolute price level. For instance, they may say, “The price of milk is only up 1.2% this past year.” Or “Used car prices are down 7.5% year over year.”

We elaborated on the stark difference in inflation views between economists and citizens in Why Economists and Citizens Have Different Inflation Realities. To help better appreciate the inflation perspective of economists and citizens, we shared the graph below and wrote the following:

Economists focus on the blue line, graphing the year-over-year change in new vehicle prices. Over the last year, the price index of new vehicles has decreased by .60%. Economists can say the cost of buying a new vehicle is in a deflationary state.

While the chart may warm the hearts of economists and the Fed, most individuals see the orange line, the CPI price index for new vehicles instead. It shows that new vehicle prices are up about 20% since the pandemic. Yes, they may have recently declined slightly, but today’s prices are nowhere close to where they were four years ago. In their minds, there is significant inflation in new vehicles.

Which statement is more stressful?

  • A new car costs $55,000 compared to $35,000 a few years ago.
  • The price of a new car is down 1% over the last year.

We venture to say every reader picked the first bullet point. Both statements can be correct. However, one statement induces stress and the other tranquility. As consumers, much higher prices for many goods and services are constant reminders of the high inflation. The recurring cues invoke memory inflation in all of us, except for the most committed economists.

Bond Investors Should Think Like Economists

Whether logical or not, memory inflation of inflation creates fear that another bout of inflation is coming. For bond investors, this can create an opportunity if you believe, as the Fed and we do, that inflation is heading back toward 2% and will likely stay there, barring an unforeseen event.

Today and throughout time, bond investors should always seek a yield that compensates them for inflation and credit risks. The higher the perceived risk, the greater the yield. We believe that the memory inflation of inflation subconsciously pushes many investors to demand higher bond yields. This condition will persist. However, assuming inflation continues to head toward or below the Fed’s 2% target, the fear will diminish over time. As it fades, bond yields will catch down to inflation rates.

From a bond investor standpoint, we need to appreciate what is truly going on with inflation now versus battling memory inflation of years past. When analyzing bonds, we must try to forget that cars now cost $60,000+ and milk is $5 a gallon. Instead, think like an economist and focus on the rate of change in inflation.

Ad for The Bull/Bear Report by SimpleVisor. The most important things you need to know about the markets. Click to subscribe.

The Fed Also Has Memory Inflation

If you worry that your inflation worries will persist even as evidence strengthens that inflation is fading, you are not alone. The Fed also fosters the same problem.

As of September, the Fed’s long-run GDP and PCE price forecasts are 1.80% and 2.00%, respectively. In 2019, before the pandemic, the Fed’s long-range forecast for GDP was 1.90% and PCE at 2.00%. In other words, growth prospects slipped slightly, and their inflation forecast is unchanged. However, despite virtually identical economic and inflation outlooks, the lowest long-range Fed Funds rate forecast for the 19 Feb members is 2.40%, well above the average Fed Funds rate in the post-finance crisis era.

federal reserve fed fund expectations
Ad for SimpleVisor. Get the latest trades, analysis, and insights from the RIA SimpleVisor team. Click to sign up now.

Summary

Memory inflation of inflation results in bond yields trading above where they might have had the recent bout of inflation not occurred. It also results in a relatively conservative monetary policy.

Memory inflation will not disappear overnight, but as the distress of higher inflation ages, the bad memories will subside. Dare we say memory disinflation will kick in?

Historically, bond yields have a solid relationship with inflation and economic growth. When one considers that today’s economic fundamentals are not much different than before the pandemic, one may question why bond yields remain high. Some will blame the massive deficits or foreign selling of Treasury bonds. We think a lot of the yield premium rests on the shoulders of memory inflation and not the truest fundamental driver of yields, actual inflation.

Amazon Is Challenging The Work From Home Trend

Starting in January, Amazon workers will be expected to work in the office five days a week. While most other companies are adapting to work-from-home schedules and even offering them as a benefit, Amazon is bucking the trend. From a macroeconomic standpoint, the question that is most important is whether Amazon successfully gets its entire workforce back into the office full time.

The job market remains robust. However, as we share below, job openings have steadily declined for two years, and the hiring rate is now at ten-year lows. Regarding Amazon employees, the trends indicate that they may not have an easy time saying no to Amazon. A recent survey by Blind, in which 2,585 Amazon employees were asked their sentiment regarding the full-time office plans, shows significant discontent. 91% of those questioned said they were dissatisfied with the coming office-only schedule. Moreover, 73% said they are considering another job because of the in-office policy.

Due to the trends we graph below, Amazon will likely retain most of its employees in January. But will they be as productive if their morale is lower? Amazon’s plan will be an interesting data point for the labor markets and corporate employers.

job openings job hires

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

As noted yesterday, the market has triggered a “seasonal buy signal.” While that is certainly bullish and the subject of today’s blog post, there are risks to seasonality.

Despite the historical reliability of seasonality and the MACD buy signal, investors must still be aware of risks.

  • Monetary Policy: Inflation, interest rates, and global economic uncertainty could weigh on stock performance, even during a seasonally strong period. Given the recent bout of strong data, if the Federal Reserve slows the pace of rate cuts, this could disappoint markets. A good example is 2018, where the Federal Reserve’s more hawkish stance preceded a 20% correction in November and December.
  • Geopolitical Risks: Ongoing geopolitical tensions, whether in Eastern Europe, the Middle East, or relations between major economic powers, can quickly disrupt financial markets. Unexpected events, such as escalating conflicts or trade wars, could derail the seasonal trends.
  • Market Volatility: Volatility can spike unexpectedly, leading to sharp market corrections. Even during strong periods like the “Best Six Months,” short-term market corrections are always possible. Investors should be prepared for heightened volatility, especially if other risk factors, like earnings surprises or economic data, create uncertainty.
  • Historical Trends Are Not Guarantees: Past performance, while instructive, does not guarantee future results. Although the MACD buy signal has been a reliable indicator in the past, external factors could reduce its predictive power. Investors must be cautious and not rely solely on seasonality and technical signals.

Most crucially, the market has been up six weeks in a row, which historically is a very long stretch without a correction.

Consecutive weekly gains.

From a purely technical view, with the markets deviating well above MONTHLY moving averages and overbought, a correction or consolidation is becoming increasingly likely before the year-end advance can take shape.

Monthly market chart

Navigating Into Year-End

With the S&P 500 now in a seasonally strong period, bolstered by the weekly MACD buy signal, investors may want to consider several strategies:

  1. Increase Equity Exposure: Large-cap stocks historically perform well during this period. You could consider increasing exposure to diversified index funds or sector ETFs that align with historical trends.
  2. Review Portfolio Risk: While the MACD buy signal is a positive indicator, you should assess your portfolio’s risk tolerance and ensure it aligns with your long-term goals.
  3. Rebalance Allocations: Now may be a good time to rebalance by reducing positions in riskier assets or diversifying across asset classes.
  4. Use Stop-Loss Orders: To manage downside risk, consider using stop-loss orders.

Yale Hirsch’s research on market seasonality, paired with the power of the MACD signal, offers a disciplined approach to navigating historical market trends. The recent MACD buy signal for the S&P 500 provides investors with a potentially advantageous entry point into the market as we head into the historically strong “Best Six Months” period. However, it’s crucial to remain aware of the risks, including macroeconomic headwinds and market volatility.

Trade accordingly.

Groceries Are Getting Cheaper

Not surprisingly, most people are very sensitive to the recent bout of inflation. However, we also find that they do not consider inflation on a relative basis. Double-digit inflation can be crippling, especially for the lower and middle classes. However, if wages keep up with inflation, the effect is minimal. For example, the graph below shows that it now takes about 3.5 hours of work to afford a week of groceries. That is down an hour from 1990 despite the price of groceries being up significantly.

That said, the graph has potential flaws. For starters, it uses average salary versus median. Furthermore, it doesn’t address the quality of food or the types of food people buy. We also presume it doesn’t fully capture “shrinkflation.” Lastly, how has the basket of groceries the BLS uses changed over time, and does that accurately reflect what the average consumer buys?

groceries prices

SimpleVisor Excess Return Analysis

On Tuesdays, we typically review the SimpleVisor sector and absolute technical scores to see which sectors or factors are overbought and oversold. This analysis allows us to forecast better which sectors or factors may lead or lag the broader market going forward. Today, we take that analysis a step further.

The first graphic shows that the healthcare sector is very oversold relative to the S&P 500. Moreover, it has an absolute score near zero despite the market hitting record highs. Note that many other sectors have absolute scores of moderately to highly overbought. If we wanted to shift our holdings toward healthcare and away from another sector, which sectors would likely give us the biggest bang for the buck doing this?

The second page below shows the correlation of excess returns for each sector. Remember, the excess return is the performance versus the S&P 500. Accordingly, the page compares the correlation of the two sector’s excess returns. So, if we scan down the healthcare sector (XLV) correlations, we find that XLV has a strong positive correlation with staples and a strong negative correlation with technology. Therefore, if one wants to add to healthcare and is looking for a sector to reduce, technology would be a likely choice. Moreover, staples could be a reasonable substitute if one wants to add to healthcare but worries about the political climate surrounding the sector heading into the election.

The third graphic helps us appreciate the current excess return relationship compared to the prior 21 and 63 days. One can argue that XLV is due for a bounce versus technology on a short-term basis. Still, over the more extended 63-day period, technology may likely continue to do better than healthcare.

sector and absolute scores
sector relationships
healthcare and technology simplevisor relationship

Tweet of the Day

cpi less shelter and insurance

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Seasonality: Buy Signal And Investing Outcomes

Seasonality has long influenced stock market trends, offering insights into predictable cycles of strength and weakness throughout the year. Yale Hirsch, the creator of the Stock Trader’s Almanac, is one of the most well-known contributors to studying these patterns. His research has highlighted that certain periods of the year consistently present better opportunities for investors to generate returns, while other times warrant caution.

The adage ” Sell May and Go Away “ is a common topic of discussion that many investors are familiar with. The historical analysis supports that the market tends to be the weakest of the year during the summer months. Hirsch’s Stock Trader’s Almanac introduced the idea that the stock market follows a seasonal rhythm, where certain times of the year offer greater return potential. This work has helped investors identify key windows where market performance historically improves, allowing them to align their strategies accordingly.

  • “Sell in May and Go Away”: One of the most famous adages in market seasonality, this concept reflects the tendency for stocks to underperform during the summer months, roughly from May through October. Investors are often advised to exit or reduce exposure during this time to avoid potential downside risk.
  • The Best Six Months: Conversely, the period from November through April has been historically stronger for stocks, with higher average returns. This seasonal trend is based on data showing that a significant portion of stock market gains often occur during this half of the year.

The Math

The chart below shows that $10,000 invested in the market from November to April has significantly outperformed the amount invested from May through October.

Strong vs Weak Market Periods

Interestingly, the max drawdowns are significantly larger during the “Sell In May” periods. Previous important dates of major market declines occurred in October 1929, 1987, and 2008.

However, not every summer works out poorly. Historically, there have been many periods when “Sell In May” did not work, and markets rose. 2020 and 2021 were examples of massive Federal Reserve interventions that pushed prices higher in April and subsequent summer months. However, 2022 was the opposite, as April declined sharply as the Fed began an aggressive interest rate hiking campaign the preceding month.

Technical analysis, however, can improve outcomes.

Schedule an appointment

The Role of the MACD in Seasonal Investing

While the seasonal trends provide a useful framework, Hirsch’s research goes further by applying technical indicators like the MACD to refine entry and exit points. The seasonal MACD (Moving Average Convergence Divergence) signal, in particular, serves as a trigger that confirms when it’s the right time to re-enter the market after the weaker summer period.

The MACD is a momentum-based indicator that measures the relationship between two moving averages of a security’s price—typically the 12-day and 26-day exponential moving averages (EMAs). When the shorter-term EMA crosses above the longer-term EMA, it generates a buy signal, indicating the potential start of an uptrend. In seasonal investing, this technical indicator is combined with Hirsch’s seasonal trends to offer more precision in market timing.

  • Seasonal MACD Buy Signal: This signal typically triggers near the end of October or early November, aligning with the start of the “Best Six Months” period. It confirms that market momentum is shifting upward and is a favorable time to re-enter the market.
  • Seasonal MACD Sell Signal: Similarly, at the end of the “Best Six Months” (usually in late April or early May), the MACD sell signal indicates weakening momentum, suggesting it may be time to reduce equity exposure.

On Friday, October 11, 2024, the S&P 500 index triggered its seasonal MACD buy signal, marking the beginning of what has historically been a seasonally strong period for the stock market. This signal arrives just before November, reinforcing Hirsch’s findings that the months ahead tend to deliver better returns.

3-Market Supports For Seasonality

In 2024, three primary drivers will likely support markets from the middle of October through year-end and likely into early 2025.

Earnings

The first is earnings season, which has proved normal so far, although this week and next will be very important in corporate outlooks. As discussed in the latest BullBearReport, analysts significantly lowered the “earnings bar” heading into the reporting season. As noted in “Trojan Horses,” analysts are always wrong, and by a large degree.

“This is why we call it ‘Millennial Earnings Season.’ Wall Street continuously lowers estimates as the reporting period approaches so ‘everyone gets a trophy.’” 

The chart below shows the changes for the Q3 earnings period from when analysts provided their first estimates in March 2023. Analysts have slashed estimates over the last 30 days, dropping estimates by roughly $3.40/share, but nearly $18 lower than their initial estimate.

Q3 Earnings Estimates

Of course, lowering the bar will generate a high “beat rate” by companies, which will help fuel stock prices in the short term.

Performance Chasing

Secondly, according to Morningstar, during the first half of 2024, only 18.2% of actively managed mutual and exchange-traded funds outperformed the cap-weighted S&P 500 index. There are several reasons for this, including the lack of allocation to the “Magnificent 7,” dispersion in returns of holdings, and lack of allocation to non-traditional assets.

Performance of select assets

This underperformance occurs during the best presidential election year in roughly 90 years, which will pressure fund managers to play “catch up” with performance moving into year-end reporting. Given the “career risk” to managers of significant underperformance, additional buying pressure could manifest.

224 is the best presidential year for stocks in nearly 90 years

Corporate Share Buybacks

Lastly, corporate share buyback windows will reopen in November and December as companies exit their earnings “blackout period.” Notably, the last two months of the year represent the best two-month period for corporate executions as companies rush to complete buybacks for the current tax year. With nearly $1 Trillion in authorizations for 2024, the pace of buybacks will be exceptionally strong this year.

Share buybacks authorizations

As noted by Goldman Sachs:

“The VWAP machines will be lining up to buy $6bn worth of equities daily during November and December.”

Yes, that is $6 billion each trading day, which provides sufficient buying power to lift asset prices into year-end.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

Seasonality: Not A Risk-Free Adventure

For investors, this seasonality signal could be an opportunity to increase exposure to equities, particularly in large-cap stocks that tend to drive the broader market. However, it’s essential to recognize that while the MACD signal aligns with historical trends, it does not guarantee future performance.

Despite the historical reliability of seasonality and the MACD buy signal, investors must still be aware of risks.

  • Monetary Policy: Inflation, interest rates, and global economic uncertainty could weigh on stock performance, even during a seasonally strong period. Given the recent bout of strong data, if the Federal Reserve slows the pace of rate cuts, this could disappoint markets. A good example is 2018, where the Federal Reserve’s more hawkish stance preceded a 20% correction in November and December.
  • Geopolitical Risks: Ongoing geopolitical tensions, whether in Eastern Europe, the Middle East, or relations between major economic powers, can quickly disrupt financial markets. Unexpected events, such as escalating conflicts or trade wars, could derail the seasonal trends.
  • Market Volatility: Volatility can spike unexpectedly, leading to sharp market corrections. Even during strong periods like the “Best Six Months,” short-term market corrections are always possible. Investors should be prepared for heightened volatility, especially if other risk factors, like earnings surprises or economic data, create uncertainty.
  • Historical Trends Are Not Guarantees: Past performance, while instructive, does not guarantee future results. Although the MACD buy signal has been a reliable indicator in the past, external factors could reduce its predictive power. Investors must be cautious and not rely solely on seasonality and technical signals.

Most crucially, the technical backdrop also poses near-term risks. The market has been up six weeks in a row, which historically is a very long stretch without a correction.

Consecutive weekly gains.

From a purely technical view, with the markets deviating well above MONTHLY moving averages and overbought, a correction or consolidation is becoming increasingly likely before the year-end advance can take shape.

Monthly market chart

Navigating Into Year-End

With the S&P 500 now in a seasonally strong period, bolstered by the weekly MACD buy signal, investors may want to consider several strategies:

  1. Increase Equity Exposure: Large-cap stocks historically perform well during this period. You could consider increasing exposure to diversified index funds or sector ETFs that align with historical trends.
  2. Review Portfolio Risk: While the MACD buy signal is a positive indicator, you should assess your portfolio’s risk tolerance and ensure it aligns with your long-term goals.
  3. Rebalance Allocations: Now may be a good time to rebalance by reducing positions in riskier assets or diversifying across asset classes.
  4. Use Stop-Loss Orders: To manage downside risk, consider using stop-loss orders.

Yale Hirsch’s research on market seasonality, paired with the power of the MACD signal, offers a disciplined approach to navigating historical market trends. The recent MACD buy signal for the S&P 500 provides investors with a potentially advantageous entry point into the market as we head into the historically strong “Best Six Months” period. However, it’s crucial to remain aware of the risks, including macroeconomic headwinds and market volatility.

Trade accordingly.

Why Are Bond Yields Rising? Lets Ask The Oil Market

It’s no secret that bond yields are heavily impacted by inflation and inflation expectations. Moreover, oil prices have a high correlation with inflation. So, to answer why bond yields are rising recently, it’s helpful to check the oil price. Since May 2023, as we share below, crude oil prices and ten-year UST yields have been tracking each other closely. But, you will see that oil tends to lead bond yields when the trends change. The lower graph shows the running 1-year correlation of oil and bond yields on a long-term basis. While there is a long-term positive relationship, it does vary significantly over time.

Crude has fallen rapidly in the last week as it appears Israel will not target Iranian oil facilities. With the relatively sharp decline lower, oil is again approaching significant support at $67 a barrel. A break below $67 could lead oil toward $60 or lower. Thus far, yields haven’t followed the decline. Is the highly tight correlation breaking? Or are bond yields waiting a couple of weeks, as they have in the past, before following crude oil prices lower?

crude oil and bond yield correlation

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Last week, we discussed the triggering of the seasonal MACD buy signal. To wit:

“On Friday, the market broke out to the upside of that wedge pattern, triggering a “seasonal MACD buy” signal. Notably, that buy signal also marks the beginning of the seasonally strong 6 months of the year. The series of high lows, now combined with higher highs, remains a significant bullish backdrop for investors. With earnings season starting in earnest this coming week, the bias remains to the upside, but risk management protocols should not be abandoned.”

The chart below is the WEEKLY S&P 500 chart, with three different signals to confirm the start of the seasonal period. With Friday’s close in the green, keeping the week broadly positive, all three seasonal buy signals have been triggered.

Market Trading Update 1

However, as noted last week, just because the seasonally strong period of the year has technically started, it doesn’t mean that the markets won’t have corrections along the way. Notably, we have already had 6-straight weeks of gains, which is a long stretch without a pullback. Secondly, while the market is on a weekly “buy signal,” the market is both deviated and overbought short-term. When the market breadth is very elevated, combined with overbought and deviated markets from the 50 and 200-DMA, corrections and consolidations tend to be more prevalent.

Market Trading Update 2

We expect that the market will experience a short-term consolidation or correction. However, there are three reasons why such will likely provide a better entry point to add exposure.

  1. The current bullish trend remains intact, and bullish sentiment is very strong. This has led to significant and continuing inflows into the market, which will support asset prices.
  2. Corporate buybacks will resume at the end of the month and will amount to roughly $6 billion per day into year-end.
  3. Many managers lag in the market and must play catch-up by year-end for reporting purposes.

These three reasons will likely push asset prices to our target of 6000 on the index by year-end. However, do not get too complacent, as 2025 will be a year of increased volatility.

The Week Ahead

Corporate earnings will make the headlines this week, as there is little economic data. Many large and small companies report, including Google on Tuesday, Tesla on Wednesday, and Amazon on Thursday. As we wrote in this past weekend’s Newsletter, earnings expectations have come down significantly over the last month. Accordingly, the odds are that most companies beat expectations. However, forward guidance often plays a more significant role than actual earnings and revenues regarding the stock’s immediate performance.

Bastiat And The Broken Window

Recent events, particularly the devastation caused by Hurricanes Helene and Milton in 2024, provide a clear example of why destruction does not create long-term economic prosperity. Despite the short-term boost in economic activity from rebuilding efforts, the broader economic implications are far more detrimental. In this post, we will delve into Bastiat’s Broken Window Theory, apply it to the aftermath of the hurricanes, and explain why destruction and the need to replace lost goods drag forward future consumption rather than create new economic value.

READ MORE…

bastiat hurricanes and economic activity

Tweet of the Day

S&P 500 multiple expansion

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Taiwan Semiconductor Nullifies ASML Fears

Wednesday’s Commentary discussed the shockingly weak booking numbers from ASML. Given that ASML is a large manufacturer of chip-making machines, we asked: “If the chip industry is facing insatiable demand, why such a stunning decline in the need for chip-making equipment?” ASML earnings introduced concern amongst semiconductor sector investors, leading many semi-stocks to decline decently. Taiwan Semiconductor’s (TSM) earnings released yesterday morning will help investors forget about ASML.

Taiwan Semiconductor is the primary chip maker for Nvidia and Apple. In their optimistic earnings call, they reported that net income handily beat expectations. Moreover, they hiked their outlook for revenues. Equally important, they confirmed that the demand for AI chips remains incredibly strong. The CEO quotes a “key” customer claiming that demand for AI chips is “insane.” The CEO supported his commentary by declaring, “We get the deepest and widest look of anyone in this industry.” AMD earnings on October 29th, and ultimately Nvidia in later November, will help us further appreciate if the demand for AI chips remains off the charts. But for now, we put much more stock in Taiwan Semiconductor’s earnings than ASML’s. The graph below shows Taiwan Semiconductor is up over 80% this year while ASML is down about 10%.

tsm taiwan semi

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Yesterday, we discussed the issue of seasonal buy signals and market risk, which can exist simultaneously. As we head into the busiest week for earnings, the market continues to hold above the rising trend line from the August lows. While on a “buy signal” currently, that signal is occurring very high, which likely limits any near-term upside. Notably, momentum indicators are also negatively diverging, suggesting some price weakness.

While there continues to be no momentary reason to be overly bearish, the risk/reward balance currently does not favor adding new equity exposure to portfolios. The good news is that any corrective action heading into the election is likely limited and will provide a better entry point for investors.

Market Trading Update

My big concern continues to be the outcome of the election. The markets will likely rally strongly into December if it is a clean election with a clear winner and a divided Congress. However, if the election is contested and drags out until December, that may be a different story.

Speaking of the election, this fits into the “awkward” category:

“In January 2025, Vice-President Kamala Harris will be in charge of certifying the election. In other words, if Donald Trump wins, the person he was running against will be in charge of certifying his victory. This is a major defect in our system, and it could potentially set the stage for widespread chaos if things do not go smoothly.” – Most Important News Blog

As I said, it’s awkward and could provide the catalyst for volatility.

For now, continue to manage risk accordingly.

S&P 500 Dividend and Earnings Yields Are Rich

The first graph below, courtesy of Charlie Bilello, shows that the dividend yield on the S&P 500 is at its lowest level since 1999. There are several reasons for this. First, valuations are high, so investors willingly sacrifice dividend yield for the promise of price growth. Second, many companies sacrifice dividends and buy back their stock instead, which promotes price returns over dividend returns.

The second graph, courtesy of Bloomberg, shows that investors are paying high relative valuations. The earnings yield on the S&P 500 (earnings/price) is now below that offered by a risk-free 10-year UST. Again, one has to go back about 25 years for a similar situation.

Neither graph portends an immediate re-valuation of stock prices, but they should alert investors to a possible drawdown to normalize valuations.

S&P 500 dividend yield
earnings yield

New Home Inventory is Rising

The graph below, courtesy of John Burns Research & Consulting, shows that the pandemic-related shortage of new homes for sale has ended. The ratio of homes per community is now above the pre-pandemic average and at levels last seen in 2012 when the housing market was still recovering from the financial crisis.

Mortgage rates above 6% are certainly part of the culprit. However, some of the high rate impact was offset by home builders offering buyers loans at reduced rates. The other issue facing homebuilders is that they shifted to more spec construction in 2021 and 2022. That model, which means you build before there is a buyer, works well with low supply. However, as builders have now found out, there are drawbacks when demand is weaker.  The bottom line is that either mortgage rates fall and spark demand to reduce the number of finished new homes, or builders will be forced to lower prices to spark demand. Either point to margin pressure ahead for new home builders.

John Palacios Jr, Director of Research at John Burns, sums up his thoughts on builders in a recent WSJ article as follows:

“The playbook for home builders is going to have to slowly shift, at least from our perspective, from buydowns, buydowns, buydowns to OK—wait a second here,” he said. “It’s going to be a tougher market.”

finished new homes

Tweet of the Day

corporate insider purchases

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Bastiat And The “Broken Window”

In times of disaster and destruction, a common narrative often emerges that rebuilding efforts will lead to economic growth. The idea that repairing damage and replacing destroyed goods creates jobs that spur consumption and stimulate economic activity is tempting. However, as French economist Frédéric Bastiat explained in his famous “Broken Window Theory,” this reasoning is fundamentally flawed. Rather than generating net economic benefits, destruction diverts resources and wealth that could have been used for more productive purposes, ultimately stifling real economic growth.

Recent events, particularly the devastation caused by Hurricanes Helene and Milton in 2024, provide a clear example of why destruction does not create long-term economic prosperity. Despite the short-term boost in economic activity from rebuilding efforts, the broader economic implications are far more detrimental. In this post, we will delve into Bastiat’s Broken Window Theory, apply it to the aftermath of the hurricanes, and explain why destruction and the need to replace lost goods drag forward future consumption rather than create new economic value.

The Broken Window Theory: A Lesson in Opportunity Cost

Frédéric Bastiat introduced the “Broken Window Theory” in his 1850 essay “That Which is Seen, and That Which is Not Seen.” The theory is illustrated by a simple example: A boy throws a rock through a shopkeeper’s window, breaking it. While some may argue that this destruction benefits the economy—after all, the shopkeeper must now pay a glazier to fix the window, creating work—the key insight lies in what is not seen.

Had the shopkeeper not needed to replace the window, he could have spent that money on something else, perhaps new inventory, equipment, or even personal savings. The repair creates no new wealth; it merely replaces what was lost. The shopkeeper’s forced expenditure on the window diverts resources that could have been used to improve his business or save for the future.

Bastiat’s principle extends beyond a broken window to any form of destruction, whether natural or man-made. Destruction leads to the misallocation of resources, pulling future consumption forward and leaving society no wealthier than before. This is a critical point that often gets overlooked in post-disaster economic analysis.

RIA Advisors advertisement for investment management services

Hurricanes Helene and Milton: Real-World Examples of Bastiat’s Theory

The devastation caused by Hurricane Helene and Hurricane Milton in 2024 offers a stark reminder of why destruction does not foster economic growth. The two hurricanes ravaged communities, destroying homes, businesses, infrastructure, and entire industries across the affected regions. In the wake of these disasters, some economic analysts argued that the rebuilding efforts would boost local economies, creating jobs in construction and stimulating demand for materials, goods, and services. The chart below is an economic composite of wages, inflation, and interest rates compared to economic growth. There are two crucial points.

The first is that inflation, wages, and interest rates track economic growth trends because of their interrelationship. Thus, predictions of higher future inflation are incorrect unless there is a surge in accompanying economic activity. Secondly, while bumps to activity did occur following hurricanes, the long-term downtrend in economic growth was unaffected.

Economic growth vs Economic Composite of wages, inflation, and rates

It is correct that there will be a likely surge in economic activity as government, insurance, and private donations support reconstruction efforts. However, the longer-term trend of economic growth will continue to decline. Here’s why:

1. Dragging Forward Future Consumption

As Bastiat’s theory suggests, rebuilding homes, businesses, and infrastructure replaces lost wealth. The destruction caused by the hurricanes forced families, businesses, and local governments to divert future resources toward rebuilding. Such actions divert money from savings, investing for growth, or purchasing new goods and services. In other words, pulling forward future consumption limits future growth.

For instance, residents who plan to upgrade their homes or purchase new vehicles in the coming years are now using those funds to repair damages instead. Businesses, particularly small ones, must spend on repairs rather than expansions or new product lines. The chart below shows the annual rate of change in retail spending of control purchases versus hurricanes and the economic cycle. Unsurprisingly, hurricanes did precede bumps in retail spending that quickly faded.

Monthly retail spending vs hurricanes

The net result is an economy that’s not growing faster but using its resources inefficiently to return to its pre-hurricane state.

2. Misallocation of Resources

Disasters also lead to the misallocation of economic resources. Economists should want capital invested in productive investments that drive future growth, such as innovation, technology, and infrastructure improvements. The “wealth creation” process depends on capital investment spending that leads to growth. Unsurprisingly, there is often a short-term boost to capital expenditures and economic growth, which fades once spending is complete.

GDP vs CapEX

In the case of Hurricane Helene and Milton, local governments will redirect funds to emergency relief and rebuilding. Again, we will see a pickup in economic growth in the short term. However, those actions now deprive funds for future projects like education and infrastructure development without further increases in debt issuance. Private businesses face the same dilemma. While insurance will provide some relief, future companies will redirect future capital expenditure plans to rebuild and repair existing damage. Such actions limit future growth and, thereby, the “wealth creation” process.

3. Destruction of Capital Stock

When hurricanes destroy homes, businesses, and infrastructure, they destroy valuable capital stock. This includes everything from machinery and tools to roads, bridges, and factories. The destruction of this capital leads to a significant loss in productivity, as businesses must either shut down temporarily or operate at reduced capacity until they can replace damaged assets. Such is seen in the chart below of productivity versus economic growth.

GDP vs Productivity Growth

Consider the industries hit hardest by the hurricanes, such as agriculture, fishing, and manufacturing. Businesses in these sectors often lost physical assets and weeks or even months of productive capacity. While rebuilding may create short-term jobs, the loss of capital stock and the resulting decrease in productivity will have longer-lasting effects on the economy.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

The Earnings Illusion

The key takeaway from Bastiat’s “Broken Window Theory” is that destruction creates the illusion of short-term economic growth by shifting resources around. In the case of the recent hurricanes, there will be a temporary uptick in GDP. Notably, the recovery actions will delay the onset of a recession for a while longer. However, that boost to activity merely represents the replacement of lost wealth, not the creation of new wealth.

There is an impact on financial markets for investors. Since investors value stocks based on forward earnings, the impact on corporate earnings is generally negative at first, with companies in the path of these storms experiencing production halts, infrastructure damage, and supply chain disruptions. However, the aftermath of these events often reveals a more complex picture.

Immediate Earnings Impact:

  • Negative short-term effects: Companies, particularly those in retail, hospitality, and energy, face sharp revenue declines due to operational shutdowns. For example, after Hurricane Katrina in 2005, several industries along the Gulf Coast saw significant revenue disruptions.
  • Rising costs: Insurance, construction, and raw materials companies often see surges in demand after a hurricane, but rising labor and materials costs can squeeze their margins.

Post-Hurricane Rebuilding Phase:

The economic activity that follows the destruction—rebuilding homes, infrastructure, and businesses—can temporarily boost sectors such as construction, utilities, and consumer goods. For instance, following Hurricanes Harvey and Irma in 2017, rebuilding efforts fueled a temporary rise in construction earnings and increased demand for durable goods.

However, that surge is temporary, not permanent. Once the rebuilding phase concludes, earnings for these companies return to pre-storm levels. Moreover, widespread destruction often diverts resources from more productive investments, dampening long-term growth prospects. As shown, the annual rate of change of earnings tracks economic growth. If economic growth does not receive a long-term benefit from destruction, neither will earnings.

GDP vs stock market rate of change

Conclusion

Analysts’ use of Bastiat’s argument that destruction creates economic prosperity rests on a misunderstanding of wealth creation. True economic growth occurs when new goods and services production increases society’s overall wealth. On the other hand, destruction forces the replacement of existing goods and services, leading to no net increase in wealth.

Think about it this way: if destruction is beneficial to economic prosperity, why not have an annual event where the Government carpet bombs a major city? When viewed in this manner, the illogic of the argument of “creative destruction” becomes evident.

While necessary, the rebuilding efforts after Hurricanes Helene and Milton do not represent economic progress. Instead, they highlight the cost of destruction. The resources spent on rebuilding can no longer be available for more productive purposes. In the long run, this diversion of resources stifles economic growth by reducing the capital available for investment, innovation, and future consumption.

Rather than creating prosperity, destruction imposes significant economic costs that hinder long-term growth. Policymakers, business leaders, and investors must recognize that while rebuilding is necessary, it does not represent real economic progress. The same applies to government interventions, welfare increases, and tax credits.

True growth comes from policies that support increases in productive investments, innovation, and the efficient allocation of resources. As investors, we should hope for those policies. As citizens, those are the policies we should demand.

Cava: A Hot Trend Comes At A Dear Cost To Investors

Since going public in June 2023, Cava (CAVA) has taken the fast-casual restaurant industry and Wall Street by storm. Cava describes itself as a “Mediterranean fast-casual restaurant brand that brings heart, health, and humanity to food.” As the chart below highlights, Cava shares are up 250+% since its IPO. The return is 5x its chief competitor Chipolte and 8x the S&P 500. Before Cava, Chipotle was a great growth story in the restaurant industry. Since 2007 it has increased the number of restaurants from 700 to 3500. Its earnings followed a similar growth rate.

At Cava’s current valuations, investors are betting that Cava can be the next Chipotle and then some. Enterprise value per store is a metric investors use to value and compare the profitability of restaurant chains. Enterprise value is a measure of a company’s total value. When divided by the number of stores, it provides a rough estimate of the value of each store. Cava has an enterprise value per store of approximately $35 million, almost double that of Chipotle. However, their AUV, measuring revenue per store, is only $2.7 million. Simply, Cava is trading at much higher multiples than Chipoltle and even more so against other restaurant chains.

Cava shares undoubtedly have value. However, is its share price getting ahead of its growth prospects?

cava and chipotle shares

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Due to a technical glitch in yesterday’s commentary, our market trading update was lost. However, I wanted to address a question I received about the “seasonal buy signal” and the confluence of overbought conditions. In this past weekend’s newsletter, I discussed the issuance of the seasonal buy signal, which was confirmed by the triggering of the weekly MACD crossover. The chart is shown below.

As shown, when you confirm “buy signals” on a weekly basis, markets tend to rise. The 2020 signals were triggered early due to the massive stimulus programs and remained intact through 2021. Interestingly, they did NOT trigger a “buy signal” in October 2021, which turned out well for investors. The next “buy signal” was triggered in November 2022 and again in November 2023. The signals have again triggered as of last month.

Market Trading Update 1

This is where the confusion seems to have set in. While the markets are indeed on a buy signal, we have suggested taking profits, rebalancing risks, and managing portfolios in the near term because they are overbought and deviated above longer-term means. The seasonal buy signals do not preclude the markets from having 5-10% corrections along the way higher.

Furthermore, negative divergences are also forming as momentum and relative strength are failing to pace the market higher. This suggests that buyers are becoming more scarce.

Market Trading Update 2

It can be confusing to have a bullish “buy signal” for the seasonally strong period while managing risk and rebalancing portfolios simultaneously. However, the two are not mutually exclusive. The confluence of the buy signal with overbought conditions does tell us that pullbacks and corrections will likely be shallow and will present investors with opportunities to increase equity exposure as needed.

As is always the case, how you manage your portfolio is up to you. However, for now, the bulls are winning the market argument.

Import Export Prices And The UK Point to Further Disinflation

U.S. import prices fell 0.4% last month following a 0.2% decline in the prior month. Export prices fell by 0.7%. On a year-over-year basis, import prices are down 0.1%, and export prices are down by 0.7%. Lower import prices will help on the U.S. inflation front, specifically the prices of food and energy. It is worth noting that typical supply and demand factors affect import and export prices, but the dollar’s value is equally important. A stronger dollar results in weaker import prices and vice versa.

British CPI fell to 1.7%, down from 2.2%. The inflation reading was .20% below estimates and, importantly, lower than the Bank of England’s (BOE) 2% goal. The BOE is now widely expected to cut rates at its November 7th meeting. As the Bloomberg graph below shows, the prices of goods are the chief culprit behind lower inflation, but services prices are also slowly decreasing. The sharper-than-expected decline results in the pound losing ground against the dollar. Since the beginning of October the pound has depreciated about 4% versus the dollar. Thus, import prices of British goods will be commensurately lower.

uk inflation

The VIX and the Market Climb- Should We Care?

With the presidential election in a few weeks, the Fed changing course on monetary policy, and Israel potentially attacking Iranian oil facilities, the increasing level of implied risk should not be shocking. Will the elevated VIX persist alongside the rising market, or will the market correct?

READ MORE…

the vix and market climb together

Tweet of the Day

soft landing headlines

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

MicroStrategy Is A Leveraged ETF In Disguise

Per its website, MicroStrategy “provides software solutions and expert services that empower every individual with actionable advice.” While Microstrategy’s mission description may seem like a profitable enterprise, reality has a different opinion. Since 1997, the company has a cumulative net loss of $1.108 billion. Accordingly, the graphs below show its revenue has been flat to slowly deteriorating for over ten years. Its EPS on the right also shows the company’s poor fundamental status. However, as both graphs show, the price of Microstrategy has risen by over 1,300% over the last five years.

Microstrategy has a market cap of $42 Billion. The reason for such a high market cap and stock performance is clearly not their underlying business. Exciting shareholders are its holdings of approximately 250k bitcoin. At current prices, its Bitcoin holdings are worth nearly $17 billion. Furthermore, Microstrategy is using approximately 2.5x leverage. If you multiply the leverage by their holdings, you get $42.5 billion, a value almost perfectly aligned with its market cap. So, what is MicroStrategy? It’s a leveraged Bitcoin fund disguised as a non-profit technology company.

microstrategy bitcoin

ASML Takes Some Steam Out Of The Chip Bubble

The SimpleVisor graph below shows that ASML Holdings fell by over 10% yesterday on a weak earnings report. ASML makes chip-making machines widely used by the semiconductor industry. ASML’s bookings were only 2.6bn euros, about half the expected number. The company also cut sales and margin guidance. Thus, the question is, if the chip industry is facing insatiable demand, why such a stunning decline in the need for chip-making equipment? Per the CEO:

While there continue to be strong developments and upside potential in AI, other market segments are taking longer to recover. It now appears the recovery is more gradual than previously expected

ASML’s earnings caused the chip sector to weaken. However, it’s important to note that the weakness appears not to be coming from AI-related machinery. Consequently, this earnings report made earnings season for chip developers, manufacturers, and related companies much more interesting.

asml stock price

Greed And How To Lose 100% Of Your Money

Few stories are as staggering or cautionary as this one. An investor turned an $88,000 investment into a mind-boggling $415 million through Tesla stock, only to lose it all. It’s a story that captures extremes of financial success and failure. It is a story of greed and the false confidence that comes with exponential returns. However, a deeper examination of the circumstances that led to this loss clarifies that there were warning signs. Common-sense strategies and risk management tools to prevent financial catastrophes were abandoned.

READ MORE…

greed tesla

Tweet of the Day

s&P 500

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

The VIX And Market Climb: Should We Care?

The financial media frequently opines on what the daily gyrations of the VIX (implied volatility index) signal regarding investor sentiment. Despite how often it is quoted and discussed, many investors do not truly appreciate what implied volatility measures.

We take this opportunity to help you better understand implied volatility. Furthermore, we discuss other lesser-followed measures of implied volatility that help better assess whether implied VIX readings infer bullish or bearish sentiment. 

The timing of this article is essential as the VIX has been rising alongside the market in a non-typical fashion. With the presidential election in a few weeks, the Fed changing course on monetary policy, and Israel potentially attacking Iranian oil facilities, the increasing level of implied risk should not be shocking. Will the elevated VIX persist alongside the rising market, or will the market correct?

What Is The VIX

The VIX volatility index, aka the “Fear Index,” is a well-followed measure of investor sentiment. Many investors believe that an increase in the VIX indicates that market participants are growing concerned about the stock market. While that is often true, it is not always true.

The VIX uses the prices of many one-month calls and put options on the S&P 500, weighing them based on their time to expiration and the difference between the strike price and the current price of the S&P 500. Based on the prices, the expected variance of the S&P 500 is estimated. After some advanced math, the VIX value is provided and expressed as an annualized percentage. Furthermore, the VIX is quoted as a one-standard deviation change. In other words, there is a 68% probability the S&P 500 will stay within the VIX percentage.

For example, a VIX of 15 implies expected annual volatility of 15%. In this case, the options market expects, with 68% certainty, that the S&P 500 will trade in a 15% range from the current level over the next year.

The graph below puts the recent range in the VIX in context. It shows how much change is and was expected for the S&P 500 based on the current (22), highest (37), and lowest (12) levels of VIX over the past year. The ranges vary significantly based on the VIX.

implied sp 500 range vix

The VIX defines what market participants, in aggregate, think the possible market range will be. However, it doesn’t determine whether the put or the call has a larger influence. Accordingly, it doesn’t disclose whether the market is speculatively betting more on the upper band of the range or whether investors are aggressively protecting against the lower band.

Fortunately, as we now discuss, other volatility measures shine additional light on market expectations.

Ad for financial planning services. Need a plan to protect your hard earned savings from the next bear market? Click to schedule your consultation today.

Put Call Skew

Put call skew measures the difference between put and call option prices at various strike prices for the same index or asset. When the price of a put and call differs despite being equally distanced from the strike price and with identical expirations, skew exists. Skew simply measures if investors are paying more for calls or puts.

A lower skew means investors are more aggressively buying call options than put buyers are looking for protection. Conversely, a positive skew implies investors seeking protection via puts are more aggressive than bullish call buyers.

The put-call skew helps us better appreciate whether bullish or bearish investors have a more significant impact on the VIX.

The graph below, courtesy of Market Chameleon, shows the put-call skew and its 20- and 250-day averages. Currently, it’s on its shorter 20-day moving average and above its longer-term averages. Thus, investors are more aggressive in buying puts than calls compared to recent history. This graph, like the VIX, implies that investor sentiment is bearish.

put call skew

Put Call Ratio

Unlike the skew and VIX, the put-call ratio gauges sentiment by measuring the volume of options contracts. The ratio divides the volume of put options by the volume of call options over a specific period. A ratio below one suggests bullish sentiment, as more call options are being purchased than put options. Conversely, a ratio above one reflects a bearish sentiment.

As shown below, the index is currently at one year lows and the second lowest level since March 2022. Simply the volume of call buying is more than double that of puts. More simply, stock hedgers are few and far between.

put call ratio
Ad for The Bull/Bear Report by SimpleVisor. The most important things you need to know about the markets. Click to subscribe.

CBOE Skew Index

Unlike the VIX, which measures expected market volatility with an expected one standard deviation or 68% band of accuracy, the Skew Index calculates the likelihood of extreme tail events defined as those of two to three standard deviations. While the Skew index and the VIX tend to move in the same direction, any differences can provide clues. Like the VIX, the Skew Index does not enlighten us on whether call or put trading drives the index.  

The Skew Index uses the prices of out-of-the-money (OTM) S&P 500 options. The index typically ranges from 100 to 150. Readings of 120 or less tend to reflect a stable environment. As it rises above 120, it suggests investors are increasingly betting on or hedging against a more outsized market move.

The table below, courtesy of VIXFAQ.com, quantifies the volatility implied by the Skew Index. For example, an Index reading of 130 indicates a 10.40% chance of a two-standard deviation move in the next 30 days and a 1.92% chance of a three-standard deviation change.

put call skew standard deviation ranges

The graph below, courtesy of StockCharts, shows that the CBOE Skew Index is near its highest level in the past five years, suggesting investors are betting on higher-than-average levels of implied volatility to continue.  

daily skew graph

Current Situation

We wrote this article to help better explain the VIX and implied volatility. Moreover, it’s important to consider whether the rising VIX alongside the market might be a warning worth heeding.

Such behavior is not typical, but it’s not unprecedented either. The first graph shows that the uptick in the VIX is still very mild in the context of its 30-year history. The second graph pinpoints similar periods where the S&P 500 was within 1% of a record high. As it shows, it may ultimately signal a significant drawdown, but that signal may be too early. In fact, based on history, it could be years too early.

vix
vix greater than 20 at record highs

In addition to the VIX, we presented other implied volatility calculations. The two skew measures support the theory that the higher VIX is more of a function of put buying than call buying. However, the put-call ratio, which sits at a one year low, does not confirm the negative sentiment. In fact, it is quite bullish.

The message we take away from the mixed options data is that the market is anxious but not fully committed to an overly bullish or bearish stance. As we note at the beginning, plenty of potential events warrant unease.

Ad for SimpleVisor. Get the latest trades, analysis, and insights from the RIA SimpleVisor team. Click to sign up now.

Summary

If the VIX remains elevated or continues to increase and the other indicators confirm that put buying is driving the VIX higher, stay alerted for changes in market patterns. Pay closer attention to technical analysis, including where prices lay compared to their key moving averages.

The VIX is currently warning of the potential for bearish price action. While the warning is helpful, remember that if one were solely positioned according to the VIX between 1997 and 1999, they would have forfeited massive profits. 

Greed And How To Lose 100% Of Your Money

In the movies, greed is a trait often exhibited by the rich and powerful as a means to an end. Of particular note is the famous quote from Michael Douglas in the 1987 movie classic “Wall Street:”

The point is, ladies and gentlemen, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.”

While greed is necessary to build wealth, excessive greed often has far more terrible consequences when investing.

Few stories are as staggering or cautionary as this one. An investor turned an $88,000 investment into a mind-boggling $415 million through Tesla stock, only to lose it all. It’s a story that captures extremes of financial success and failure. It is a story of greed and the false confidence that comes with exponential returns. However, a deeper examination of the circumstances that led to this loss clarifies that there were warning signs. Common-sense strategies and risk management tools to prevent financial catastrophes were abandoned.

In this post, we’ll examine what happened, how greed played a key role in the investor’s downfall, and the steps that could have been taken to mitigate the risks. Ultimately, the goal is to highlight valuable lessons to help you avoid the same fate and safeguard your wealth.

The Journey from $88K to $415M

The story begins with Christopher DeVocht making hundreds of millions from Tesla options with an initial investment of $88,000. This feat occurred during the speculation boom driven by massive Government interventions in 2020. As Tesla’s market value skyrocketed, Christopher’s position grew exponentially. The leverage provided through options and margin lending allowed him to continue to take on increasingly larger positions. As shown, in 2020, Tesla’s shares rose by 1700% as zero interest rates and massive monetary interventions led to the most speculative stock market run in recent history.

Tesla stock value

During that meteoric rise, Christopher’s portfolio value surged to an unbelievable peak of $415 million. However, Christopher chose to stay the course instead of cashing out or diversifying his holdings. Despite the risks of a highly concentrated portfolio, the allure of even greater returns was too hard to resist.

Unsurprisingly, just like staying too long at the Blackjack table in Las Vegas, the market eventually turned against him. In 2022, the market reversed course as the Federal Reserve began an aggressive rate-hiking campaign and stimulus checks ran out. During that year, Tesla’s stock value fell by nearly 70%. Of course, had Christopher just been long Tesla shares, his value would have still been roughly $100 million. However, Christopher’s problem was that he was using leveraged options and margin debt. The problem with margin loans is the borrower must liquidate shares to repay the loan. Additionally, options contracts expire worthless. The portfolio was wiped out with the forced liquidation of Tesla shares to repay margin loans and options expiring worthless.

Naturally, a lawsuit against his financial advisor followed, blaming them for not taking action to preserve his wealth.

Lawsuit by Christopher on RBC for losing 415 million.

I can almost assure you there were suggestions that he should take action to reduce his exposure. However, when greed is involved, that advice likely went unheeded. I can tell you from personal experience clients will not take advice to sell rising holdings during a market frenzy. One excuse is the “fear of missing out. The other is often unwillingness to pay taxes on gains.

This story should serve as a potent reminder that unchecked greed and poor risk management are often the architects of financial ruin.

Schedule an appointment

Stocks Often Lose 100%

One of the most crucial elements of this story is greed’s role in amplifying the investor’s downfall. Greed can cloud judgment, leading individuals to chase ever-higher returns without regard for the growing risks. Here is an important statistic for you.

Hendrik Bessembinder examined the history of 29,000 stocks in the United States over the 90 years of good data available. He’s also examined about 64,000 stocks outside the U.S. on a slightly shorter time horizon because of available data. To understand the result, we must understand the difference between mean, median, and mode.

The mean is the average value among the sample. The median is the middle value. Importantly, the mode shows the most repeating value. 

What was the result?

The “mode” was (-100%.)

In other words, the most common outcome of buying a stock is losing all your money.

Here is a visual representation. If you picked 100 stocks, 70% would likely underperform the market.

The stocks you pick make a difference

Managing Risk

In this case, Christopher happened to latch onto one of the few companies that soared well above norms. Given the historical distribution of returns from single stocks, a cursory understanding of risk should have provided some caution. As such, Christopher had ample opportunity to lock in substantial profits or at least diversify a portion of his wealth. But, as is often the case when emotions dictate investment decisions, he opted to “ride the wave.”

For a deeper understanding of risk, read our previous post, Howard Marks’ View Of Risk.

Many investors fall into this trap, believing that the market will always move in their favor. What they fail to consider, however, is that markets are always cyclical, and what goes up eventually comes down. By not acknowledging this, he exposed himself to an unnecessary risk that ultimately cost him everything.

The loss of $415 million wasn’t inevitable—it was preventable. There were several options that Christopher could have taken to mitigate risk and safeguard his wealth. Here are three strategies that could have changed the outcome of this story:

1. Portfolio Diversification

When Christopher turned his initial $88,000 investment into $1 million, a simple strategy would have been to diversify. When betting on margin, the loan value is based on the collateral of the underlying account. Therefore, shifting some of his profits to Treasury bonds would have decreased the decline in 2022, requiring fewer liquidations. However, by keeping his entire wealth in Tesla stock, he was highly exposed to the volatility of a single company. In this instance, Christopher effectively bet “all in” on every hand at the blackjack table. Logic would dictate that, eventually, you would lose that bet.

Given that diversification spreads risk across various asset classes, stocks, bonds, real estate, and other investment vehicles, such moves early in the cycle would have significantly reduced the impact of Tesla’s eventual downturn on his overall wealth.

2. Setting a Stop-Loss or Trailing Stop Order

The problem with diversification, however, is that it would have limited Christopher’s significant upside. Therefore, to remain aggressive in the position, Christopher could have taken several strategies to reduce his risk significantly. Since Christopher was already using call options to bet on Tesla, he could have bought “put” options to hedge his downside risk. While the cost of the options would slightly reduce his overall return, the “insurance” would have saved him millions in 2022.

Another effective risk management tool is setting stop-loss or trailing stop orders on investments. A stop-loss order allows an investor to automatically sell a stock once it hits a predetermined price, limiting potential losses. A trailing stop-loss, on the other hand, adjusts with the stock’s price as it rises, locking in gains while protecting against large downturns.

In Christopher’s case, setting a trailing stop-loss would have allowed him to capture most of Tesla’s extraordinary rise while preventing catastrophic losses when the stock eventually declined. This safeguard ensures that you are not solely reliant on timing the market, which, as we all know, is nearly impossible to do consistently.

3. Profit-Taking

It’s often said that “bull markets make geniuses out of everyone.” When stocks soar, it’s easy to get complacent. However, a process for regularly taking profits would have been an easy solution for Christopher.

For example, when Christopher turned $88,000 into $1 million, a prudent exercise would have been to put $500,000 into cash or Treasury bonds. Then, repeat that process at regular intervals, $5, $10, $25, $50, $100 million, and so on. Regular profit-taking and storing those gains in the safety of Treasury bonds would have yielded a massive amount of protected wealth. In the end, while Christopher may have still lost a lot of money on his aggressive betting on Tesla, he would have still had $100 million or so in Treasury bonds.

This is not an uncommon issue that I always see with clients and prospects. Greed comes in three destructive forms: 1) the need to make more, 2) the lack of knowing when “enough is enough,” and 3) the unwillingness to pay taxes.

Christopher lost all his wealth. I am sure he now realizes the error of excess greed and hopes a lawsuit will return some of his gains. (Such will likely be the case as the brokerage firm’s insurance company will likely settle the case in arbitration for $100 million or so rather than going to court.)

The good news, however, is that Christopher didn’t have to pay any taxes.

In hindsight, those taxes would have been a cheap price to pay.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

What the Advisor Could Have Done

While Christopher is responsible for his decisions, the financial advisor must protect the client’s wealth. An advisor’s job is to execute trades and provide sound guidance that aligns with a client’s risk tolerance and long-term objectives. In this case, the advisor could have done several things differently:

  • Proactively encouraged diversification: A responsible advisor would have emphasized the importance of not putting all the investor’s wealth into one stock, no matter how well it had performed.
  • Insisted on setting up risk management tools: The advisor should have suggested stop-losses, rebalancing strategies, or profit-taking checkpoints, giving the investor automatic mechanisms to reduce risk.
  • Maintained clear communication: Regular discussions about the portfolio’s risk exposure and the potential dangers of an overly concentrated position could have kept emotions in check and led to more rational decision-making.

As I said, the advisor likely discussed these options with Christopher, who assured the advisor he understood the risk. However, if Christopher failed to heed the advice, the advisor should have taken another precaution: fire the client.

Yes, the advisor should have fired the client in clear written communication, stating that the client was not heeding the advisor’s advice. More than once in my career, I have fired clients or not taken on prospects for the same reasons. Unrealistic expectations, greed, excessively risky positions taken, etc., are all good reasons not to take on a client, regardless of how big the account is. When things inevitably go wrong, the advisor is always the first to get sued.

We take our portfolio management and advisory services very seriously, primarily focusing on preserving wealth through a disciplined and conservative process. Therefore, we work to ensure that clients and prospects align with that philosophy to minimize the risk of something going wrong, as in Christopher’s case.

The Bottom Line

This case is a sobering reminder of how greed, unchecked by rational decision-making and proper risk management, can turn a once-in-a-lifetime financial windfall into a crushing loss. As investors, it’s crucial to understand that market gains are never guaranteed and that the risks of overexposure can be devastating.

If you are in a similar situation, riding the wave of massive market gains, ask yourself: Is now the time to take some chips off the table? Are your investments aligned with your long-term goals and risk tolerance?

At RIA Advisors, we specialize in helping investors navigate these complex decisions with sound financial planning and proven risk management strategies. Don’t wait until it’s too late—schedule an appointment with one of our experienced advisors today. Together, we can help you protect and grow your wealth responsibly.


That’s it for today! If you’re looking for more insights like these, subscribe to our newsletter for regular updates on market trends and investing strategies..

The Economic Surprise Index Helps Explain Higher Yields

The Fed cut rates on September 18th and many expect them to follow through with more rate cuts in the coming meetings. Yet bond yields have steadily risen. Why is this occurring? While there are many answers, it boils down to two primary reasons. As we will explain, the Citi Economic Surprise Index is rising. Furthermore, as we noted on numerous occasions leading to the FOMC meeting, bond prices were very overbought.

The Citi Economic Surprise Index measures whether economic data performs better or worse than Wall Street estimates. When the index rises, economic data performs better than expected; conversely, when it falls, it is worse than expected. The graph below charts the Citi Economic Surprise Index. Moreover, to show how it relates to bond yields, we also show how ten-year UST yields changed when the index troughed and rose. The last three cycles from trough to peak saw yields rise between 11bps and 41bps. Currently, yields are up 26bps, which is about the average for this recent history. It’s worth adding that the two surges in yields were occurring as the Fed aggressively raised rates and inflation started soaring. Therefore, there were many factors, not just the Citi index, driving yields higher.

Bond prices are now oversold. Once the Citi Economic Surprise Index peaks and starts to reverse, bond yields will likely resume their trend lower. The most recent yield change on the graph is to date, not peak, as there is no indication the Citi index has peaked yet.

Regarding the technical situation leading to the FOMC meeting, we share a sentence from our Daily Commentary, the day before the rate cut.

With the Fed meeting this week, the current setup suggests that even if the Fed cuts rates as expected, this could be a “buy the rumor, sell the news” setup for bonds.

citi economic surprise index and bond yields

What To Watch Today

Earnings

Earnings Calendar

Economy

Market Trading Update

As noted yesterday, the market broke out to the upside of the ascending wedge pattern, triggering a “seasonal MACD buy” signal.

“Notably, that buy signal marks the beginning of the seasonally strong 6 months of the year. The series of high lows, now combined with higher highs, remains a significant bullish backdrop for investors. With earnings season starting in earnest this coming week, the bias remains to the upside, but risk management protocols should not be abandoned.”

While the “buy signal” for the “seasonally strong period” has been triggered, it doesn’t mean there are no risks to be aware of. The chart below is a longer-term chart going back to 2007. It is worth noting the negative divergence in the Relative Strength Index (RSI) which does suggest some concerns. Historically, such negative divergences preceded corrective periods. However, given that this is weekly data, such corrections can be several months to a year away. Secondly, the deviation from the 5-year moving average and the weekly MACD signal are certainly elevated. The last time the MACD signal was as elevated as it is now and was flipping back and forth on “buy signals” was mid-2021. Of course, the market corrected by 20% in 2022. Lastly, with the market at the upper end of its trend channel from the 2009 lows, such suggests that outsized gains from here are unlikely.

Market Trading Update

The takeaway from this analysis is that in the short term, over the next two months, the market is very likely to be higher than it is currently. However, once we get into 2025, the risk of a modest correction of 10% or more will increase to relieve some extended market conditions.

While the “seasonal buy signal” is bullish, it does not mean that corrections cannot occur along the way. Trade accordingly.

Into The Presidential Election Home Stretch

Greg Valliere is a Washington insider with over 40 years of experience analyzing and assessing the political landscape. With only a few weeks until the election, we again share some of Greg’s daily snippets from his “Morning Bullets.”

  • WE WROTE LAST FRIDAY that Kamala Harris was stalling out, and we wouldn’t change a word. Her lead has evaporated, slowly, to an advantage nationwide of 2 or 3 points, while Donald Trump leads by nearly 20 electoral votes.  
  • LIKE IN BIG SPORTS GAMES, momentum is crucial and hard to predict in political campaigns. There’s usually 4 or 5 momentum swings, and this year will be no exception.
  • BOTTOM LINE: The race is a virtual tie.  There will be several state recounts. There will be numerous allegations of voter fraud.  In a race this close, there will be ties in several states. You want to know the outcome of the Nov. 5 election? Wait until December — or longer.

Safety Sectors Follow Bonds

Since the FOMC rate cut in mid-September, bond yields have risen consistently. As a result, four of the more conservative stock sectors, also among the highest dividend-yielding sectors, have underperformed the market. The logic appears to be that the Fed may only cut a few more times as the economy remains robust and the labor market is not showing signs of significant weakening.

As our SimpleVisor relative analysis below shows, staples are the sector that is most oversold on a relative basis. Healthcare and real estate have similar oversold scores. Utilities, also a conservative sector with higher dividends, have been bolstered by the surging demand for more electricity due to the massive expansion of AI data centers. However, utilities have gone from the most overbought sector to the middle of the pack over the last few weeks.

It’s also worth noting that the absolute scores on technology, industrials, and financials are overbought on an absolute basis. This should not be surprising, given the market as a whole is technically overbought. Going into the election, sector rotation will likely be a function of the changing odds of which party will win the presidential campaign and the House and Senate.

simplevisor relative analysis staples

Tweet of the Day

equity exposure

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

JP Morgan And Wells Fargo Kick Off Earnings Season

JP Morgan and Wells Fargo kicked off the third-quarter earnings season on Friday. JP Morgan handily beat expectations for EPS and revenue. Furthermore, its charge-offs were slightly below expectations as credit quality remains solid. However, they increased their credit loss provision, as shown in the graph courtesy of ZeroHedge below. Such tells us they think credit losses will increase going forward. Further, CEO Jamie Dimon provided a cautious economic outlook as follows:

We have been closely monitoring the geopolitical situation for some time, and recent events show that conditions are treacherous and
getting worse. There is significant human suffering, and the outcome of these situations could have far-reaching effects on both short-term economic outcomes and more importantly on the course of history. Additionally, while inflation is slowing and the U.S. economy remains resilient, several critical issues remain, including large fiscal deficits, infrastructure needs, restructuring of trade and remilitarization of the world. While we hope for the best, these events and the prevailing uncertainty demonstrate why we must be
prepared for any environment.

Wells Fargo also beat expectations on earnings per share, but its EPS was lower than the same quarter last year. Its return on capital, another measure of profitability, also fell from last year. Investment banking fees helped drive earnings and offset a decline in lending revenue.

A steadier flow of earnings reports across various industries will start next week. While most are likely to beat reduced expectations, comments and projections from their executives will help shed more light on the state of the economy.

jp morgan loan loss reserve

What To Watch Today

Earnings

  • No notable earnings releases today.

Economy

Economic Calendar

Market Trading Update

On Friday, we discussed the recent selloff in bonds and why a decent trading setup is forming. However, an even more bullish setup is forming in the stock market. Last week’s newsletter noted that the “ascending wedge” pattern in the market developed from the August lows. To wit:

“An ascending triangle is forming on the daily charts, another bullish pattern that typically signals further upward movement. In this case, we’ve seen a series of higher lows in recent weeks, indicating buyers are stepping in earlier during each pullback. The flatter upper trendline from the previous to the recent all-time high indicates an ongoing increase in buying pressure.”

Market Trading Update

On Friday, the market broke out to the upside of that wedge pattern, triggering a “seasonal MACD buy” signal. Notably, that buy signal also marks the beginning of the seasonally strong 6 months of the year. The series of high lows, now combined with higher highs, remains a significant bullish backdrop for investors. With earnings season starting in earnest this coming week, the bias remains to the upside, but risk management protocols should not be abandoned.

Just because the seasonally strong period of the year has technically started, it doesn’t mean that the markets won’t have corrections along the way. The market is short-term overbought, so use the current rally to rebalance risk as needed, but pullbacks to support should be bought.

The Week Ahead

The Retail Sales report on Thursday will provide an update on consumer activity. The estimate is for a 0.2% gain, which points to no growth after adjusting for inflation. Four of the last five months have shown zero aggregate retail sales growth. The one outlier was July, which saw retail sales grow by 1%.

Fed speakers will be aplenty this week. With Bostic discussing the possibility that the Fed doesn’t cut at the next meeting, as discussed below, it will be informative to see if other Fed members are on the same page.

Earnings releases will pick up this week after JP Morgan and Wells Fargo reported on Friday. The larger companies reporting are UNH, PG, JNJ, BAC, NFLX, and AXP.

Bostic Opens The Door To No Rate Cut

Following the CPI data on Thursday, Atlanta Fed President Raphael Bostic was quoted as saying, “I am totally comfortable with skipping a meeting.” However, the data didn’t seem to change the mindset of other Fed members. To wit:

Month to month, there’s wiggles and bumps in the data, but we’ve seen this pretty steady process of inflation moving – John Williams New York Fed

He then said it was “appropriate” to continue bringing monetary policy to a more neutral stance. Autstan Goolsbee and Thomas Barkin agreed with Williams, leaving the market to assume that they, too, believe that rate cuts at the next two meetings and beyond are probable. While most other members lead us to think that two 25bps rate cuts are still on the table for this year, the market is starting to handicap the odds they do so at both meetings. As shown below, the market now assigns an 18% chance they do not cut at one of the two remaining meetings.

fed funds implied forecast

GDP Report Continues To Defy Recession Forecasts

The Bureau of Economic Analysis (BEA) recently released its second-quarter GDP report for 2024, showcasing a 2.96% growth rate. This number has sparked discussions among investors and analysts, particularly those predicting an imminent recession. There are certainly many supportive data points that have historically predicted recessionary downturns. The reversal of the yield curve inversion, the 6-month rate of change in the leading economic index, and most recently, consumer confidence warn of a recessionary onset.

READ MORE…

pce trends

Tweet of the Day

vix and market record highs

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

GDP Report Continues To Defy Recession Forecasts

The Bureau of Economic Analysis (BEA) recently released its second-quarter GDP report for 2024, showcasing a 2.96% growth rate. This number has sparked discussions among investors and analysts, particularly those predicting an imminent recession. There are certainly many supportive data points that have historically predicted recessionary downturns. The reversal of the yield curve inversion, the 6-month rate of change in the leading economic index, and most recently, consumer confidence warn of a recessionary onset.

Consumer confidence expectations vs current conditions

However, despite these warning signs, the U.S. economy continues to show resilience, defying many bearish forecasts. This article will explore the recent GDP report, the risks to continued growth, and potential investing opportunities.

Defying Recession Calls: The Resilient U.S. Economy

Numerous market analysts have warned of an impending recession since early 2023, citing several factors: rapid rate hikes by the Federal Reserve, high inflation, and growing geopolitical risks. Yet, the Q2-2024 GDP growth of 2.96% suggests the U.S. economy is holding up better than expected. That resilience is particularly evident in consumer spending, which remains strong despite persistent inflation and higher interest rates. Currently, Personal Consumption Expenditures (PCE), which comprises about 70% of the GDP report, continue to be well above the polynomial growth trend.

PCE Exponential and polynomial trends

Given PCE’s rather significant impact on the GDP report, a recession remains unlikely unless spending slows markedly.

GDP vs PCE

Several aspects of the GDP report highlight the economic strength that has caught many bearish forecasters off guard:

Furthermore, the labor market remains supportive of economic growth. Yes, as shown, employment growth has slowed substantially following the “re-hiring” surge after the pandemic-related shutdown. However, as demand in the economy normalizes, employment growth is returning to its long-term growth trend. The chart below shows the 3-month average growth rate of hiring. As noted, employment growth has slowed but remains in growth mode. Until that 3-month average approaches zero job growth, the risk of a recession remains muted.

Employment 3-month average growth rate

Lastly, business investment, another contributing factor to the GDP calculation, doesn’t support the recessionary expectations. Although business investment has been somewhat uneven and certainly weaker following the post-pandemic surge, there are signs that companies are still expanding. At nearly 5% annualized, private investment is not near levels normally associated with an economic recession.

Private investment annual percent change

These elements, all part of the last GDP report, suggest that predictions of an impending recession may have been overly pessimistic, at least for now. We will continue to monitor this data, and when it begins to approach levels normally associated with recessionary outcomes, we will warn our readers accordingly.

However, the implications for the stock and bond markets are clear for now.

RIA Advisors advertisement for investment management services

Market Reactions: Why Investors Are Optimistic

Unsurprisingly, financial markets reacted positively to the latest GDP report, viewing it as evidence that the economy has avoided a recession from a period of elevated interest rates. That optimism has been particularly evident in the stock market, where equities have climbed on the back of positive consumer data.

A notable example is the recent surge in economically sensitive sectors of the market. As noted recently by Sentiment Trader:

“When 90% of cyclical sub-industry groups close above their respective 10, 20, 50, 100, and 200-day moving averages for the first time in six months, and the S&P 500 is within 2% of a five-year high, the world’s most benchmarked index displayed solid returns and consistency across all time horizons. Over the following three months, the S&P 500 advanced 81% of the time, achieving 13 consecutive gains since 1992.”

Most notably, growth-oriented sectors outperformed the S&P 500 over the subsequent year.

Sector performance about broad market surge

Unsurprisingly, as the risk of recession remains low, growth stocks have outperformed high-dividend “defensive” stocks. This is because economic growth provides support for earnings growth. Over the last year, analysts have continued pushing estimates higher into 2025, favoring stocks dependent on faster earnings growth rates.

Forward earnings vs the market

Since investors are willing to “pay up” for future earnings, valuations have risen sharply.

Valuations based on forward operating and reported EPS

As we discussed recently, the overall stock market is trading on optimism the Federal Reserve will continue to cut rates. With inflation coming down and growth remaining positive, many investors are betting on a scenario where the economy avoids a recession entirely. This “soft landing” narrative has propelled the S&P 500 and other indices despite many recessionary concerns.

Ad for SimpleVisor. Don't invest alone. Tap into the power of SimpleVisor. Click to sign up now.

Risks to Continued Economic Growth

Despite the Fed’s intervention, several risks to economic growth remain. The Q2 GDP report, while positive, revealed certain vulnerabilities that could threaten future growth, even with lower rates.

1. Weakened Business Investment

Business investment has slowed in recent reports, and as noted above, is a direct input into the GDP report. While lower borrowing costs will encourage some companies to expand, sectors like manufacturing and construction remain constrained by global supply chain issues and external demand. Additionally, as noted in the NFIB Small Business report, businesses may become more reluctant to invest significantly if the economy slows further or the upcoming election outcome suggests higher taxes and more regulations are forthcoming.

CapEX vs Real GDP

2. Housing Market Still Under Pressure

The housing market, one of the most interest-sensitive sectors, has been battered by high mortgage rates. The Fed’s rate cut will provide some relief, but it may not be enough to fully revive housing demand. With mortgage rates still elevated by historical standards and home prices high, affordability remains an issue for many potential buyers. Therefore, while we may see a slight pickup in housing activity, the overall impact of the rate cut on the housing market could be limited.

3. Consumer Spending Could Slow

Although consumer spending remained strong in Q2, higher consumer debt levels—particularly credit card debt—are an increasing concern. While lower interest rates will ease the burden for some borrowers, the overall level of consumer debt remains high. As the labor market cools and wage growth moderates, consumer spending could slow in the coming quarters, especially if inflation continues to pinch household budgets. Notably, PCE as a percentage of GDP has remained relatively stagnant since 2010 despite a significant surge in household debt levels.

PCE as percentage of GDP vs household debt

Conclusion

I don’t disagree there are many reasons to be concerned about the economy currently. The Government is clearly spending like a “drunken sailor” on pet projects that don’t produce long-term economic prosperity. Geopolitical risks remain along with upcoming election risks that could significantly change the landscape for taxes and regulations.

However, while it is easy to focus on those risks as a reason “not to invest,” the Q2 GDP report continues to provide evidence that undermines many of the “doom and gloom” predictions for the U.S. economy.

At least for now.

Will that eventually change? Absolutely. There will be a recession at some point in the future, whether in six months or three years. However, if we focus on sectors and asset classes that can perform well in both slow-growth and inflationary environments, investors can navigate the current landscape and capitalize on opportunities, even as some analysts continue to warn of recession risks.

Importantly, when a recession approaches, the market has a long history of letting investors know.


Sources:

  1. Bureau of Economic Analysis (BEA) – Q2 2024 GDP Report
  2. Federal Reserve Economic Data (FRED)
  3. U.S. Treasury – Bond Yield Data

Hawkish Dovish Monetary Policy: The Feds Unusual Stance

The graph below, courtesy of Bloomberg, shows their Intelligence data rates the latest Fed meeting minutes as the most hawkish since April. Qualifying the minutes as hawkish is pretty ironic, considering the Fed’s 50bps rate cut three weeks ago was the most dovish action they have taken in a few years.

Is it possible for the dovish Fed to be hawkish simultaneously? Based on the recent FOMC minutes, pushback appears to be against cutting rates by 50bps. While all but one Fed member voted for the increase, many hesitated. Accordingly, in getting the first cut of 50bps, Powell may have given leverage to others arguing for a slower, wait-and-see approach. The following quotes from the minutes show the hawkish and dovish views on the board.

Some participants emphasized that reducing policy restraint too late or too little could risk unduly weakening economic activity and employment.

Several participants remarked that reducing policy restraint too soon or too much could risk a stalling or a reversal of the progress on inflation.

Some participants noted that uncertainties concerning the level of the longer-term neutral rate of interest complicated the assessment of the degree of restrictiveness of policy and, in their view, made it appropriate to reduce policy restraint gradually

Given the co-existence of hawkish and dovish views, we should prepare for more stock and bond market volatility around economic data and Fed speeches.

Fed hawkish or dovish indicator

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

Yesterday, we discussed how the market remains contained in a bullish rising wedge pattern, which remains the case heading into this morning’s trade. However, the once notable move yesterday was in bonds following the latest CPI report. Several weeks ago, we noted that investors should NOT buy bonds given their extreme overbought condition heading into the September Fed meeting. Since that meeting, the reversal has sent bonds into extreme oversold conditions.

As shown, bonds are trading well into 3-standard deviations in oversold territory, and their relative strength and momentum are becoming very negative. As noted by the vertical lines, previous similar conditions have provided decent bond trading opportunities. Once election uncertainty is behind us, such may well be the case heading into year-end. There is still additional downside risk to bonds between now and the end of the month. However, most of the selling is likely complete.

From a trading perspective, there is a decent opportunity for adding bonds to portfolios. If you are a long-term holder of bonds, with rates back to 4% on a 10-year paper, the opportunity to add bonds to portfolios is also compelling.

Bond trading update

CPI

The BLS CPI report was a little hotter than expected, with the monthly and annual headline and core numbers coming in at a tenth of a percent higher than expected. However, the year-over-year rate is down to 2.4%, which aligns with pre-pandemic inflation rates, as shown below.

Transportation (auto insurance) and health care drove the rate higher. Moreover, rents remain firm despite real-world evidence that they are flat to declining. However, an alternate measure of underlying core inflation, services less rent, healthcare, and transportation, showed zero monthly inflation. The CPI number has something for the inflation bulls and bears.

Our take: Inflation continues to decline, and while the month-to-month numbers do not show a perfect trend lower, the macroeconomic dynamics impacting inflation will likely keep inflation near current rates or lower. If the economy slows, inflation is likely to follow.

The Tweet of the Day below shows that despite the higher-than-expected CPI, the Core PCE inflation data, the Fed’s preferred inflation measure, will likely come in at 0.2%.

Hurricanes Helene and Milton may result in volatility in CPI and other economic data over the next few months.

annual CPI

Jobless Claims

Despite the higher CPI data, the bond market had a muted reaction. It may have been because the BLS Jobless Claims data was higher than expected. The number of initial claims was 258k versus 225k last week, and the expectations were that it would rise by 5k to 230k. Measuring jobless claims this week and for the next couple of months will be complicated by the hurricanes. That said, the graph below shows that the South Atlantic region, including the areas hardest hit by Hurricane Helene, only saw a 15k increase in jobless claims. That number will likely increase over time. However, excluding the 15k, the number of initial claims was still about 18k more than last week.

Jobless claims can be whippy, so don’t read much into the increase, but as always, keep an eye to see if the number, excluding the hurricane impacts, continues higher.

jobless claims south atlantic region

Tweet of the Day

cpi and pce

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

The VIX Is Rising With The Market: Should We Care?

The VIX volatility index spiked on the August 5th yen carry trade sell-off and has not recovered to prior lows. Since then, it has risen steadily alongside the S&P 500. Often, the VIX declines or resides at low levels when the S&P 500 is increasing and vice versa. Might the irregular VIX/S&P 500 relationship be a warning of pending trouble? To better appreciate the volatility market, we share two other measures of volatility derived from the options markets.

The graph on the bottom left is the CBOE Skew Index. Instead of computing volatility using in-the-money options like the VIX, the Skew Index uses the prices of out-of-money, at-the-money, and in-the-money options to assess the differences in volatility. A higher skew reading means the market is assigning greater tail risk. Currently, the Skew Index assigns a greater than 15% chance of a two standard deviation move in the next thirty days. When the index is 100, the odds are only 2.30%. Despite the Skew and VIX warnings, the Put-Call Ratio shows little concern. This ratio measures put volume divided by call volume. A higher ratio indicates that bearish traders are adding protective puts more aggressively than bullish traders are buying speculative calls. That is currently not the case.

Concern is warranted with the upcoming election and decent odds of it being contested. Furthermore, there is the risk that Israel will attack Iranian oil facilities, resulting in an oil spike. Lastly, the equity markets are extended technically and fundamentally, making a correction possible. The market has ample reasons to worry and hedge its concerns. The VIX and Skew confirm that. Trade with caution!

We are writing an in-depth article on VIX and other volatility measures that will be released next week.

vix volatility

What To Watch Today

Earnings

Earnings Calendar

Economy

Economic Calendar

Market Trading Update

In yesterday’s update, we discussed the rise in the volatility index as it relates to the market, which suggests some caution in the near term. However, the market rallied again yesterday in anticipation of this morning’s inflation report. As with the employment report, all eyes are focused on an outcome that suggests the Fed can continue to cut interest rates. Therefore, an inline reading of 0.2% inflation growth (2.4% annualized) would be preferred. However, there is a risk to the upside, but weaker oil prices during the data collection period will likely tame this month’s report. That outcome seems to be anticipated by the market.

As shown, the market is pushing up against the top of the current rising wedge. If the market breaks to the upside today, such will also trigger a MACD “buy signal,” giving the markets some running room over the next week. However, the upside will likely be contained with the markets pushing overbought conditions. The good news, however, is that downside risk is also limited to the rising trendline and the 20-DMA for now.

Market Trading Update

With portfolios nearly fully weighted to equity exposure, there is little action to take. However, we continue to rebalance risk and allocations as needed.

What’s Next For Treasury Yields

Based on the current inflation rate and its expected downward trajectory, Treasury yields should be lower than they are. However, investors are still scarred by the recent bout of high inflation. Accordingly, they may not believe inflation will continue to decline.

We graph the ten-year UST yield and its 200-day moving average below to appreciate better where yields might be going. The circles highlight how each significant change in the yield trend over the last ten years coincided with a breaking of the 200-day moving average. While new, the recent trend lower appears to have ample room to continue. But, recently, yields are heading up toward the 200-day moving average. If the yield nears the moving average, bounces off it, and proceeds lower, that is bullish, with lower yields likely. However, some caution is warranted. A sizeable break above the moving average may signal higher yields to come.

Bear in mind that the moving average is far from perfect. As we saw in 2017, the yield could decidedly break through the moving average for a brief period. Such a head fake is possible today if the inflation rate stops declining and the economy remains robust. In such a case, the Fed may stop its easing campaign, and yields could head upward.

We think the moving average should hold as inflation is not showing signs of heating up. The latest CPI report will tell us more today.

10 year UST yield

Analyzing Agency REITs

Numerous reader requests following our article, Agency REITs For A Bull Steepener, prompted us to write this follow-up with more detail about how to analyze agency REITs. This article doesn’t recommend specific agency REITs, but it does lay out some of the fundamental basics of the largest publicly traded agency REITs. In doing so, this analysis and the prior article provide a solid foundation for further evaluating agency REITs.

READ MORE…

agency REIT profiles

Tweet of the Day

nfib uncertainty index

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Chinese Pavlov Traders Are Hungry For Stimulus

Chinese stocks (CSI 300) opened Tuesday morning following their week-long Golden Week holiday, with a massive 11% pop higher. However, shortly after opening, the index gave up half of the surge as China’s economic planning agency did not offer additional economic, monetary, or financial stimulus. As shown below, Chinese stocks have been soaring since mid-September due to lower interest rates, new QE, economic stimulus, and measures allowing banks to buy equities more easily. Before Tuesday’s trading, the CSI 300 was up nearly 50% on the stimulus measures in just a few weeks. But the index gave up a third of its recent gains without new stimulus. (The ETF in the graph traded all week despite the holiday; therefore, its daily performance is slightly different than the CSI Index.)

As we also see in the U.S. and other developed markets, volatility ensues when stimulus is repeatedly used to soothe markets and jump-start economic activity. Investors, like Paavolov’s dogs, develop a taste for stimulus. Any shortfall versus their expectation, even if minimal, can rapidly erase gains on prior stimulus. Consequently, when used repeatedly and for non-crisis reasons, stimulus adds market volatility. As we have seen with Chinese equities, volatility can often accompany strong returns, but as we learned on Tuesday, failing to provide enough of what the market wants can push markets lower violently.

As the Fed embarks on a series of rate cuts, the U.S. and global market will build in expectations. Failure to meet said expectations can result in sharp downdrafts. Conversely, meeting or bettering expectations can cause markets to soar. Stimulus-driven markets detract investors from fundamentals and instead force their focus on government actions. While the government and investors benefit from the short-term effects, the long-term result is weaker economic growth, rich stock valuations, and unproductive low bond yields.

mchi china csi 300 etf

What To Watch Today

Earnings

  • No notable earnings releases today.

Economy

Economic calendar

Market Trading Update

In yesterday’s commentary, we discussed how bonds are approaching a more deeply oversold basis as we head into the upcoming auctions. I have been getting a lot of emails on TLT in particular, so read that commentary if you have any questions.

Today, I want to return our focus to the market’s ongoing consolidation. As discussed in “Technical Takes On The Market,” the market continues to act bullishly. To wit:

“An ascending triangle is forming on the daily charts, another bullish pattern that typically signals further upward movement. In this case, we’ve seen a series of higher lows in recent weeks, indicating buyers are stepping in earlier during each pullback. The flatter upper trendline from the previous to the recent all-time high indicates an ongoing increase in buying pressure.”

The market continues to trade off support, retesting the 20-DMA yesterday but failing to make any progress higher. The market’s “consolidation” above support is bullish, as the previous overbought condition is reversed. However, the one concern that both Michael Lebowitz and I have discussed recently is the consolidation of the market, which is occurring with volatility rising. As shown, when such an environment has occurred, it has either been coincident with or a precursor to a correction. Could this time be different? Sure. However, history is an important guide to outcomes, and the current setup suggests there is a higher degree of risk than not.

Trade accordingly.

 Market Trading Update

Hurricane Milton And The Broken Window Theory

With hurricane Helene causing massive destruction and Milton likely to do the same, many pundits will declare these catastrophes as beneficial to the economy. Their simple logic is that significant spending is needed to rebuild. They are not wrong from a short-term point of view. Inevitably, both hurricanes will boost GDP. However, as nineteenth-century economist Frederic Bastiat pointed out, there is also an unseen negative effect. Consider Bastiat’s logic when seeing inflated economic activity in the next few quarters. The following summary of his theory comes from our article, Tales of Cobras, Windows, and Economic Promise.

Nineteenth-century French economist Frederic Bastiat has a well-known theory about unintended consequences. He uses a parable to explain that which is seen and what is not seen. His lesson starts with a stone that shatters a shopkeeper’s window. Most noticeable to the town’s people is the economic benefit of the broken window. In their minds, the shopkeeper must buy a window and employ a glazier to install it. As an aside, many economists peddle similar logic in the aftermath of natural disasters.

Bastiat’s brilliance is pointing out the not so obvious opportunity cost of the broken window. In this case, after paying to fix the window, the shopkeeper has less money to spend elsewhere. The shopkeeper could have bought new equipment making his shop more productive and profitable. The benefits of which would have had a positive impact on the shopkeeper’s wealth but also the economy and the populace.

Instead, replacing the window is at best a neutral economic event. There is undoubtedly no net economic gain, but there is an opportunity cost. Financial and material resources were used in a non-productive manner.

hurricanes boost the economy

How Howard Marks Thinks About Risk… And You Should Too

One of the biggest takeaways from Marks’ series is the idea that risk and volatility aren’t the same thing. For years, many investors (and academics) have been taught that volatility—the ups and downs of stock prices—equals risk. However, Marks argues that this is a big misunderstanding.

Volatility is one part of the picture, but risk is the probability of losing money. Just because prices bounce around doesn’t mean you’re at risk of a big loss. Investors should focus on managing their downside, not just trying to avoid every little price swing.

READ MORE…

risk management rules to follow

Tweet of the Day

chinese stocks csi 300 index

“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.


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

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

Analyzing Agency REITs

Numerous reader requests following our article, Agency REITs For A Bull Steepener, prompted us to write this follow-up with more detail about how to analyze agency REITs. This article doesn’t recommend specific agency REITs, but it does lay out some of the fundamental basics of the largest publicly traded agency REITs. In doing so, this analysis and the prior article provide a solid foundation for further evaluating agency REITs.

Before diving in, it’s worth noting that most agency REITs offer preferred shares. While we do not discuss them in this article, preferred shares may also prove rewarding and less risky in the current bull-steepening interest rate environment. 

(Disclosure: RIA Advisors has a position in NLY and REM in its client portfolios.)

Managing A REIT

An agency REIT is only as good as its portfolio management team. As we wrote in Agency REITs For A Bull Steepener, the portfolio management team has to buy rewarding assets and issue appropriate liabilities to fund the investments, but it must also constantly hedge the portfolio for interest rate and mortgage spread risk. Furthermore, they actively trade derivatives to transform the terms and conditions of their liabilities.

Due to the leverage employed by the agency REITs, a firm making poor hedging decisions could be forced to sell assets or issue liabilities at inopportune times. Poor management can result in reduced or missed dividend payments. 

Conversely, the costs of over-hedging can eat dearly into the REITs profits, resulting in minimal dividends. Finding the right balance between assets, liabilities, and hedges is a tall task. The portfolio manager’s skills in managing the portfolio can make a big difference in returns when comparing REITs.

We cannot quantify portfolio management skill levels, but we share information on each REIT to help you better understand some differences between the largest agency REITs.

Ad for financial planning services. Need a plan to protect your hard earned savings from the next bear market? Click to schedule your consultation today.

Evaluating Agency REITs

Due to the unique agency REIT business model, evaluation requires tools different from those commonly used for stocks. Agency REIT investors prefer metrics like price to book value, leverage, interest rate spreads, dividend reliability, and value at risk. Earnings, sales, and traditional margin and valuation calculations are not as helpful.

The following table shares information on the top publicly traded agency REITs. Further sections below focus on three factors that help determine risk and investor returns. The tables in those sections show the latest respective data, the ten-year ranges, and the size of the ranges to provide better context for the current figures.

top agency REITs

Price To Book Value

The price to book value tells investors how much portfolio value or equity (assets minus liabilities) they own per share. The ratio varies due to the whims of investors. Investors should prefer a price-to-book value ratio below 1.0 as they essentially buy the portfolio for less than 100% of its value. However, a price-to-book value ratio well below 1.0 may indicate trouble.

Due to the volatile nature of agency REIT assets, liabilities, and hedges, the book value is in constant motion. Unfortunately, most agency REITs only report the book value quarterly. Accordingly, caution is warranted because the book value is always stale, while price changes are current. In other words, there are only four days a year when the price-to-book value ratio is correct. There are ways to estimate book value to help overcome this problem.

Agency REITs are incentivized to grow as a larger portfolio creates more income for the company executives and the portfolio management team. Growing entails issuing more equity.

Agency REITs often offer new shares to the market when the price-to-book value is above 1.0. Doing so allows them to raise more money per share than the net portfolio value. New issuance often causes the stock price to decline toward a price-to-book ratio of 1.0. When the price-to-book ratio is below 1.0, issuing shares is not as economically beneficial to the REIT; however, it adds value to existing shareholders.

The table below shows the latest price-to-book value of the eight largest publicly traded agency REITs. In most cases, these are about three months old. Since bond yields fell over the last few months and the spread of mortgages to liabilities tightened, the portfolio values are likely higher than last reported. That said, many share prices of the stocks also increased in value.

price to book value
Ad for The Bull/Bear Report by SimpleVisor. The most important things you need to know about the markets. Click to subscribe.

Leverage

To better appreciate the importance of leverage, we share the following simplified summary of the creation of an agency REIT. It is from Agency REITs For A Bull Steepener.

Hypothetically, let’s start a new agency REIT to help you appreciate how they operate.

  • We solicit $1 billion from equity investors.
  • A significant portion of the $1 billion is used to buy mortgage-backed securities (MBS).
  • We then borrow $4 billion from a bank using the $1 billion of MBS as collateral.
  • The proceeds from the $4 billion loan are also used to purchase MBS.
  • Our new REIT has about $5 billion of MBS against $1 billion of equity and $4 billion of debt.
  • As a result, the REIT has 5x leverage.

The amount of leverage is an essential gauge of risk. If, in the example above, the REIT borrowed $50 billion with only $1 billion of equity, resulting in 50x leverage. A 2% adverse move in the portfolio would wipe out the entire equity value. Conversely, 5x leverage takes a 20% loss before equity holders are wiped out.

Not only is the amount of leverage essential to track, but how and when the leverage changes can help us gauge the portfolio manager’s stance toward present risks. Also of equal importance to those gauging risk is the hedging activity. Specifically, how is the portfolio management team using derivatives to transform liabilities and manage risk?

Solid hedging skills can partially offset the risks of high leverage. Conversely, a REIT may have low leverage but still poses high risk due to poor hedges.

leverage agency REITs

Dividend Reliability

Given the outsized dividend yields on agency REITs, the reliability of the REIT’s dividend is important. Like other key metrics, we should compare the current dividend to its historical range to appreciate how it can potentially change in favorable or adverse environments.

dviidend reliability

An Agency REIT Alternative

If you are uncomfortable picking specific agency REITs, we recommend diversifying among many to reduce idiosyncratic portfolio risks.

One way is via the iShares Mortgage Real ETF (REM). The ETF’s two largest holdings, accounting for over 25%, are NLY and AGNC. Bear in mind some of its holdings are not agency REITs. Accordingly, they may contain assets that the government does not guarantee.

REM ETF holdings
Ad for SimpleVisor. Get the latest trades, analysis, and insights from the RIA SimpleVisor team. Click to sign up now.

Summary

Without a background in managing a portfolio of mortgages, analyzing agency REITs can be challenging. However, putting in more homework than is typical for a stock investment can provide investors with returns often uncorrelated with the broader market, thus offering a unique form of diversification. If you decide to research agency REITs, we highly recommend you read their quarterly and annual reports, which are incredibly detailed and insightful.

Agency REITs are not for buy-and-hold investors. They tend to perform well in specific economic and interest rate environments and poorly in others. We believe the current bullish steepening shift in the yield curve could offer investors opportunities with the agency REIT sector. However, we stress REIT portfolios can gain value while its shares lose value.